Fitch Ratings affirms Romania at ‘BBB-‘, outlook stable

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Fitch Ratings has affirmed Romania’s Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at ‘BBB-‘. The Outlooks are Stable.

Romania’s investment-grade rating is supported by moderate levels of public debt, and GDP per capita and governance indicators that are in line with ‘BBB’ range medians. However, pro-cyclical fiscal loosening and a rapid increase in wages in excess of productivity growth pose risks to macroeconomic stability, a release posted on Fitch website reads.

Expansionary fiscal policy has weakened Romania’s public finances. Fitch estimates the general government budget deficit was 3% of GDP in 2017, unchanged from 2016, but worse than a 0.8% deficit in 2015. The Maastricht budget deficit threshold of 3% is an important policy anchor for the government. However, fiscal performance in 2017 was flattered by very strong economic growth, which the agency does not believe can be sustained. The budget target was only achieved by implementing half of planned capital spending. Tax cuts have decreased Romania’s revenue-to-GDP ratio to one of the lowest in the region, while step increases in minimum wages, public sector salaries and pensions have raised underlying expenditure.

For 2018, Romania targets a headline fiscal deficit (ESA 2010) of 2.96% of GDP. In Fitch’s view, optimistic projections for economic growth and revenue, and lack of impact assessment on discretionary expenditure measures, means the agency forecasts a wider deficit of 3.4% of GDP. Fiscal pressures will come from additional tax cuts and increases to wages and pensions. A cut in personal income tax (PIT) to 10% from 16% is forecast to reduce revenue by 1.5% of GDP, which the authorities plan to offset with changes in its VAT payment system and the transfer of social security contribution payments from employers to employees. Higher expenditure will also be driven by increased absorption of EU funds. However, pressure to meet its fiscal target has historically caused the government to fall short on its capital expenditure plans.

Romania’s structural fiscal deficit, according to the European Commission, is estimated to have reached 3.3% of GDP in 2017, widening 3pps in two years. The 2018 budget will result in further deterioration, contrary to national and EU fiscal rules, leaving Romania at risk of re-entering the EU Excessive Deficit Procedure, having only exited it in 2013.

Romania’s debt/GDP ratio increased to 38% end-2017 from 37.6% in 2016 under Fitch’s estimates, although it remains below the ‘BBB’ range median of 40.9%. Upcoming debt repayments are moderate, at 4.6% and 4.3% of GDP in 2018 and 2019, respectively. In addition, the government holds an adequate FX cash buffer covering 3.8 months of gross financing needs (end-2017).

Economic growth is estimated by Fitch to have accelerated to 6.8% in 2017, the fastest in the EU, from 4.8% in 2016. As the magnitude of fiscal stimulus fades, an economic slowdown is projected for 2018-2019, with Fitch forecasting average real GDP of 3.6%. Rising inflation will see a lower contribution from household consumption, but a recovery in fixed capital formation will keep GDP driven by domestic demand, while the contribution from net exports is forecast to remain negative.

At its January 2018 meeting, the National Bank of Romania (NBR) increased its key monetary policy rate to 2% from 1.75% where they had been since May 2015. The rate hike follows two months of higher-than-expected inflation in October and November 2017, when inflation moved within the upper bound of NBR’s 2.5% +/- 1 percentage point target, increasing to 2.6% and 3.2%, respectively, from 0.1% back in January 2017. Fading base effects (from tax cuts), increasing demand pressures, and higher global commodity prices will keep inflation in the upper range of NBR’s target. Fitch forecasts average inflation of 3% in 2018, anticipating further rate hikes this year.

Romania’s external finances are weaker than ‘BBB’ rated peers. Pro-cyclical fiscal policy has led to a widening of the current account deficit (CAD) to an estimated 2.8% of GDP in 2017 from 2.3% in 2016. For 2018-2019, Fitch is projecting an average CAD of 3.4%. This compares with a median CAD of 1% across ‘BBB’ rated peers. Export growth has been positive, but external competiveness has weakened due to rising unit labour costs. A widening of the CAD risks stalling the decline in Romania’s net external debt position, which at an estimated 18.8% of GDP for 2017 remains above the majority of ‘BBB’ rated peers.

Banks are well-capitalised with a sector capital adequacy ratio of 19% in 3Q17 and are sufficiently funded by local deposits. Banks’ balance sheets have improved with non-performing loans declining to 7.96% in 3Q17 from 9.62% end-2016.

Uncertainty surrounding judicial reform remains a risk to Romania’s governance indicators, which currently stand in line with the ‘BBB’ peer median. The Senate’s approval in December 2017 of bills containing amendments weakening judicial independence triggered public protests and criticism from EU member states. Controversial proposals to change the criminal code, including pardoning certain crimes of those abusing powers in office, are still on the agenda of the ruling PSD-ALDE coalition, the release concludes.


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