Fitch says Romania’s loose fiscal policy to continue under new PM, warns on growing imbalances

Romania’s expansionary fiscal policy looks set to continue following last month’s change of prime minister and this will increase macro-economic imbalances, Fitch Ratings says. A sizeable structural budget deficit leaves the public finances more vulnerable to shocks.

Parliament approved Viorica Dancila as Prime Minister on 29 January, after the resignation of Mihai Tudose earlier in the month following disagreements within the Social Democrat Party (PSD), part of the governing PSD-ALDE coalition. Dancila’s appointment is the second change of prime minster in seven months, FitchRatings.com informs.

Dancila’s cabinet has presented its governing programme, which includes proposals for further tax cuts and increases to minimum wages and pensions. These include increasing the minimum monthly wage by a net RON100 a year until 2020, annual increases to public sector pensions, tax waivers for doctors from 2019 and eliminating tax on dividends. The programme also resurrects a proposal for an additional 1pp cut in VAT from January 2019, which had been suspended under the previous prime minister to meet fiscal targets. These measures have yet to be legislated for.

Pro-cyclical fiscal policy has boosted growth but increased the risk of the economy overheating. A strong fiscal impulse contributed to robust consumption-driven growth of close to 7% in 2017 – the highest in the EU. With the economy operating above capacity, further fiscal easing risks increasing macroeconomic imbalances, potentially increasing inflationary pressures, weakening competiveness and widening the current account deficit, which we project to average 3.4% of GDP in 2018-2019, from 2.3% in 2016.

The National Bank of Romania raised its key policy rate by 25bp on 7 February to 2.5% after a 25bp increase in January. Inflationary pressures are developing faster than the NBR expected and we forecast at least a further 50bp of increases this year as inflation remains around the upper end of the NBR’s target range.

Dancila’s swift appointment avoided the immediate prospect of early elections, but has not eliminated political tensions, with public discontent at the government’s judicial reform plans and with next year’s presidential elections approaching.

Against this backdrop, the government may be inclined to keep fiscal policy loose, although Romania targets budget deficits below the Maastricht ceiling of 3% of GDP over the next few years, and this remains an important policy anchor. This was evident in 2017, when the government cut capital expenditure to hit the target. However, with no proposal for new taxes in the governing programme and existing revenue-raising measures dependent on improving tax compliance (successive tax cuts have decreased Romania’s tax-to-GDP ratio to one of the lowest in the EU), risks of fiscal slippage have risen, Fitch Ratings further informs.

Our baseline GDP forecast, which projects a slowdown in household consumption and tighter monetary policy bringing growth rates down to 3.8% this year and 3.3% in 2019, would see a negative impact on government revenue. Fitch’s forecasts are lower than the government’s and this partly explains why we think fiscal deficits for 2018 and 2019 will exceed the Maastricht limit, rising to 3.4% and then 3.6% of GDP, respectively.

Fitch affirmed Romania’s ‘BBB-‘/Stable sovereign rating on 12 January.