Poverty, deficit expected to rise in Romania, WB report says

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The protracted COVID-19 pandemic has seriously affected Romania’s economic activity and household incomes in the short-run, says the World Bank’s Human Capital Index. “A proactive but constrained fiscal response supported firms to retain employees and fed into household incomes. The economy is expected to shrink by 5.7 percent in 2020, on the back of a slow recovery of manufacturing and a poor agricultural year. Poverty is anticipated to increase, as the impacts of COVID-19 affect domestic income sources, and lead to contractions in remittances, while drought affects farmers,” the report mentions for Romania.

The economy contracted by 4.7 percent in H1 of 2020, driven by a decline of 10.5 percent in Q2. On the demand side, exports of goods and services fell by 15.1 percent in H1 of 2020, as European trading partners were significantly affected by the crisis. Imports contracted less than exports (down 9.4 percent), leading to a 21 percent increase in the trade deficit in H1. The weakening of external demand from Europe alongside pandemic related restrictions caused industry to contract by 14.1 percent in H1. Turnover in trade and services decreased by 17 percent in H1, but high-frequency indicators point to a relatively quick rebound.

The sharp decline in output led to deteriorating labor market conditions, with deeper effects noted for younger workers and women: job vacancies fell between Q1 and Q2 2020 while the unemployment rate increased to 5.4 percent in July from 4.1 percent in February. Job and household income losses were stemmed by the technical unemployment relief program, which covered 1.3 million beneficiaries during the state of emergency at a cost of approximately Euro 370 million (0.2 percent of GDP). Rapid household assessments of COVID-19 impacts show a substantial rise in the share of the population at risk of poverty in April 2020, as income generating opportunities for the working poor and near-poor declined and nearly a third of households reported income drops. As temporarily
inactive workers returned to employment between April and July, the share of households reporting lower incomes relative to the pre-COVID-19 period has declined to just under 20 percent, with income impacts being felt across better and worse-off households.

The fiscal deficit widened to 4.2 percent of GDP in H1 of 2020 reflecting lower revenues and higher expenditures due to COVID-19. Pro-cyclical fiscal policies since 2016 limited the fiscal space available to counter the crisis; as a result, Romania’s COVID-19 related expenditures of Euro 5 billion (2.4 percent of GDP) were among the lowest in the EU. The recession reduced H1 revenues from VAT (down 15.8 percent) and CIT (down 7.5 percent). Higher PIT revenues and EU funds, up 10.4 percent and 18.1 respectively, have limited the total budget revenue decline to -1.6 percent compared to the same period in 2019. Budget expenditures were 13.6 percent higher, reflecting the COVID-19 response through expansions in social assistance and health-related spending, up by 23.7 percent and 16 percent respectively. The widening fiscal deficit has increased the estimated financing needs to around 13 percent of GDP in 2020, or around Euro 26-27 billion. The economic conditions and a relatively stable inflation environment, with the annual inflation rate running at 2.8 percent in July, allowed the NBR to lower the monetary policy rate by 0.25 pp twice, in May and August, to 1.5 percent in an attempt to bolster financial sector liquidity and support the economic recovery.

Key risk indicators of credit institutions remain at adequate levels. The banking sector remains well capitalized, as the total capital ratio stood at 22.8 percent in June above the NBR’s minimum requirements, and highly liquid with the liquidity coverage ratio at 269 percent in June compared to 245 percent in March.

Outlook

The economy is expected to contract by 5.7 percent in 2020. The severity of the recession and the magnitude of the 2021 economic recovery will depend on the evolution of the health crisis and its policy response, on the impact of the national economic stimulus, and on the spillovers from the stimulus pursued at EU level. Romania is expected to receive 79.9 billion euros from the EU by 2027. This amount would be received under the multiannual budget funds 2021-2027 (49.5 billion euros) and the economic recovery plan (30.4 billion euros, of which 13.7 billion euros in grants as reported by Romania’s Ministry of European Funds). The EU grant funds are budget neutral and will be critical for Romania’s growth recovery and for keeping the fiscal deficit in check. To address the consequences of COVID-19, the fiscal deficit is expected to widen to around 9 percent of GDP in 2020, up from a planned deficit of 3.6 percent before the crisis. A substantial reduction of the deficit in 2021 is improbable as the government will have to support the economic recovery process. A widening fiscal deficit would push public debt to an estimated 45.1 percent of GDP in 2020 and 47.7 percent in 2021 from 37.6 percent in 2019. The bulk of the increase stems from the fiscal deficit. However, public debt remains one of the lowest in the EU. Poverty is projected to increase on the back of the triple-hit in incomes facing poorer segments of the population, in the form of the domestic COVID-19 pandemic, the poor agricultural year, and declining remittance incomes. These households are anticipated to have been less supported by the fiscal response measures, which extended more directly to those in formal employment structures. Responsive social protection and active labor market policies would be needed to support these households, and the broader segment of workers who have been affected by labor market slowdowns.

Risks and challenges

In the short run, the key challenge is to contain the COVID-19 crisis and limit its
health and economic consequences. A prolonged crisis with extensive additional mitigating measures to reduce transmission would affect growth prospects and push back the nascent resumption of activity seen in high frequency data of companies and jobs while raising unemployment and poverty. The pro-cyclical fiscal trajectory before the COVID-19 crisis added to the fiscal space constraints, feeding into lower investor confidence and increasing financing costs. Slower recovery of the European economy, and in particular of Germany and Italy, Romania’s main trading partners, would put additional pressure on the domestic economy. In addition, the 40 percent increase in public pensions (resulting in fiscal costs close to 2.7 percent of GDP) passed recently by the Parliament, if not reversed, would seriously impact macroeconomic stability while, in the short run, could lead to a downgrade in Romania’s sovereign ratings. Additional risk stems from Romania’s historical low EU funds absorption rates raising questions on the country’s capacity to take advantage of the EU recovery funds, which is one of its main economic recovery engines.

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