Pressure on Romania’s 2016 budget and signs of economic overheating, BCR-Erste analysts warn

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VAT cutting and public expenditure specific to electoral years will put pressure on the 2016 budget, the analysts BCR-Erste Group anticipate. The government will not be able to control the structural deficit and the economy could show signs of overheating, all these in a dangerous external context marked by the Greek crisis.

“The central bank acknowledged that, whereas the reduced VAT for all food products will act as a suppressor of inflation in the short term, there are concurrent forces, such as the quick growth in unit labor costs, which have already led to a faster than expected narrowing of the output gap,” the largest bank in Romania say, referring to the recent decision of National Bank of Romania (BNR) to keep the monetary policy rate unchanged at 1.75 percent.

„First of all, the external context is likely to remain treacherous, with investors torn between a prospective Grexit and the impending key rate hike by the Fed later this year which could lead to spikes in volatility every once in a while.

On the domestic front, the Parliament recently ignored the IMF and European Commission’s recommendations to not rush to cut VAT to 19 percent (from 24 percent) and passed the new Fiscal Code, (…) which is expected to come into effect in 2016. (…) While the cabinet will struggle to keep the nominal fiscal deficit within 3 percent of GDP next year, there is little they can do to contain a spike in the structural budget deficit well beyond the target agreed under the Fiscal Compact (1 percent of GDP + 0.25 pp for projects co-funded by the EU),” Erste Group shows in a short note recently released.

The analysts also note that the Parliament on June 30 reinstated legislation regarding preferential pensions for military retirees which will put additional pressure on the expenditure side of the budget.

Following the planned VAT slash to 19 percent, BCR-Erste Group has lowered its headline inflation forecast to 0.7 percent yoy for December 2016, while the average CPI is likely to become slightly negative (-0.3 percent yoy).

„The reduced VAT will largely obscure the inflation pressures in 2016, while we do not rule out the economy showing signs of overheating. With increased prospects of the budget policy turning pro-cyclical in the election year 2016 and the local economy shifting to a positive output gap for the first time in eight years, the central bank’s monetary stance could turn less accommodative,” the analysts’ research concluded.

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