UniCredit: Romania’s GDP to slow. Fiscal policy remains the biggest risk for growth, macroeconomic stability

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UniCredit Bank analysts expect Romania’s economic growth to slow to 4.4 percent in 2017 and 3.5 percent in 2018 due to falling public investment, a weaker harvest than in 2016 and tighter fiscal policy from this year’s Q4 onwards if the government wants to keep the deficit below 3 percent of GDP.

“Fast consumer-driven economic growth is hiding widening fiscal imbalances, reminiscent of last decade’s fiscal profligacy that triggered a tough austerity program. The political landscape may change over the summer, with rifts appearing inside the ruling Social Democratic Party. The economy continues to grow above potential, although the speed is set to slow gradually. Huge wage increases will keep private consumption and retail sales as the main growth drivers in 2017. However, export orders are likely to outpace domestic ones, especially for durable and capital goods, as domestic demand continues to slow,” the bank’s quarterly report reads.

According to the quoted document, the fiscal policy remains the biggest risk for growth and macroeconomic stability. Poor tax collection is prompting the government to backtrack on some election promises like 0 percent VAT for real estate transactions and advertising. Public wages will increase only in January 2018 (by 25 percent, instead of doubling), with teachers and doctors receiving a second raise in March 2018. Even so, the budget deficit may exceed 3 percent of GDP in 2018. The August budget amendments could bring further fiscal tightening. In addition, the planned move to a household tax may not be implemented in 2018 due to the expected fall in revenues (more than 3 percent of GDP in H1 of next year).

Moreover, important spending commitments could trigger tax increases if the government wants to avoid a return to the excessive deficit procedure in 2018 or 2019. Thus, the flat personal income tax may be replaced by a progressive tax. Businesses may also be targeted. Tax increases could raise uncertainty and affect consumption and productive investment in the private sector.

A widening C/A deficit and rapid wage growth may push EUR – RON higher, but inflation could stay inside the target range in 2017 – 2018 of 1.5 – 3.5 percent.

“While our fair value estimate is close to EUR – RON 5,00, sharp depreciation is unlikely and we expect the trading range to be shifted higher in steps of RON 0,10,” UniCredit analysts show.

At the same time, reinvested earnings by multinationals may fall if the tax outlook becomes uncertain (as it happened in Poland in 2016). Moreover, productive FDI that took advantage of small production costs could decline as well. Thus, Romania’s extended basic balance could narrow sharply to less than 0.5 percent of GDP in 2017 – 2018.

National Bank of Romania (BNR) is expected to raise the marginal deposit rate in H2 of 2017 and the policy rate in H1 of 2018.

“We still expect three policy rate increases in 2018 starting in February, but there are risks of delays. First, the central bank may have to shift its focus from a stable exchange rate to stable RON interest rates as the weight of RON loans in total private-sector lending rises towards. Second, BNR may follow regional peers and postpone normalizing interest rates,” the report reads.

The analysts point out that the politics expected to influence asset prices over the summer.

“Given the narrow scope for populist measures, the government should strive to keep the budget deficit below 3 percent of GDP. If it manages to do this, then a decline in political noise could help RON assets from Q3 of 2017 onwards. If transfers to local authorities increase, then both EURRON and ROMGB yields would move higher”, UniCredit report concluded.




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