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February 2, 2023

Fitch Ratings confirms Romania’s rating at ‘BBB-‘, but warns it could exceed deficit target in 2019

Fitch Ratings has affirmed Romania’s Long-Term Foreign and Local Currency Issuer Default Rating (IDR) at ‘BBB-‘ with a Stable Outlook, but warned that the budget deficit might widen to 3.4 percent of the GDP in 2019, according to a release of the agency,  as quoted by Agerpres.

Romania’s ceiling was affirmed at ‘BBB+’ and the Short-Term Foreign and Local Currency IDR was confirmed at ‘F3.’

“Romania’s investment-grade ratings are supported by moderate levels of government debt, and GDP per capita and human development indicators that are above ‘BBB’ category peers. These are balanced against twin budget and current accounts deficits, net external indebtedness that is higher than its rating peers and pro-cyclical fiscal policy that poses risks to macroeconomic stability,” according to Fitch.

“The government’s 2019 budget foresees a narrowing of the general government deficit to 2.8% of GDP from 3.0% in 2018 (versus a ‘BBB’ peer median deficit of 1.9%). However, the projected revenue increase (15.7%) appears highly optimistic, as Fitch believes it relies on unrealistic macroeconomic assumptions, including private employment growth of over 3.0% (it expanded by 1.7% in 2018). The Fiscal Council has also identified under-budgeting of goods and services and interest payments costs, which could lead to higher spending. In previous years the government has been able to meet its targets by containing capital investments. However, Fitch believes this strategy is reaching its limit and we expect the deficit to widen to 3.4% of GDP in 2019.”

According to Fitch Ratings “fiscal loosening could continue in 2020 and beyond, in particular if the government moves ahead with plans to increase pensions by a further 40% in September 2020 (following a 15% approved for September 2019). In the absence of revenue raising reforms we estimate the deficit to widen to 4.0% of GDP in 2020, which would lift the public debt/GDP ratio to 37.9%, from 35.0% in 2018, although this is still slightly below the projected BBB median of 38.8%. Risks are on the downside and are partly tied to unpredictable policymaking, especially given the busy electoral cycle in the next two years.”

The quoted source mentions that the authorities’ implementation of a controversial emergency tax ordinance in December 2018 and the reversal thereafter of some of the measures – following pressure from National Bank of Romania (BNR) and private sector – highlight the weakness of the fiscal policymaking framework and the challenges the government faces in lifting revenue to match expenditure promises. Fitch assesses the fiscal impact of the revised measures to be very limited, in particular the watered-down bank asset tax. However, there is a risk of fallout in terms of adverse impact to business environment, investment and economic growth.

“For the banking sector, the new tax should dent profitability only very slightly, with Fitch expecting broad stability in the industry. Capital adequacy remains high (19.7% at end-2018), the ratio of non-performing loans continues to decrease (4.8% in February 2019 from 6.4% at end-2017) and there is ample liquidity. The credit cycle appears moderate in the context of very rapid economic growth in recent years, with lending to private sector rising by a total of 7.9% in 2018 and 13.2% in local currency (versus nominal growth of 10.2%). This helps reduce risks of credit-bubbles and negative spill-overs to the wider economy.”

Fitch continues to forecast a gradual slowdown of the economic activity between 2019 and 2020, with an average growing pace of the GDP of 3.1%, in line with the average level of other states in the ‘BBB’ category, but compared to an advance of 4.6% between 2013-2018.

“Private consumption has been the main driver of headline growth since 2014 and we expect this trend to continue over the medium term, albeit at a slower pace given lower projected wage increases. Investment should recover in 2019-2020–it contracted in 2018, partly due to cyclical trends in sectors such as construction–thanks in part to higher absorption of EU funds. Given net population loss, the GDP per capita should continue to increase steadily, narrowing the gap with the rest of the EU,” Fitch argues.

“The current account deficit (CAD) widened to 4.5% of GDP in 2018, the largest since 2012 and compared with the current peer median of 1.0% of GDP. This reflects strong growth in imports of goods and services and stagnating current transfer credits. We forecast a further widening of the CAD to 5.5% of GDP in 2020. Rapid wage growth in excess of productivity growth–nominal unit labour costs growth at 14% in 2018 was the highest in the EU–risk eroding cost competitiveness, contributing to the widening in the CAD,” reads the release.

The main factors that could, individually or collectively, leads to negative rating action are: high fiscal deficits that would lead to a rapid increase in government debt/GDP and an overheating of the economy or hard landing that undermines macroeconomic stability, as well as a significant deterioration in the balance of payments.

Whereas, the main factors that could, individually or collectively, lead to positive rating action are: reducing risks of macroeconomic instability and improving macroeconomic policy credibility, the implementation of a fiscal consolidation to improve the long-term public debt/GDP trajectory and a sustainable improvement in external finances.

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