The outlook is negative because S&P sees risks to Romania’s fiscal and external balances over the next 18 months if policymakers cannot stabilize and consolidate Romania’s budgetary stance after this COVID-19-induced recession. S&P could revise the outlook to stable if the government makes headway in anchoring fiscal consolidation, leading to a stabilization of Romania’s public finances and external position.
S&P estimates in a statement that Romania’s output will contract by 5.5% in 2020 compared with its previous expectation of 3.5% growth. In particular, it expects the firm lockdown measures to take a significant toll on domestic demand, primarily in the second quarter. Furthermore, weak external demand from key trading partners will eat into Romanian full-year exports, of which over 20% go to Germany and 10% to Italy, countries also facing deep recessions in 2020. S&P currently estimates Romania’s economic activity will gradually recover from midyear 2020 and rebound to 4.0% growth in 2021. That said, S&P recognizes that its current projections are subject to high uncertainty because the relaxation of containment measures could be a protracted exercise and subject to setbacks.
“Romania’s confrontational politics and highly politicized discourse cloud predictability of policy. The COVID-19 pandemic has fostered some political unity, however. It seems to have catalyzed formation of a government after months of disagreements, which included two no-confidence votes and a few failed attempts to force early elections. That said, we anticipate the underlying confrontational dynamics of Romanian politics will likely re-emerge as the unifying COVID-19 context is replaced by the divisive election mode in the latter half of 2020. We assume that parliamentary elections will be held before 2020 is over. We continue see elections being held as central to providing visibility on medium-term policy choices,” S&P said in its statement.
“We believe the COVID-19-induced fiscal fallout will provide the government a political context to reduce the cost of pension hikes legislated for September 2020. But as elections loom, we believe it will stop short of fully retracting the increase and still raise pensions by about 10% (instead of the 40% agreed in earlier legislation). This will add about 1% of GDP to the fiscal deficit in 2021. The remainder of the budgetary allocation in 2020 will be re-distributed among regular expenditure, but higher owing to COVID-19 effects,” per the statement.
According to S&P, with spending on wages and pensions now standing at about 90% of tax revenue, Romania’s budget structure is rigid. Furthermore, yields on government securities have edged up in 2020 amid the political and fiscal instability in combination with the COVID-19 context. And with surging short-term financing needs, the interest bill could rise further.
“We estimate the public-sector financing requirement in 2020 will comprise about 11% of GDP and we expect the majority will be sourced from the domestic market. In this regard, we believe the domestic banking sector will be supportive of government financing needs, but its capacity to digest the total financing needs of the government will be constrained. Its existing exposure to the government, at more than 20% of the banking sector’s assets, is already substantial. Positively, we observe that Romania successfully placed Eurobonds worth €3.3 billion on May 26, exhibiting strong subscription levels and calming yields from the elevated trades recorded through March. As per the Eurobond issuance, the Romanian Ministry of Finance has secured 50% of its revised funding need for 2020, based on its expectations of a fiscal deficit of 6.7%, a figure we believe will likely prove to be understated,” the statement also reads.
S&P also said Romania’s current account deficits will widen, reaching about 5% of GDP in 2020 as a reflection of the government’s fiscal position. Pent-up demand and a solid rebound in exports in 2021 will temper the current account deficit toward 4% of GDP in our base case through 2023. We observe that the current account deficit is increasingly covered by debt-financed inflows, which pushes Romania’s narrow net external debt ratio toward 45% of current account receipts in 2023. There are risks for further strains on net FDI as international companies face pressure. Most recently, automaker Dacia, subsidiary of French automaker Renault, has seen its medium-term expansion plan cut by EUR100 million. It added that it remittances–Italy is the origin of about one third–will reduce notably in the short term.
“Romania’s predominantly foreign-owned banking sector remains sound, in our view, and we see it as a limited contingency risk for the government. The Romanian banking sectors enters the COVID-19 turbulence from a position of strength with a sectorwide loan-to-deposit ratio of 72% at year-end 2019, from its peak of 142% in 2010. We expect liquidity and solvency ratios have built sufficient buffers to contend with the lower profitability expected from the consequences of the Ministry of Finance’s nine-month loan moratorium. The system also benefits from low levels of nonperforming loans, which, at 4%, have reduced notably from over 21% in June 2014,” the rating agency also said in its statement.