March 21 (SeeNews) - Romania's economic growth is expected to quicken to 4.1% in 2016, driven by private consumption, as deficit reaches almost 3% of GDP, Erste Group analysts said on Tuesday.
According to the Erste analysts, the central bank, BNR, could hike the key rate to 2% in the first quarter of 2017.
"We do not rule out a modest overheating of the local economy this year, as the country seems now on pace to close the negative output gap, which persisted for the last seven years," they said in a macroeconomic outlook report.
Romania's GDP grew 3.7% y/y in 2015, fuelled by domestic demand and higher investments and private consumption, which were backed by growing wages, low interest rates and falling prices.
Given the broad fiscal easing and higher wages in the public sector enforced by the government last year and early this year, the budget deficit could soar to almost 3% of GDP in 2016, in parallel with a spike in the structural deficit to above 3%, as the local economy is likely to grow to potential, the report reads.
"With Romania being one of the poorest tax collectors in the European Union - 32.8% of GDP, the budget deficit might continue to swell in 2017 and thereafter in the absence of proper remedies," the analysts noted.
Erste said that the election year could also complicate things even more, as the technocratic cabinet has already faced pressure for additional pay rises from various professional groups.
On the monetary policy front, Erste expects the central bank to raise its key rate to 2% in the first quarter of 2017, and further to 2.5% in the second quarter.
"We foresee a tighter monetary policy in 2017, due to fiscal risks and a higher inflation rate," analysts said.
In its last macroeconomic report in March, Erste said it expects a rate hike in the last quarter of 2016 and further to 2.25% in the subsequent quarter. BNR's monetary policy rate has stayed at 1.75% since May 2015, when it cut it from 2.0%.
Romania's annual deflation accelerated to a record high of 3.3% in April from 3% in March, influenced by the VAT cut to 20% from 24% starting with January.
Annual inflation is likely to remain negative until November 2016 and rise towards the inflation target of 2.5% in 2017, Erste added.
Erste sees the Romanian leu mostly trading in a range of 4.4-4.6 in 2016, as the central bank will continue to keep volatility in check by means of the managed floating regime.
The analysts also said they expect yields to remain close to the current levels in the coming months, thanks to the pretty good current market liquidity conditions and decent investor interest in Romanian bonds. However, investor sentiment can turn sour quite suddenly, as higher funding needs of the local government could lead to bouts of higher volatility in the local fixed-income market, they added.
"Bond yields are driven by external developments like monetary policy divergence between the FED and the ECB and local factors like fiscal risks. A deterioration of the public finances later in 2016 and in 2017 could add upward pressure on LCY yields," the report reads.