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Fitch affirms Romania at 'BBB-', outlook remains negative

Fitch affirms Romania at 'BBB-', outlook remains negative Fitch Ratings Romania

BUCHAREST (Romania), April 24 (SeeNews) - Fitch Ratings said it has affirmed Romania's long-term foreign and local currency issuer default ratings (IDR) at 'BBB-', with a negative outlook.

Romania's investment-grade ratings are supported by government debt and debt service levels below peers, and GDP per capita, governance and human development indicators that are above 'BBB' category peers and underpinned by EU membership, Fitch said in a press release on Friday evening.

These are balanced against larger twin budget and current account deficits (CAD) than peers and relatively high net external debtor and negative net international investment positions, it added.

Fitch's negative outlook reflects uncertainty regarding the implementation of policies to address structural fiscal imbalances over the medium term and the impact from the coronavirus pandemic on Romania's public finances.

The current administration plans a series of fiscal and macro reforms to anchor medium-term fiscal sustainability, but a weak track record of fiscal consolidation and very high budget rigidities constitute key public finance challenges., the agency noted.

In October 2020, Fitch affirmed Romania at BBB-', with a negative outlook.

Fitch also said in the statement:

"KEY RATING DRIVERS

(...)

Fitch forecasts a very gradual narrowing of the general government deficit to 8.2% of GDP in ESA terms in 2021 from 9.2% in 2020 (the highest in the CEE region), broadly in line with the budget. Stronger revenue growth thanks to solid economic recovery will largely be offset by pandemic-related spending as well as higher investment outlays. Short-term risks are mitigated by the approval of emergency ordinances that have reduced the scheduled pension hike from 40% to 14% in 2021 and frozen public wages and bonuses.

The authorities aim to reduce the deficit to under 3% of GDP by 2024 based on expenditure restraint and revenue raising measures. A unitary wage bill and a pension law are currently being finalised with the aim of reducing the weight of social entitlements in the budget starting in 2022. In 2020, wages, pensions and subsidies were equivalent to over 80% of total revenue, among the highest shares in the EU. On the revenue side, the authorities are focusing on improving compliance and increasing digitalisation with the aim of reducing a large VAT gap. However, these measures have not been projected in the medium-term budget and there is less visibility about their scope and timeline.

Overall, Fitch sees broad commitment to reform and still favourable prospects that expenditure rationalisation measures will be approved in 2021 despite recent coalition tensions. We also expect more clarity regarding revenue measures in 2022, as without progress in this area the fiscal targets will not be achievable. However, we note implementation challenges remain, including in streamlining other expenditure components (such as acquisition, services and transfers to regions) as well as reducing revenue gaps beyond larger tax contributors. Romania has a poor record of meeting fiscal targets (particularly on structural deficits) even in periods of strong growth and under different administrations.

We forecast the public deficit falling to 6.6% of GDP in 2022, which would be consistent with public debt/GDP increasing to 53.2% in 2022 from 47.3% in 2020 and still below the current 'BBB' median of 57.3% of GDP. We expect gross financing needs to remain elevated (11.6% of GDP in 2021 according to the authorities), but Romania has good access to external markets, as well as sound debt management (interest payments to revenue are among the lowest in the 'BBB' category). Moderate contingent liabilities (despite extensive use of guarantee schemes in 2020) and support from different EU scheme reduce financing risks.

A three-party coalition led by the centre-right PNL took power in December 2020 and thus far has managed to implement its agenda without major delays. However, recent cabinet changes have highlighted lingering tensions among coalition parties, even if the risks of a breakdown remain low given limited governing alternatives. Although it is the largest party in parliament, the opposition, PSD, also appears unable to provide an alternative. We expect tensions to become more evident as elections near in 2024 or if the government is faced with policy setbacks, including in the implementation of very large EU-funded projects or judicial reforms.

Fitch expects Romania´s economy to expand by an average of 5.8% in 2021-22 (versus the 'BBB' peer median of 4.4%), thanks to strong investment momentum and a gradual recovery in exports and private consumption. The economy performed very well in 4Q20 despite moderate pandemic restrictions (limiting full year contraction to only 3.9%), providing a strong carry-over and highlighting the resilience of important sectors such as construction and some service industries. Fiscal measures helped limit the damage to employment and corporate balance sheets, with few sectors likely to see any long-term effects.

The country will be a major beneficiary of EU Funds over the medium term, including around 13% of GDP in Next Generation Funds (half of which is grants to be disbursed in 2021-26). The country plans to invest heavily in infrastructure and digitalisation, combined with a number of reforms that will help address longer-term challenges such as an ageing population and declining productivity. However, a record of weak EU Fund absorption and administrative challenges (particularly at regional level) could reduce the effectiveness of investment.

Romania's external finance indicators are a rating weakness, with structural imbalances preventing an improvement in the CAD in 2020, despite a sharp contraction in domestic demand. Fitch forecasts a modest widening of the CAD in 2021-22 (averaging 5.7% of GDP, from 5.2% in 2020) as a recovery in exports is offset by stronger import demand.

We expect non-debt financing inflows to cover around 75% of the CAD, with the rest primarily financed by public sector external debt issuance. This will keep the net external debt ratio at around 20% of GDP, compared with the current 'BBB' peer median of 5.8%. Although Romania's ability to access large EU capital flows and sizeable FX reserve position (close to 19% of GDP) serve as stabilising factors, challenges around external competitiveness could constrain policy effectiveness, in particular if exchange rate or inflation pressures were to rise.

Fitch forecasts headline inflation to remain at the upper bound of the National Bank of Romania's (NBR) target band (2.5% +/-1pp) in the next two years, with supply trends acting as the main drivers. Stronger demand pressures could pose upside risks but the NBR has the capacity to anchor inflation expectations via different monetary tools. Measures to preserve financial stability have proven successful, with liquidity and capitalisation of the banking sector at ample levels. The ratio of non-performing loans has been broadly stable around 4% since early 2020, and we do not expect a significant increase once the moratoria schemes elapse.

ESG - Governance: Romania has an ESG Relevance Score (RS) of '5' for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption, as is the case for all sovereigns. Theses scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model (SRM). Romania has a moderate WBGI ranking at 58.4 percentile, reflecting a recent track record of peaceful political transitions, a moderate level of rights for participation in the political process, moderate institutional capacity, established rule of law and a moderate level of corruption.

RATING SENSITIVITIES

The main factors that may, individually or collectively, lead to negative rating action/downgrade are:

- Fiscal: Weaker confidence in the implementation of a credible medium-term consolidation strategy that would lead, for example, to a faster-than-projected increase in public debt

-External: a sustained deterioration in the balance of payments, for example reflecting a stronger widening in the current account deficit and/or failure to attract non-debt financing flows, that undermines external and macroeconomic stability.

The main factors that could, individually or collectively, lead to positive rating action/upgrade:

-Fiscal: Confidence that general government debt/GDP will stabilise over the medium term, for example due to the effective implementation of expenditure-control reforms and credible plans for revenue raising measures.

-External: A reduction in external vulnerabilities for example via a sustained improvement in external debt ratios.

SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)

Fitch's proprietary SRM assigns Romania a score equivalent to a rating of 'BBB' on the Long-Term LTFC IDR scale.

Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LTFC IDR by applying its QO, relative to rated peers, as follows:

- External Finances: -1 notch, to reflect Romania's higher net external debtor and net investment liabilities positions than the 'BBB' range median, as well as higher external vulnerability than implied by the SRM model given adverse policy developments in recent years that have impacted external competitiveness and aggravate exposure to shocks.

Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LTFC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.

BEST/WORST CASE RATING SCENARIO

International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance.

KEY ASSUMPTIONS

The global economy performs broadly in line with Fitch's latest Global Economic Outlook published on 17 March 2021. We forecast eurozone real GDP to recover 4.7% in 2021 and 4.5% in 2022."

(1 euro=4.9257 lei)

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