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BUCHAREST (Romania), July 15 (SeeNews) - Fitch Ratings said on Saturday it has affirmed Romania's long-term foreign and local currency issuer default ratings (IDR) at 'BBB-', with stable outlooks, but warned on a growing budget deficit and economy overheating.
The issue ratings on Romania's senior unsecured foreign and local currency bonds have also been affirmed at 'BBB-'/F3, while the country ceiling has been affirmed at 'BBB+' and the short-term foreign currency IDR at 'F3', the rating agency said in a statement.
"Romania is at risk of re-entering the EU Excessive Deficit Procedure this year, having only exited it in 2013," the rating agency warned.
Fitch noted that Romania's structural budget deficit is set to widen to 3.9% of GDP in 2017, according to the European Commission, which would represent an expansion of 3.3% of GDP in two years, contrary to national and EU fiscal rules.
Also,Fitch said there is a risk of the economy overheating, although inflation and bank credit growth are currently subdued.
Fitch last reviewed Romania in January, when it maintained the long-term foreign currency issuer default ratings (IDR) at BBB-, with stable outlooks, warning that ratings are constrained by fiscal uncertainties that stem from continued pro-cyclical fiscal loosening.
In April, Moody's Investors Service has changed the outlook on Romania's Baa3 government bond rating to stable from positive due to deterioration in public finance and debt outlook for government of Romania.
Also in April, Standard & Poor's maintained Romania's rating at BBB-/A-3, with a stable outlook, and said that the country's deficit will widen due to the government's loose fiscal policy.
Fitch also said in the statement:
"KEY RATING DRIVERS
Romania's investment grade rating is supported by its still moderate level of public debt, stable banking sector, and GDP per capita and governance indicators that are in line with 'BBB' range medians. However, the rating is facing an increase in downside risks owing to a substantial pro-cyclical fiscal loosening and rapid increase in wages in excess of productivity growth, which pose risks to macroeconomic stability.
Romania's general government budget deficit widened to 3% of GDP in 2016 from 0.8% in 2015, despite the booming economy. The increase was due to large tax cuts and increases in public wages and social welfare payments. Fitch projects the deficit will widen to 3.7% of GDP in 2017, above the government's target of 2.9%, owing to further cuts in VAT and excise rates, and increases in public wage, pensions and other measures. Outturns for the first five months of 2017 show an underperformance in tax receipts of goods and services and corporate income, and the budget deficit (cash basis) RON1.4 billion wider year-on-year, despite rapid economic growth and low execution of capital expenditure.
The structural budget deficit is set to widen to 3.9% of GDP in 2017, according to the European Commission, which would represent an expansion of 3.3% of GDP in two years, contrary to national and EU fiscal rules. Romania is at risk of re-entering the EU Excessive Deficit Procedure this year, having only exited it in 2013.
In Fitch's view, there is a high level of uncertainty over the outlook for the budget deficit over 2017-2019 owing to an incompatibility between further expansionary fiscal measures in the government's programme and its budget deficit targets of 2.9% in 2018 and 2.5% in 2019. The recently approved Unified Wage Law involves a 25% hikes in public sector wages (more for the health and education sectors), albeit potentially partially offset by a shift in social security contributions to employees from employers effective January 2018.
Other proposals include a net 23% increase in the minimum wage in 2018, a potential cut in the personal income tax rate to 10% from 16%, increased pensions and child benefits, a further cut in VAT (in 2019), changes to the corporate and personal income tax structure and the creation of an off-budget sovereign investment fund to increase investment in infrastructure and state owned enterprises. Further tax cuts would risk eroding the revenue-to-GDP base, which is the lowest in the EU. Taking advantage of EU structural funds would require an increase in the amount and quality of infrastructure expenditure. Fitch forecasts the budget deficit at 4% of GDP in 2018 and 2019.
Nevertheless, Romania's general government debt/GDP ratio remains in line with the median 41% ratio of 'BBB' rated peers. Fitch forecasts it to increase to 39.9% of GDP by end-2017 from 37.6% in 2016. Debt repayments are moderate, averaging 3.5-4.0% of GDP annually up until 2019, and the government holds an adequate cash buffer equivalent to 3.6% of GDP, covering 5.1 months of gross financing needs.
Economic growth is boosted by the fiscal stimulus. For 2017, Fitch has revised up its real GDP forecast to 5.1% from 4.8% previously, after a stronger than expected 1Q17, when GDP expanded 5.7% yoy (1.7% qoq). Growth is mainly consumption driven, led by households benefiting from robust growth in real wages. Import growth remains strong, but recovery in demand from Romania's key export partners helped net exports contribute positively to Q1 GDP, albeit at a modest level (0.2pp). Contribution from gross fixed capital formation remained negative. Fitch expects growth to ease to 3.4% in 2018 as the magnitude of the fiscal stimulus fade.
There is a risk of the economy overheating, although inflation and bank credit growth are currently subdued. The National Bank of Romania estimates that the economy is already operating around 2% above potential and this will increase as actual GDP growth outstrips potential growth, which most independent institutions estimate at around 3.5%. The labour market is tight, with unemployment at a record low and hikes in the minimum wage and public wages have contributed to average wages outstripping productivity growth by a large margin leading to rising unit labour costs. Against this background, Fitch forecasts the current account deficit to widen from 2.3% of GDP in 2016 to 3.1% in 2017 and 3.3% in 2018.
Progress in converging Romania's GDP per capita levels towards that of higher rated peers has been slow, despite robust economic growth as the economy still faces structural challenges improving the efficiency of state-owned enterprises and absorption of EU-funds into economically viable projects.
Romania's rating is constrained by its net external debtor position, which Fitch estimates at 18.9% of GDP for 2016, higher than the 'BBB' median estimate of 2%. Nevertheless, net external debt/GDP is declining, with the majority owed by the private sector and relating to intercompany lending.
Romania's ratings are supported by a stable banking sector. Banks are well capitalised (sector capital adequacy ratio 18.8%, 2016), sufficiently funded by local deposits and their balance sheets continue to improve as the share of non-performing loans declines. Legislative risks to the sector have stabilised following a favourable ruling by the Constitutional Court on the Debt Discharge Law and CHF loan conversion, diminishing the risk of a large financial cost for the sector.
Recent political developments risk weakening governance indicators and government policy direction. In June, former prime minister Sorin Grindeanu was ousted by his own party in unusual circumstances, ostensibly for slow progress in implementing the government programme. The PSD-ALDE coalition policies will now be carried through by new prime minister, Mihai Tudose of PSD. This includes the controversial Penal Code, which would result in pardoning certain crimes of those abusing powers in office, and which triggered large public demonstrations against the government in January.
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 FC IDR scale.
Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final Long-Term IDR by applying its QO, relative to rated peers, as follows:
- External Finances: -1 notch, to reflect Romania's significantly higher net external debtor position than the 'BBB' median, and lower international liquidity ratio than the 'BBB' median.
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 LT FC 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.
The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are currently balanced. The main risk factors that, individually or collectively, could trigger negative rating action are:
- Persistent high fiscal deficits leading to an increase in government debt/GDP.
- An overheating of the economy that poses a risk to macroeconomic stability.
The main factors that could, individually or collectively, trigger positive rating action include:
- Implementation of fiscal consolidation, which improves the long-term trajectory of public debt/GDP.
- Sustained improvement in external finances.
Fitch assumes Romania's main economic partners in the EU will benefit from economic growth in line with its Global Economic Outlook."
(1 euro=4.5645 lei)