October 17 (SeeNews) - Standard & Poor's said it maintained Romania's rating at BBB-/A-3, with a stable outlook, due to an expected improvement of the country's fiscal imbalances over the next years and to upcoming reform under the recovery and resilience plan.
The stable outlook balances economic risks from the Russia-Ukraine conflict, namely surging inflation and more adverse economic developments in Romania's main trading partners, as well as high twin deficits against the buffers provided by its still modest stock of external and government debt and incoming EU transfers, S&P said in a statement on Friday evening.
"We anticipate that commitments under the EU's Recovery and Resilience Facility (RRF) will continue to anchor authorities' commitment to political reforms and fiscal consolidation," the global ratings agency added.
S&P Global Ratings expects real GDP growth in Romania to moderate to about 4% over 2023-2025, compared with close to 6% in 2021-2022, as the recovery in demand following the Covid-19 pandemic wanes and high inflation curbs consumption growth, at least in the near term.
The stability of the country's energy supply is supported by a substantial share of domestic production. Although the country's fiscal and current account deficits will remain high in 2022, S&P expects them to decline from 2023 onward due to the government's consolidation efforts, coupled with lower domestic demand growth.
On October 7, Fitch Ratings affirmed Romania's long-term foreign and local currency issuer default ratings (IDR) at 'BBB-', with a negative outlook. The rating is underpinned by EU membership and EU capital flows that support external and macro-stability, and GDP per capita, governance and human development indicators that are above 'BBB' category peers, Fitch said at the time.
S&P also said in the statement:
"Downside scenario
We could lower the ratings over the next two years if:
The government's medium-term fiscal consolidation efforts prove insufficient, failing to sustainably reduce deficits below 4% of GDP, or if the government's financing costs increase beyond our expectations; or
Financing for Romania's twin deficits were to be increasingly oriented toward debt-creating external flows, perhaps due to lower-than-expected inflows of EU funds.
Upside scenario
We could raise the ratings if we see evidence that Romania can sustain high economic growth, while the current account deficit (CAD) and government's fiscal deficit narrow, indicating the economy's strengthening productive capacity.
Rationale
Romania's economy grew strongly in first-half 2022 (5.7% year on year), despite the Russia-Ukraine war's indirect effects, but we expect growth rates to decrease substantially over the next few quarters. High inflation, buoyed by rising food and energy prices, will cut into disposable incomes, limiting private consumption, a key growth driver in recent years. Given the government's consolidation strategy, we also believe further fiscal stimulus to the private sector will moderate, which will weigh on domestic demand from next year. Over 2023-2025, we believe Romania's economic development will be highly contingent on the execution of EU-funded investments. The country has EU grants of 25%-30% of GDP available to it under the RRF and the previous and current Multiannual Financial Framework (MFF).
We expect strong domestic demand, rising import prices, and primary income outflows will push the CAD beyond 8% of GDP this year, the highest level since 2008. However, nondebt-creating inflows on the capital and financial account, namely in the form of foreign direct investments and EU funds, will cover a significant share (close to 60%) of these deficits. We also expect CADs will decrease through 2025 as domestic demand moderates, partly due to the government's fiscal consolidation plans. High nominal GDP growth will support the moderation in fiscal deficits. This will help contain government debt, net of liquid government assets, at below 50% of GDP and interest expenditure at below 5% of government revenue. As elsewhere, the high inflation levels pose a challenge for the National Bank of Romania (NBR), which has raised rates a cumulative 5 percentage points since January 2021. We continue to classify the exchange rate regime as a managed float. Foreign currency interventions by the NBR remain moderate and have helped keep the leu broadly stable vis-a-vis the euro.
Further supporting the ratings are Romania's continued access to external financing in difficult market conditions, together with the benefits from the country's EU membership, which constitutes a key policy anchor and benefits the institutional framework.
Institutional and economic profile: After a strong expansion in first-half 2022, the growth outlook for Romania's economy will become more challenging
Domestic demand growth will weaken as high inflation and more moderate fiscal support will weigh on consumption, resulting in real growth of about 3% in 2023.
Available EU grants, estimated at 25%-30% of GDP, will remain an important growth driver over the forecast period to 2025.
The continued commitment to a balanced and credible fiscal agenda as well as further political reform will be anchored by Romania's Recovery and Resilience Strategy (RRS).
Romania's economy grew substantially in first-half 2022 despite the Russia-Ukraine war's indirect impact. We expect 2022 real GDP growth of about 6%, primarily driven by high private consumption. However, the outlook over the next few quarters will become more challenging as the conflict's indirect effects become more prominent. Therefore, we expect GDP growth to slow to below 3% next year. High global commodity prices have resulted in surging consumer price inflation (CPI), which we expect will amount to over 13% in 2022 and almost 9% in 2023, dragging substantially on disposable incomes and thus consumption. In fact, we expect real wage growth will be negative in 2022 and stable in 2023. Also, Romania's economy will be affected by lower growth in its main trading partners in the EU as well as diminishing business confidence, which will drag on private sector investments. Positively, the labor market has largely held up and unemployment remains close to prepandemic levels.
At the same time, Romania is one of the most self-sufficient countries in Europe in terms of energy production. Domestic production of natural gas could cover up to 90% of annual consumption. This suggests that Romania has a comparatively low dependance on Russian energy and therefore a more favorable position in adapting to disruptions to European energy supply.
A key factor that will determine Romania's medium-term economic development will be its ability to efficiently use the significant EU financing available to it under the European Commission's MFF and RRF framework. EU funds still available under the 2014-2020 MFF, the incoming 2021-2027 MFF, and the RRF amount to 25%-30% of GDP. The RRF includes €14.2 billion in grants and €14.9 billion in loans, about 10% of estimated 2022 GDP, and we understand that €10 billion of EU funds could be received throughout 2022.
EU transfers under the RRF are contingent on Romania implementing fiscal and political reforms according to the RRS, which are agreed upon with the European Commission. We therefore consider the RRF an important policy anchor that can provide incentive to improve Romania's fiscal position (along the lines of the existing Excessive Deficit Procedure [EDP]) and conduct key reforms to the country's institutional framework. Romania scores some of the lowest governance indicators within the EU, with corruption and government effectiveness as specific weak points. While many political reforms under the RRS will be largely uncontentious, others will be harder to implement, particularly those concerning state-owned enterprises and anti-corruption measures. However, we expect progress on the RRS, given the high importance of EU funds for Romania.
Flexibility and performance profile: We expect Romania's twin deficits to decrease over 2023-2025, containing public and external debt at moderate levels
We forecast Romania's government deficit will decrease to below 3% of GDP in 2025 from 5.9% in 2022, supporting net government debt stabilizing at below 50% of GDP.
A widening trade deficit will push the CAD to almost 9% of GDP this year, but lower CADs and higher EU fund inflows will limit increases of external debt over the next few years.
The NBR's monetary policy tightening has been more moderate than that of regional peers and foreign currency interventions have kept the exchange rate stable vis-a-vis the euro.
Substantial fiscal measures to support the economy will result in a sizable government deficit of 5.9% of GDP in 2022, in line with the government's target. The support measures include an energy price cap potentially resulting in fiscal costs up to 3% of GDP, which will only be partially financed from windfall taxes on state-owned utility companies. However, we believe the government will achieve its fiscal target given the budget execution in first-half 2022 as well as high nominal GDP growth supporting tax revenue.
We believe the government remains committed to fiscal consolidation, however. We expect its efforts will be supported by high nominal economic growth and rising tax revenue. The European Commission's ongoing monitoring of the EDP process, together with the stipulations within the negotiated RRF framework, represent an important mechanism to support budgetary discipline. Notwithstanding efforts both on the expenditure and revenue sides, such as the closing of the largest value-added tax gap in the EU, we expect spending proposals in the runup to the election year of 2024 to result in the 3% target outlined in the EDP only being achieved in 2025, albeit with continuous decreases. We expect net general government debt to GDP to stabilize at below 50% until 2025.
We estimate the gross government financing requirement over 2022 at over 10% of GDP. The majority will come from the domestic market, notwithstanding the domestic banking sector's already-substantial exposure to the government, at more than 20% of assets. In an effort to reduce the volatility of financial markets, the NBR temporarily resumed its purchases of government securities during first-half 2022 (but in very limited volumes) after being absent in the secondary markets for government securities since April 2021. The bank's activities helped improve the domestic market's liquidity and had a positive effect on the primary market issuance during this month.
While rising interest expense strains Romania's already-rigid budget, we acknowledge the government's established market access and liquidity holdings (consisting of a hard currency buffer of about 3% of GDP), which provide financing flexibility. We forecast that interest expenditure will remain below 5% of government revenue, albeit rising over our forecast horizon until 2025.
Similar to other Central and Eastern European countries, inflation has surged in Romania, to 15.9% in September, one of the highest rates in Europe. We expect full-year CPI to average about 14% in 2022. As elsewhere, the primary drivers of inflation are rising energy and food prices, despite a price cap on energy prices. Food prices have increased more than 19% year on year, fuel prices over 31%, and other energy prices over 36%. We believe inflation will remain elevated but decreasing throughout 2023, due to base effects, but only move into the 1-percentage-point band around the NBR's target inflation level of 2.5% in early 2024.
Romania's elevated inflation and medium-term GDP growth prospects highlight the difficult environment for the NBR. The central bank has raised its main policy rate by a cumulative 5 percentage points since January 2021, to 6.25%, in an effort to rein in inflation. Further rate hikes are possible if prices rise faster than expected. Simultaneously, we expect the NBR to continue to moderately and intermittently intervene in the foreign exchange market to support currency stability. The bank's international reserves stood at €49.3 billion (17.3% of GDP) in September 2022, up from €48.5 billion in January 2022, despite its stabilization efforts. Furthermore, the NBR holds a repo line with the European Central Bank at €4.5 billion. We estimate reserves will remain at about three months of current account payments over the next few years. About half of Romania's government debt and an estimated third of financial sector deposits are denominated in foreign currency.
High domestic demand, rising import prices, and primary income outflows will likely push the CAD beyond 8% of GDP this year, the highest since 2008. Although a significant share of the external deficit represents a consequence of the fiscal spending, the persistently wide trade deficit, in our view, also reflects underlying competitiveness problems. Furthermore, over the past three years, the CAD has been increasingly covered by external debt, which we estimate pushed Romania's narrow net external debt ratio to about 31% of current account receipts in 2022. However, as domestic demand moderates, we expect Romania's CAD to narrow to 5.5% by 2025. At the same time, we expect the external financing mix to improve from 2023 due to the inflow of EU investment grants and resumed foreign direct investment. We forecast that the country's narrow net external debt will stabilize. However, the accumulation of external debt, as well as some reserve depletion by the NBR on foreign currency interventions this year, will keep gross external financing needs over 100% of current account receipts and central bank reserves over the next few years.
Romania's predominantly foreign-owned and largely deposit-funded banking sector remains stable, in our view, and we see it as a limited contingency risk for the government. The share of nonperforming loans stands at a historical low, profitability remains high, and capital and liquidity ratios look healthy. We understand that Romanian banks have only minor financial links to Ukraine. Still, the underbanked Romanian market prevents the financial sector from acting as an intermediator and catalyst to economic activity. With loans to the private sector at about 26% of GDP as of midyear 2022, the Romanian banking sector ranks last in Europe in terms of financial intermediation."
(1 euro=4.9350 lei)