The stable outlook balances the agency's view on the country's high twin deficits against the buffers provided by its modest stock of external and government debt and solid growth outlook over the next two years, S&P said in a statement on Friday.
"We anticipate that Romania's commitments under the EU's Recovery and Resilience Facility (RRF) will continue to anchor the authorities' political and fiscal reforms," Standard & Poor's added.
The agency expects that strong domestic demand and an uptick in investment activity will increase Romania's GDP growth this year to about 3%.
S&P Global Ratings expects real GDP growth in Romania to rise to 3.8% in 2025 and to stabilise at 3.6% in 2026 and 2027, as private consumption continues to expand, underpinned by one of the highest levels of real wage growths globally, as per the report.
The agency expects Romania's fiscal deficit to remain high, at slightly below 6% due to the country's fiscal policy mix ahead of elections weighing heavily on its already large twin deficits. Uncertainty in post-elections fiscal policy lead S&P to assume that deficits will narrow only gradually in 2025-2027, averaging 5.1% of GDP.
S&P also said in the statement:
We could lower the rating if government deficits and public debt levels exceeded our current projections, for instance as a result of lower economic growth.
Upside scenario
We could raise the rating if Romania's fiscal deficits narrowed substantially and government debt, as a share of GDP, declined. This could improve the government's debt profile and reduce its financing costs. We could also raise the ratings if external deficits narrowed more strongly than we anticipate.
Rationale
An expansive fiscal policy mix ahead of Romania's four elections this year will weigh on its already large twin deficits. We therefore expect the fiscal deficit to remain high, at slightly below 6% of GDP. Fiscal policy post-elections is uncertain and we assume deficits will narrow only gradually over the next years, averaging 5.1% of GDP in 2025-2027. Consequently, we project net government debt will steadily rise, exceeding 53% of GDP by 2027. The government's interest bill will also remain high, averaging 6.3% of revenue through 2027. Similarly, the current account deficit will exceed our previous expectations and average over 6.8% of GDP over the next four years. Mitigating those external imbalances, non-debt-creating inflows in the form of EU funds and net foreign direct investments (FDIs) will continue to fund a significant share of Romania's external deficit (between 50%-60% on average).
We expect the Romanian government's pro-cyclical fiscal policy will help stimulate domestic demand and we project real growth of around 3% this year. In addition to strong private consumption, we anticipate that EU-funded investment will underpin growth. The reforms required to receive EU funds, and the country's EU membership in general, constitute key policy anchors for Romania's institutional framework. The stronger economic outlook will also add to inflation, which we forecast will remain elevated and thus continue to pose a challenge for the National Bank of Romania (NBR). We classify the exchange rate regime as a managed float. The Romanian leu has remained broadly stable vis-à-vis the euro over the past two years.
Institutional and economic profile: Romania will hold four elections this year, which will underpin a pro-cyclical fiscal policy and spur higher real growth
We expect GDP growth to rise to about 3% this year, backed by strong private consumption and an uptick in investment activity.
EU funds will continue to represent a substantial backstop to growth over the next few years, with grants available to Romania under the EU's RRF and the new Multiannual Financial Framework (MFF) 2021-2027 amounting to about €50 billion, equivalent to more than 16% of estimated 2024 GDP.
The political establishment's commitment to further political reforms continues to be anchored by Romania's Recovery and Resilience Strategy.
We expect strong domestic demand to result in real GDP growth of around 3% this year. Private consumption continues to expand, buoyed by one of the highest levels of real wage growth globally. The labor market has remained resilient and employment continues to rise while unemployment remains close to historical lows. Rising fiscal transfers--in the form of higher pensions, wages, and social transfers--will also bolster consumption. This outweighs sluggish external demand from the eurozone and specifically Germany, an important export destination for Romania.
EU-funded investment will underpin what we consider a substantial growth outlook of about 3.6% on average between 2025 and 2027. EU funds of more than €49 billion are still available to Romania under the next 2021-2027 MFF and under the RRF. This roughly corresponds to annual EU fund inflows of about 3%-4% of GDP on average over the next few years. We expect Romania to receive the third tranche of the RRF funds--potentially up to €1.8 billion--in 2024, which will enable more investment in energy transition, transportation, and health care.
Romania's economy will face several structural challenges after 2027, including adverse demographic trends. The declining working-age population could increasingly drag on growth, absent reform efforts to address skill mismatches or improve the business environment, and ultimately to slow net emigration. Over the past decade, Romania's working-age population has decreased by about 1.1% per year and we expect this trend to reduce only marginally over the next few years.
EU transfers under the RRF are contingent on fiscal and political reforms under Romania's Recovery and Resilience Strategy, which are agreed upon with the European Commission. We therefore consider the RRF an important policy anchor that incentivizes the government to reform the country's institutional framework. Romania has some of the lowest governance indicators within the EU; corruption and government effectiveness specifically are weak points. While many political reforms under the Recovery and Resilience Strategy will be largely uncontentious, we think that those concerning the pension system, state-owned enterprises, and anti-corruption measures will be harder to implement. We note that the lack of improvement in Romania's fiscal position, along the lines of the European Commission's ongoing Excessive Deficit Procedure (EDP) against Romania, could delay some RRF funds.
Flexibility and performance profile: Pro-cyclical policies will weigh on Romania's twin deficits, which we expect will only narrow from 2025
Pre-election spending will push the general government deficit to close to 6% of GDP this year; without active consolidation measures, we do not expect deficits to dip below 5% of GDP until 2027.
CADs will remain elevated at slightly below 7% on average between 2024-2027, however, significant EU fund inflows will limit the increase in external debt over the next few years.
Inflation continues to decline, but we expect it to remain above the NBR's target of 2.5% (plus or minus 1 percentage point) at least until the second half of 2025.
We expect rising fiscal spending ahead of the four elections this year will push the deficit to 5.9% of GDP; we also assume only gradual consolidation thereafter. The Romanian government has announced a substantial increase in pension payouts (see "Romania's Proposed Pension Law Would Derail Medium-Term Fiscal Consolidation," published on Nov. 23, 2023 on RatingsDirect), which will occur toward the end of this year. We also expect a substantial pay rise in the public sector, and further discretionary spending seems likely. Pension increases and wage hikes will weigh on the budget for several years, which leads us to expect average deficits of more than 5% of GDP between 2025 and 2027. These projections already encompass consolidation measures equivalent to about 1.3% of GDP from 2024, including raising additional tax revenue from closing tax exemptions, adjusting specific tax rates, and improving tax collection. We therefore believe further fiscal adjustments could be required to reach the 3% of GDP deficit target stipulated by the EDP and the RRF framework by 2027. We expect such adjustments would likely target additional tax revenue, for example, VAT.
Romania's high deficits imply that net government debt will continually rise over the next years, reaching about 50% of GDP by 2027, despite high nominal GDP growth. We believe the country will meet most of its government financing requirements over the next several years on the domestic market, including from selling retail bonds and notwithstanding the domestic banking sector's already-substantial exposure to the government, at over 20% of its assets. In addition, Romania has built a good track record in issuing foreign currency bonds in international markets in recent years. Further external financing sources are available in the form of the loan component in the RRF and from pan-European financial institutions. Overall, over 50% of Romania's government debt is denominated in foreign currency, predominantly in euro. We forecast interest expenditure will exceed 6% of government revenue through 2027.
The expansionary fiscal policy will also contribute to high external imbalances and we expect the current account deficit will remain at 7% of GDP this year, and average 6.8% of GDP between 2025 and 2027. We expect the goods' trade balance to remain above 9% of GDP over the next few years, reflecting high domestic demand and some underlying competitiveness issues. At the same time, we expect the external financing mix will continue to include a significant share (between 50%-60% on average) of inflow of EU investment grants and FDI. This will also support the NBR's strong reserve position. We estimate reserves will remain at close to four months of current account payments over the next few years.
We forecast that the country's narrow net external debt will remain slightly below 30% of current account receipts on average until 2027. However, the existing stock of external debt and a high CAD will contribute to gross external financing needs remaining above 100% of current account receipts and NBR usable reserves over the next few years.
Inflation remains high in Romania, currently standing at 7.1% year-on-year in February. Although this represents a reduction from the peak of 14.6% reported in November 2022, we note that inflation has remained elevated and only gradually reduced over the past months. We think this raises the risk of inflation becoming more persistent over the next several months. We expect inflation to remain above the NBR's target of 2.5% (plus or minus 1 percentage point) until year-end 2025, also given the pro-cyclical fiscal policy and persistently high wage growth. This inflation outlook poses a challenge for the central bank, which has raised its main policy rate by a cumulative 5.75 percentage points between October 2021 and January 2023, to 7% currently, in an attempt to rein in inflation.
Romania's banking sector is predominantly foreign owned and largely deposit funded, and we see it as a limited contingency risk for the government. Nonperforming loans have marginally reduced further and remain in the European Banking Authority-defined low-risk bucket. Profitability improved from already high levels, and capital and liquidity ratios are healthy and slightly above the average of Central and Eastern European (CEE) countries. Still, loans to the private sector are only about 24% of GDP, reflecting a low level of financial intermediation, even compared with other CEE countries. The banking sector's elevated exposure to construction and real estate lending, alongside firms' rising level of indebtedness and a considerable share of foreign currency loans, could challenge financial stability if the related risks were to materialize."
