S&P affirms Romania at BBB-/A-3 with stable outlook on moderate debt, strong growth prospects

S&P affirms Romania at BBB-/A-3 with stable outlook on moderate debt, strong growth prospects Romania ratings Author (SeeNews Wire) License: all rights reserved.

BUCHAREST (Romania), March 3 (SeeNews) - Standard & Poor's maintained Romania's rating at BBB-/A-3, with a stable outlook, due to the country's Romania's moderate external and government debt, amid strong growth prospects.

"The stable outlook reflects our expectation that, although Romania's twin deficits will remain elevated as a result of the government's pro-cyclical fiscal stance, general government and external debt will increase only gradually over the next two years, barring a major economic slowdown," S&P said in a statement late on Friday.

S&P also said it could raise the ratings if Romania's government made more sustained headway with budgetary consolidation, put net general government debt firmly on a downward trajectory, and strengthened its governance framework, translating into more predictable and stable macroeconomic growth and government finances.

On the other hand, ratings could be lowered if S&P considered that policy reversals could cause general government deficits, debt, and borrowing costs to increase significantly. Moreover, S&P would consider a negative rating action if external imbalances re-emerged, in particular if an uncertain political environment led to lower foreign direct investment (FDI) inflows, implying that Romania's widening current account deficit would increasingly be financed with debt.

S&P last reviewed Romania's rating on October 2017, when it affirmed it at BBB-, with a stable outlook and said that the country's budget and trade deficits will widen due to the consumption-focused growth.

In April 2017, Moody's Investors Service 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.

Standard & Poor's also said in the statement: 

The ratings are supported by Romania's moderate external and government debt, amid strong growth prospects. However, we estimate Romania's GDP per capita at just over $10,000 in 2017, the second lowest in the EU. Low income and wealth levels therefore constrain the rating, alongside Romania's widening budget deficit, weak institutional and governance effectiveness, and continued political uncertainty.
Institutional and Economic Profile: Political volatility overshadows the economic boom

In 2017, Romania's economy was among the fastest growing in the EU.
Continued conflict within the ruling party, PSD, led to the appointment of three consecutive prime ministers within 14 months.
Structural reform efforts remain weak, while fiscal policy is expedient and consumption focused.

Fiscal stimulus and a favorable external environment sparked an economic boom in Romania last year. We forecast the economy will have expanded by 7%, fueled mainly by domestic demand, especially related to consumption, which was supported by double-digit wage growth and tax cuts that boosted disposable incomes. Net external demand, however, most likely subtracted from growth as domestic demand pushed up imports. Overall, Romania's average per capita growth exceeds that of its peers. But we expect this momentum to be transitory, albeit fairly long lasting, given that the increased absorption of EU funds should bolster solid investment growth in the later years of our forecast horizon through to 2021.

In 2018, we forecast a moderation of real GDP growth to about 4.7%. Budgetary constraints will limit the government's ability to add fuel to Romania's economy while structural factors start to impede growth. A reduction of Romania's headline unemployment rate to 4.9% in 2017 indicates increasing shortages in skilled labor. Moreover, if rapid wage increases, which arguably foster convergence and may help reduce net emigration, were to continue, Romania's hard-won competitiveness gains could quickly erode.

In the medium term, GDP growth rates will converge toward those more in line with Romania's growth potential, absent stronger structural reform efforts. We forecast average growth of 3.5% annually in 2019-2021. Repeated bouts of political volatility have distracted the government's attention from reforms that could boost the economy's long-term growth potential. In particular, Romania's business environment has deteriorated over the past three years, as indicated by the World Bank's Doing Business survey and the World Economic Forum's Global Competitiveness Ranking, with Romania dropping by as many as 15 spots in the latter ranking.

A lack of visibility on the government's agenda and frequent revisions to the country's tax code have hampered businesses' ability to make long-term plans. Another leadership battle between Prime Minister Tudose and PSD party leader Liviu Dragnea, who is barred from becoming prime minister due to an indictment for abuse of public office, led to the resignation of Prime Minister Tudose in January 2018. This is the second change in that position, after the previous prime minister, Sorin Grindeanu, lost a no-confidence motion put forward by his own party less than six months into his term. It remains to be seen whether Prime Minister Viorica Dancila, Romania's first female prime minister, will be able to steer a stable government for the remaining legislative period.
More concerning than the frequent turnover at the helm of the government are frequent attempts to implement legislative changes that could diminish checks and balances between institutions and potentially delay structural reforms. Romania continues to suffer from corruption, although the work of the anti-corruption agency, DNA, has led to gradual improvements in recent years. The government is yet to implement important reforms, such as those to improve the country's infrastructure or the health and education sector. In the medium term, these structural factors could hamper growth and act as a deterrent for foreign investors.

Flexibility and Performance Profile: Widening twin deficits amid remaining fiscal and external buffers

Despite continued easing, the fiscal deficit was about 2.9% of GDP in 2017.
Last year, the current account deficit almost doubled in nominal terms, although its funding remains stable.
Inflation has accelerated, leading the National Bank of Romania to raise rates in January this year, for the first time in almost a decade.

Stronger-than-expected revenue performance, thanks to high nominal GDP growth and another year of underspending of the capital budget, helped keep the general government budget deficit below 3% of GDP in 2017. Increased dividends from state-owned enterprises and a hike in fuel excise taxes contributed to this development. However, double-digit wage increases in the public sector have tilted the structure of government spending further toward social- and wage-related spending and away from investment. Romania's high fiscal deficit during very rapid economic expansion highlights the country's vulnerability to potential external shocks. Moreover, it erodes painful fiscal gains achieved during post-crisis years.

We note the authorities' strong commitment to the general government deficit remaining below the 3% of GDP Maastricht deficit ceiling, partly because a breach could jeopardize Romania's access to EU structural funds. Still, we forecast a deficit of 3.6% of GDP in 2018, based on likely lower growth, among other factors. Moreover, we believe the government's strategy, which was previously to slash investment spending to keep the deficit in check, is not sustainable, given Romania's infrastructure needs. Rather than using one-time measures, Romania's government will need to find ways to close the gap between value-added tax (VAT) owed and VAT collected, which is the widest in the EU, according to data from the European Commission. We believe these pressures on Romania's budget will persist over our forecast horizon through to 2021.

In line with our deficit forecast, we also expect Romania's general government debt will continue to increase. While still modest in an EU comparison, we forecast Romania's debt could reach 42% of GDP by 2021. Moreover, its debt profile remains constrained by a relatively high share of foreign-currency-denominated debt, as well as the domestic banking sector's high exposure to the government. Government measures that will lower contribution rates to the second pension pillar may have adverse effects on the sovereign's ability to refinance itself on the domestic market, given banks' already high exposure to the government. In recent months, a spike in inflation figures and an associated rise in inflation expectations have depressed demand and pricing in domestic bond auctions. However, the government continues to cover a large part of its financing needs on the domestic market. Importantly, the government maintains a hard currency buffer covering four months of gross financing needs, which provides an additional safeguard during periods of market turbulence. We do not expect any significant impact on government debt from potential privatizations in the medium term. The Romanian government is in the process of setting up a so-called Sovereign Development and Investment Fund (FSDI) with legislation expected to pass in 2018 and the fund potentially becoming operational in 2019. This fund will pool the state's shares in a number of state-owned enterprises, such as Hidroelectrica, and is supposed to more efficiently carry out and finance larger investment projects. Together with a to-be-established development bank, this could fuel investments. The government aims to create the FSDI outside the general government sector as defined by the European system of national and regional accounts.

In nominal terms, Romania's current account deficit almost doubled in 2017, reaching $7.7 billion (3.8% of GDP). Robust export performance was not able to offset the impact of domestic demand on the import side of the trade balance. Rising import prices, especially for energy, also had an adverse effect on the current account. We forecast an increasing current account deficit in nominal terms, although as a share of GDP it could start declining after peaking at over 4% of GDP in 2018 to about 3.9% of GDP by 2021. Surpluses on the financial and capital account covered about 80% of the current account deficit in 2017. An acceleration of EU fund absorption and continued FDI inflows could help maintain similar levels of financing over our forecast horizon. However, we note downside risks should Romania fail to boost its EU fund absorption capacity or slip back into large deficits. Moreover, rapid wage growth, lack of infrastructure development, and persisting political uncertainties could reduce Romania's attractiveness to foreign investors.

Stable, non-debt-creating inflows to fund the current account deficit will also contain Romania's external debt metrics in our base-case scenario. We forecast net narrow external debt, our preferred measure, will average 25% of current account receipts (CARs), while gross external financing needs will be less than 100% of CARs on average throughout our forecast horizon. Continued external deleveraging, in particular by Romania's financial sector, which used a period of low credit demand and rising deposits to repay loans to foreign parent companies, helped Romania achieve the fourth-lowest narrow net external debt ratio in the EU in 2017 (for more, see www.spratings.com/sri).
Romania's predominantly foreign-owned banking sector remains sound, in our view. The system's loan-to-deposit ratio declined to just over 76% at year-end 2017 from its peak of 137% in 2008. Liquidity and solvency ratios remain strong, and banks have maintained their profitability despite low interest rates. Lending growth has remained positive for the past two years, with loans to households and loans denominated in Romanian leu increasing strongly. Most of the credit growth stems from mortgage loans that benefit from the government's Prima Casa program, designed to support first-time homebuyers through a 50% guarantee by the government. Nonperforming loans have shown an impressive decline, reducing more than threefold to less than 8% of total loans by Sept. 30, 2017, from over 21% at midyear 2014.

Romania continues to operate a managed float of the Romanian leu under an inflation-targeting regime. At the end of 2017, inflation moved toward the upper end of the National Bank of Romania's target band of 2.5% (+/-1%) and, in January, it even exceeded the target (4.3% year on year). As a result, the central bank raised rates twice, for the first time in a decade, by a total of 50 basis points. We expect inflation will ease back toward the upper end of the target range by year-end 2018, although further increases cannot be ruled out."

(1 euro=4.6590 lei)

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