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S&P affirms Romania at BBB-/A-3 with stable outlook, warns on excessive fiscal loosening

S&P affirms Romania at BBB-/A-3 with stable outlook, warns on excessive fiscal loosening Romania ratings Author (SeeNews Wire) License: all rights reserved.

BUCHAREST (Romania), April 7 (SeeNews) - Standard & Poor's maintained on Friday 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.

"Romania's fiscal and external deficits are increasing on the back of a procyclical fiscal stance, although strong nominal GDP growth is keeping government and external debt ratios contained for now. We are therefore affirming our 'BBB-/A-3' ratings on Romania," S&P said in a statement.

S&P added that the stable outlook reflects the agency's expectation that Romania's twin deficits will widen as a result of the government's loose fiscal stance, while general government and external debt will remain at modest levels supported by strong economic growth.

S&P last reviewed Romania's rating on October 7, 2016, when it affirmed it at BBB-, with a stable outlook.

In March, Japan Credit Rating Agency (JCRA) has affirmed the outlook on Romania's long-term government debt in foreign currency and local currency to BBB/BBB+ stable.

In January, Fitch Ratings has affirmed Romania's long-term foreign and local currency issuer default ratings (IDR) at 'BBB-', with stable outlooks.

Moody's last reviewed Romania's rating in December 2015, when it improved the outlook on the country's Baa3 rating to positive from stable.

Standard & Poor's also said in the statement: 

"RATING ACTION

On April 7, 2017, S&P Global Ratings affirmed its 'BBB-/A-3' long- and short-term foreign and local currency sovereign credit ratings on Romania. The outlook is stable.

RATIONALE

The ratings are supported by Romania's moderate external and government debt, amid reasonably firm growth prospects. The ratings are constrained by low income and wealth levels (we estimate Romania's GDP per capita at $9,300 in 2017, the second lowest in the EU), alongside a widening budget deficit and Romania's weak institutional and governance effectiveness, although we note ongoing efforts to reduce corruption in recent years.

Amid a relatively low turnout in which only about 40% of the electorate cast their vote, the Social Democrats (SDP) gained 45% of the vote and formed a coalition with the liberal ALDE party. Shortly after the election, large scale public protests erupted over an emergency decree the government passed that decriminalized the abuse of public office for offenses valued at less than RON200,000 (roughly USD50,000). Shortly after it was passed, the government repealed the decree amid public protests and strong opposition from President Iohannis, opposition parties, and the European Commission.

Nevertheless, the fall-out from this controversial attempt to decriminalize potentially corrupt behavior by public officials has also indicated that Romania's system of checks and balances may be strengthening. We view positively that both the country's president and judicial institutions such as the High Court of Cassation and Justice (Romania's supreme court), and the National Anticorruption Directorate (DNA) issued negative opinions on the emergency decree.

Overall, however, we expect the current ruling coalition will remain stable over its parliamentary term as it enjoys a relatively comfortable majority. Although recent opinion polls have shown a strengthening of the opposition following the political turmoil earlier this year, recent history has shown that coalitions can be short-lived in Romania if new corruption accusations emerge or other controversial laws are being passed. Therefore, we cannot rule out the risk of renewed bouts of political uncertainty over our forecast horizon.

Despite an uncertain pre-election period and turbulence post-election, the economy has shown signs of resilience and strengthening. In 2016, growth reached 4.8%, one of the fastest rates in the EU (for more, see www.spratings.com/sri). Strong exports, in both the goods and services sector, and buoyant private consumption on the back of tax cuts, wage increases, and a strengthening labor market strongly supported this growth. Moreover, very strong private investments (up by over 10% year-on-year) were able to offset the fall in public investment stemming from the transition between EU programming periods.

We expect a similar growth mix to support average growth of 3.1% through to 2020. That said, we expect structural constraints, such as a tightening labor market, a shrinking labor force,and relatively weak infrastructure will weigh on potential growth in the medium term and may reduce output growth to below 3% by 2019/2020. Moreover, we expect that budgetary constraints will necessitate a more restrictive fiscal policy stance in the medium term.

In the near term, however, growth will face tailwinds from the government's procyclical fiscal stance. In 2017, the government further cut the main value-added tax (VAT) rate from 20% to 19% with a potential additional cut to 18% in 2018. On the expenditure side, EU co-sponsored investment is expected to resume but, more importantly, current spending--especially on wages and pensions--will also significantly increase. Certain wages in the public sector, such as in health and education, have seen double-digit increases, which has set precedents for private sector wage increases as well. Moreover, the pension point, a key component for calculating government pensions, was increased by 9% to RON1,000 (effective as of July 1, 2017).

Taking into consideration these very accommodative fiscal measures and our growth forecast, which is lower than that of the Romanian government, we expect the deficit to reach 3.6% of GDP this year, against the government's explicit target to stay below 3% of GDP in the medium term. In the medium term, it could gradually decrease to around 3% by 2020 if the current growth momentum is sustained and no additional deficit-increasing measures are passed. However, we note a significant degree of uncertainty around the fiscal deficit forecast. This is because the government has pledged to implement a host of other measures, such as cuts in social security contributions and a differential reduced personal income tax on the revenue side, and a unified public wage system on the expenditure side. The International Monetary Fund estimates these measures combined could cost the government over 4% of GDP in 2017-2020.

Romania's sustained fiscal deficits will also lead to a gradual but steady increase in general government debt levels, both in nominal terms and as a percent of GDP. While still low in a European comparison, we forecast gross general government debt will increase to over 42% of GDP by 2020. More than half of Romania's government debt is denominated in foreign currency, mostly euros, increasing the country's reliance on access to external markets. We note, however, that the government has increasingly been able to borrow domestically. That said, access to the domestic market may become more difficult because domestic banks have increased their exposure to the government over the last few years, meaning individual institutions could approach internal exposure limits.

Overall, Romania's debt profile has become more robust. Average maturity on Romania's Eurobonds was eight years and on domestic debt it was 5.8 years at year-end 2016. In addition, the government maintains a cash buffer amounting to at least four months (currently standing at five months) of gross financing needs, which should reduce risks if the external environment becomes more challenging, for instance as a result of a faster rate hikes by the Federal Reserve.
We note a gradual improvement in Romania's external debt ratios as a result of the government's increased efforts to rely on domestic borrowing to meet its net borrowing needs, paired with the banking sector's continued external deleveraging which was facilitated by strong domestic deposit growth averaging 8.3% over the last three years. We expect the external deleveraging in the banking and government sector will continue, albeit more gradually.

At the same time, external flows will likely deteriorate, which we reflect in our forecast that the current account deficit will widen. Between 2015 and 2016, the current account deficit as a percentage of GDP doubled to around 2.4% as the fiscal stimulus boosted domestic demand, especially consumption, and led to a continued negative contribution of net exports to growth. We expect this trend will continue and that further fiscal loosening will widen the current account deficit to above 3% of GDP by 2020. That said, we forecast that this widening deficit will continue to be financed by non-debt-creating inflows, that is by net FDI and EU fund inflows.

Romania's banking sector continues to be faced with adverse regulatory initiatives, such as the law on debt discharge that allowed borrowers the right to discharge debt by transferring the title on a mortgaged property to creditors. However, this law was watered down somewhat by a Constitutional Court ruling that the borrower has to prove exceptional hardship. Similarly, a proposed blanket conversion of Swiss franc-denominated mortgages that parliament passed last year was struck down by the Constitutional Court. This has made its final implementation less likely, in our view.

In both instances, the National Bank of Romania (the central bank) criticized the proposed laws, asserting its independence and credibility. Nevertheless, the central bank has struggled to reach its inflation target of 2.5% (± 1 percentage point). This is because deflation has persisted over the last two years as a result of cuts in indirect taxes and low commodity prices. As these effects begin to fade and slightly higher oil prices, strong wage growth, and an economy operating above potential all add to price pressures, we expect inflation to move back into the target range by the end of this year.

Overall, Romania's banking sector has strengthened in the last two-to-three years, in particular with the system's loan-to-deposit ratio declining to just over 80% at end-2016, down from its peak of 137% in 2008. Moreover, banks have maintained their profitability and overall lending growth has remained positive. Loans to households and loans denominated in Romanian leu have grown particularly strongly such that the share of foreign currency loans declined to less than 43% of total loans at end-2016, down from almost 64% in 2011. Nonperforming loans, while still relatively high at 9.5% of total loans at year-end 2016, have more than halved since end-2014, a trend that is expected to continue.

OUTLOOK

The stable outlook reflects our expectation that Romania's twin deficits will widen as a result of the government's loose fiscal stance, while the general government and external debt will remain at modest levels supported by strong economic growth.
We could raise the ratings if Romania's government made more sustained headway with budgetary consolidation and put net general government debt firmly on a downward trajectory, including by successful restructuring or privatization of public enterprises; and if Romania's governance framework improved, translating into more predictable and stable macroeconomic growth and government finances.
We could lower the ratings on Romania if we considered that policy reversals could cause general government deficits, debt, and borrowing costs to deteriorate significantly, or if Romania's external imbalances re-emerged."

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