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, S&P said in a statement on Friday afternoon.
"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.
It expects a slowdown of Romania's economic growth in 2023, which it projects at 2.3%. Nonetheless, Romania's GDP growth will be one of the strongest real growth rates in Central and Eastern Europe (CEE).
S&P Global Ratings expects real GDP growth in Romania to moderate to about 3.6% over 2024-2026, underpinned by strong private consumption and substantial EU-funded investments.
The agency has increased its projections for Romania's fiscal deficits to 4.4% of GDP on average over 2023-2026, compared with 3.6% previously. It still expects the government to consolidate its fiscal position over the period, narrowing the deficit to 3% of GDP by 2026.
On September 11, Fitch Ratings reaffirmed Romania's outlook at 'stable' and the local currency issuer default ratings (IDR) at 'BBB-'. The rating is supported by EU membership and related capital inflows that support income convergence, external finances, and macro stability.
S&P also said in the statement:
We could lower the rating over the next two years if real growth fell significantly short of our current expectations, coupled with the government's medium-term fiscal consolidation efforts proving insufficient to sustainably reduce deficits.
We could raise the rating if the deterioration in the government's debt service costs proves transitory, perhaps due to an improvement in the structure of the debt or if lower inflationary pressure leads to looser monetary conditions.
We could also raise the rating if Romania's economic performance strengthens, supporting higher wealth levels, while the current account deficit (CAD) and government's fiscal deficit narrow, indicating the economy's strengthening productive capacity.
We expect economic activity in Romania to slow in 2023. Nevertheless, it will report one of the strongest real growth rates across Central and Eastern Europe (CEE), which we currently project at 2.3%. Private consumption remains relatively robust, backed by positive real wage growth since March. At the same time, EU-funded investments also underpin growth. Romania still has available EU grants equivalent to over 22% of estimated 2023 GDP under the RRF, as well as the previous and current Multiannual Financial Framework (MFF). Beyond providing economic support, the associated reforms required to receive EU funds and the country's EU membership in general constitute key policy anchors for Romania's institutional framework.
We have modestly increased our projections for Romania's fiscal deficits to 4.4% of GDP on average over 2023-2026, compared with 3.6% previously. We still expect the government to consolidate its fiscal position over the period, narrowing the deficit to 3% of GDP by 2026, but with a relatively weak performance expected this year, the path to 3% will be more challenging. We expect this year's deficit to remain around 6% of GDP, similar to the level in 2022. Parliamentary elections are scheduled for next year. Nevertheless, the government aims to implement fiscal consolidation measures to increase the revenue base from 2024. As a result, we expect the deficit to fall to around 5% of GDP next year. Our expectation of further consolidation measures over the next few years, coupled with high nominal GDP growth rates, will help stabilize net government debt at around 46% of GDP and interest expenditure at above 5% of government revenue through 2026.
At the same time, we note that Romania continues to report some of the highest external deficits across CEE. We expect the CAD will remain between 6%-7% of GDP through 2026, following a CAD of 9.1% of GDP in 2022, the highest level since 2008. Importantly, non-debt-creating inflows in the form of EU funds and net foreign direct investments (FDI) will continue to fund a significant share of Romania's external deficit (about 60% on average over the next three years) and the central bank's international reserves, increased to €65 billion in September (over 20% of GDP, buoyed by government deposits from the proceeds of recent foreign currency issuances and EU fund inflows). Though declining from its peak levels of 14.6% in November, high inflation poses a challenge for the National Bank of Romania (NBR), which has raised rates by a cumulative 5.75 percentage points since October 2021, to 7% currently. We classify the exchange rate regime as a managed float. Foreign currency interventions by the NBR remain moderate and have helped keep the Romanian leu broadly stable vis-a-vis the euro over the past 18 months.
Institutional and economic profile: Strong EU fund inflows will support economic growth over the next several years
We expect real GDP growth to slow to 2.3% in 2023, but for domestic demand to strengthen again over the period to 2026 and growth to accelerate close to 4%.
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 MFF 2021-2027 amounting to over €45 billion, close to 15% of estimated 2023 GDP.
The political establishment's commitment to further political reforms, and a balanced and credible fiscal agenda over the medium term, continue to be anchored by Romania's Recovery and Resilience Strategy.
Inflation has weighed on consumption and economic growth slowed to 1.7% in the first half of 2023. However, we note that the labor market has remained resilient and real wage growth in Romania already turned positive in March, earlier than for many other CEE countries. At the same time, EU-funded investments remain an important backstop of growth. The country is trying to finalize the funding cycle from the previous EU MFF 2014-2020. The remaining funding is about 2% of estimated 2023 GDP and is progressing quicker in the contracting of funds from the RRF. These developments outweigh sluggish external demand from the eurozone and Germany specifically, an important export destination for Romania.
EU-funded investments will also underpin what we consider a substantial growth outlook of about 3.6% on average over the next three years. EU funds available to Romania under the next 2021-2027 MFF still amount to €49.9 billion and the RRF to €13.5 billion, totaling over 20% of estimated 2023 GDP (€5.4 billion of RRF grants have already been received). This roughly corresponds to annual EU fund inflows of about 3-4% of GDP on average over the next few years. We expect Romania will receive the third tranche of the RRF funds in early 2024, well ahead of most other EU members as the country continues to implement required reforms in line with its Recovery and Resilience Strategy. This will enable progress on key investments in energy transition, transportation, and health care.
Romania's economy will face several structural challenges beyond 2026, including adverse demographic trends. The declining working-age population could become an increasing drag on growth, absent reform efforts to address skill mismatches or improve the business environment, and ultimately to slow net emigration. Before the pandemic, Romania's labor force was decreasing by about 1.2% per year and we expect this trend to only marginally reduce over the next few years.
The 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 incentivizing the government to implement reforms to the country's institutional framework, which the current government is progressing on. Romania has some of the lowest governance indicators within the EU, with corruption and government effectiveness as specific weak points. While many political reforms under the Recovery and Resilience Strategy will be largely uncontentious, others will be harder to implement, particularly those concerning the pension system, state-owned enterprises, and anti-corruption measures. Similarly, we note that lack of improvements to Romania's fiscal position, along the lines of the European Commission's ongoing Excessive Deficit Procedure (EDP) against Romania, could ultimately also result in the delay of some RRF funds. However, we expect progress on the Recovery and Resilience Strategy, given the high importance of EU funds for Romania.
Flexibility and performance profile: Romania's twin deficits will be higher than previously expected in the short term, but should moderate over the period to 2026
The budget deficit will remain at a substantial 6% of GDP this year, mainly due to a shortfall in tax revenue, but current consolidation efforts will help reduce the deficit to 3% by 2026, in our view.
We expect a moderate narrowing of the CAD over the next few years, from 9.1% of GDP in 2022 to about 6.3% by 2026, but high EU fund inflows will limit increases of external debt over the next few years.
Inflation continues to decline, but we expect price level increases will remain above the 1.5%-3.5% target band of the NBR until the second half of 2025.
Romania's fiscal deficit this year will exceed our previous expectations and the government's budget, mainly due to a shortfall in tax revenue, mostly value-added tax (VAT). We project the general government deficit will come in marginally above 6% of GDP this year. The consolidation measures announced in September aim to achieve Romanian leu 20 billion (1.3% of GDP) additional tax revenue annually from 2024 by closing tax exemptions, adjusting specific tax rates, and improving tax collection. These should help put the deficit on a downward trend, to slightly below 5% of GDP in 2024. We believe further fiscal adjustments could be required to reach the 3% of GDP deficit target stipulated by the EDP and the RRF framework by 2026. We expect such adjustments would likely target additional tax revenues, for example VAT.
Alongside fiscal consolidation, high nominal GDP growth will help stabilize net general government debt at 46% of GDP on average over 2023-2026. This is despite the pressure that rising interest expense will put on Romania's budget. We believe Romania 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 assets. In addition, Romania has built a good track record in recent years in issuing foreign currency bonds in international markets. 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 5% of government revenue over the next years until the end of our forecast horizon through 2026.
High domestic demand and rising import prices pushed the goods trade balance into a deficit of €32 billion in 2022 (11.2% of GDP), contributing to an overall CAD of 9.1% of GDP, the highest since 2008. Although a significant share of the external deficit has been brought about by higher import prices, namely energy, the persistently wide trade deficits over several years, in our view, also reflect underlying competitiveness issues. We expect moderating domestic demand and ongoing fiscal consolidation will help narrow Romania's CAD over the next years, to 6.3% of GDP by end-2026. At the same time, we expect the external financing mix to continue to include a significant share (about 60% on average over the next three years) of inflow of EU investment grants and FDI. This will also support the NBR's strong reserve position. Furthermore, the NBR has a €4.5 billion repurchase line with the European Central Bank. We estimate reserves will remain at above five 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 through 2026. 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 9.3% year-on-year in August. Although this represents a reduction from the peak of 14.6% reported in November 2022, we note that inflation has remained rather stable and elevated around current rates since April. This raises the risk of inflation becoming more persistent over the next several months. We expect inflation to remain above the NBR's tolerance band of 1.5%-3.5% until the second half of 2025.
The central bank 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 reduced further and are in the European Banking Authority-defined low-risk bucket. Profitability remains high, and capital and liquidity ratios are healthy. Still, loans to the private sector are about 26% of GDP, the lowest level in Europe, limiting the financial sector's ability to act as an intermediator and catalyst to economic activity.
