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S&P Global Ratings affirms Romania at BBB-/A-3 with stable outlook

S&P Global Ratings affirms Romania at BBB-/A-3 with stable outlook credit rating

BUCHAREST (Romania), October 16 (SeeNews) - Standard & Poor's 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 reflects our expectation that Romania's fiscal balances will improve over the next two years, S&P said in a press release on Friday evening.

"We anticipate that the policy anchors of the Recovery and Resilience Facility (RRF) and the ongoing Excessive Deficit Procedure (EDP) will require reforms, and expect these instruments to invoke fiscal stringency in a complex and unpredictable political setting, " S&P added.

In the agency's view, the dismissal of the Citu government after a no-confidence vote has left Romania without a government in the midst of surging COVID-19 infection levels and much-needed fiscal consolidation.

Although persistent political uncertainty could accentuate fiscal risks over the medium term, we expect adherence to the ongoing Excessive Deficit Procedure to enforce budgetary consolidation sufficient to stabilize net government debt below 50% of GDP by 2024.

According to S&P, risks from Romania's still-elevated twin deficits are mitigated by the prospect of sizable EU funds deployment, a reform program that is anchored in the recently agreed Recovery and Resilience Facility plan, and strong economic growth prospects.

S&P last reviewed Romania in April, when it has revised its outlook to stable from negative due to decreasing fiscal risks, while maintaining rating at BBB-/A-3.

Also on Friday, Moody's said it has changed the outlook on Romania to stable from negative and affirmed the Baa3 foreign and domestic long-term issuer and senior unsecured ratings.

In a statement issued on Friday evening, Romania's finance ministry said that decisions of the two rating agencies are proof of the government's sound economic measures. "The announcements are a sign of confidence in our fiscal consolidation policies, in our possibility of achieving assumed targets and of implementing reform through the Recovery and Resilience Plan, PNRR. At the same time, the reconfirmation of Romania's rating is a proof of our external partners' confidence in the government's capacity to implement reforms laid out in the PNRR," finance minister Dan Vilceanu said.

S&P also said in the statement:

"Outlook

The stable outlook reflects our expectation that Romania's fiscal balances will improve over the next two years. We anticipate that the policy anchors of the Recovery and Resilience Facility (RRF) and the ongoing Excessive Deficit Procedure (EDP) will require reforms, and expect these instruments to invoke fiscal stringency in a complex and unpredictable political setting.

Downside scenario

We could lower the ratings if:

Romania's efforts to rebalance its budget derail because of persisting political gridlock, endangering the consolidation of its fiscal finances, and adding to Romania's external deficits; or
Financing for Romania's twin deficits is oriented toward debt-creating foreign flows, signaling an inability to absorb EU funding sources and restore foreign direct investment (FDI) flows.

Upside scenario

We could raise the ratings if Romania's economic growth becomes sustainably investment-led, strengthening productive capacity and leading to meaningfully improved wealth levels. We would expect this scenario to be accompanied by reforms that foster a more-solid fiscal framework that limits the potential for costly policy reversals. Aside from making Romania's fiscal framework more predictable, these reforms would likely revitalize foreign investor interest in the country's real economy, making the sovereign less sensitive to external developments.

Rationale

Despite the heightened political uncertainty following the government's recent dismissal on a no-confidence vote, we expect that the policy anchors in the recently approved RRF plan and the ongoing EDP will invoke sufficient fiscal discipline to overcome partisan wrangling and produce budgetary consolidation over the coming two years.

We maintain our view that Romania's consolidation course will ensure that the government and external debt stocks remain moderate through 2024, with net general government debt stabilizing just below 50% of GDP and narrow net external debt below 45% of current account receipts.

We expect the government's fiscal efforts will be facilitated by a rebounding economy as activity appears unaffected by periods of recurring political instability. The pandemic remains a pressing issue, however, because infection levels have surged since August, resulting in significant pressure on the health care system and rising mortality rates. Although we do not foresee a return to full-scale lockdowns, we cannot rule out additional restriction measures, dampening economic activity in the fourth quarter.

The economic rebound in 2022-2023 will rely on the successful execution of EU-funded investments because Romania stands as a key beneficiary of grants under the RRF and 2021-2027 Multiannual Framework, which combined have a total envelope exceeding 20% of GDP over the next six years. In this respect, the country's comparatively weak track record in absorption of EU funds stands as a risk.

The ratings are further supported by Romania's solid access to external financing markets together with the benefits from the country's EU membership, which constitutes a key policy anchor and benefits the country's institutional framework.

Institutional and economic profile: Strong GDP growth continues to offset the lack of structural reform efforts

The Citu government's dismissal has increased political risks, with budgetary rebalancing yet to find traction.
We expect Romania's economic growth to reach 7.0% in 2021 and average 4.6% over 2022-2023 as investment bolsters activity amid rising consumption.
Surging COVID-19 infections could require new restrictions as the vaccination campaign lags.

The fall of the Liberal Party (PNL)-led minority government of Mr. Florin Citu on Oct. 5 following a no-confidence vote, the third it had faced over its nine-month tenure, illustrates the confrontational and volatile nature of Romanian coalition politics.

It remains unclear how the next government will be composed. On Oct. 12, President Klaus Iohannis nominated Dacian Ciolos of the URS-Plus party to present a government that could receive parliamentary approval, but from statements by the possible coalitions partners, it remains uncertain if Mr. Ciolos will succeed. In view of the severe COVID-19 situation, we believe that political parties will have an incentive to quickly form a functioning government that can guide the country through the pandemic's fourth wave. If two consecutive prime minister designees fail to get Parliamentary approval, we believe the president could be compelled to call new elections.

Romania's economy staged a strong comeback in 2021, with output returning to prepandemic levels by the first quarter. Activity has remained solid through the third quarter on rebounding consumption, investment activity, and favorable agriculture output.

We expect Romanian output to expand by 7% in 2021 and remain steady in 2022-2023 on a recovery in private consumption and uptick in investment, in particular within the public sphere. The latter will be boosted by the government's investment agenda, itself supported by financing from plentiful EU funds that are designated for Bucharest.

The rebound faces headwinds, however, because the pandemic's fourth wave has hit Romania hard. Only 31% of the population had been fully vaccinated by Oct. 6, the second-lowest rate in the EU and less than half of the government's target of 70% by September, announced at the beginning of the year.

Our economic forecast remains sensitive to the still-uncertain situation regarding the pandemic and continued delays in vaccination rollout from a high degree of vaccine hesitancy. The country's comparatively weak absorption of EU funds also remains a risk.

On Sept. 27, the European Commission approved Romania's recovery and resilience plan, effectively unlocking €14.2 billion in grants and €14.9 billion in loans to Romania under the RRF, which totals 12% of GDP. Disbursements under the RRF are based on reaching milestones, reflecting progress on implementing investment and reforms. We consider the RFF an important policy anchor that can provide incentive and facilitate key reforms to promote sustainability in Romania's social spending. We anticipate progress on reforms to be most likely over 2022-2023 before the political situation returns to election mode in the run-up to the 2024 super election year.

Flexibility and performance profile: The front-loaded NextGen EU inflows are set to assist fiscal consolidation and will be necessary to fund the elevated external deficit

We expect fiscal rebalancing efforts to stabilize Romania's net general government debt at just below 50% of GDP while keeping interest expenditure below 5% of revenue.
Inflows from the NextGen EU funds and returning FDI are set to fund the majority of Romania's elevated current account deficits in 2022-2023.
We consider firm budget consolidation key to economic stability, and its progress will be essential to the National Bank of Romania's (NBR's) policy as it starts to normalize interest rates.

Romania's nominal GDP growth is slated to be over 10% for 2021, providing a strong backdrop for windfall fiscal revenue. In its budget revision in August 2021, the government increased spending, leaving the expected general government deficit nominally higher compared with the original budget stipulation. We forecast the fiscal deficit will stand at 7% of GDP in 2021, unchanged from our previous expectations, and leading to general government debt nearing 50% of GDP by year-end.

Romania entered the pandemic with the highest structural budget deficit in the EU, emphasizing an overdue need to rebalance the budget's composition. With spending on wages and pensions standing at about 90% of tax revenue, the country's budget structure is highly rigid. While the political upheaval clouds the trajectory of budgetary consolidation, we believe that adherence to pan-European policy requirements, outlined in the ongoing EDP dialogue and detailed in the milestone achievements required for disbursements of RRF funds, will enforce fiscal discipline.

In this respect, we anticipate that the government will be required to formalize and broaden its budgetary rebalancing efforts as the EDP progresses with the goal of concluding in 2024. We expect efforts both on the expenditure and revenue side, such as improved revenue performance and closing of the largest value-added tax gap in the EU.

We forecast the fiscal deficit will decrease toward 3% of GDP in 2024, supported by the government's medium-term consolidation ambitions in tandem with the rebounding economy. We continue to believe this will halt the erosion of Romania's government balance sheet and see its net general government debt to GDP stabilizing at just below 50% by 2024.

We estimate the gross public-sector financing requirement over 2021 at Romanian leu 135 billion or about 11% of GDP, and we expect a majority will be sourced from the domestic market. To date, about 70% of the financing need has been covered. In this regard, we anticipate that the domestic banking sector will support the government's financing needs, although its capacity to cover the government's financing needs is constrained given that the sector's existing exposure to the government, at more than 20% of its assets, is already substantial.

We forecast that Romania's interest expenditure will remain below 5% of government revenue. While rising interest expense would further strain an already-rigid budget, we acknowledge Romania's solid market access and the benign financing conditions will mitigate its higher debt burden. The country's borrowing costs stand below effective interest rates on existing debt. The state treasury enjoys flexibility from a sizable hard currency buffer of about 3% of GDP and has restarted its retail issuance program to expand its domestic sources of financing.

We expect Romania's current account deficit to average close to 6% of GDP through 2024 as domestic consumption and investments spur imports. Although the external deficit is a consequence of the fiscal imbalances, the widening trade deficit, in our view, also reflects underlying competitiveness problems. Furthermore, over the past three years, the current account deficit has been increasingly covered by debt-financed inflows, which we expect will push Romania's narrow net external debt ratio to close to 40% of current account receipts in 2021. We believe the financing mix of the external deficit will improve in 2022-2023 on the front-loaded absorption of NextGen EU grants and resumed FDI flows. We forecast that the country's narrow net external debt will stabilize below 45% of current account receipts in 2023.

Further widening of the fiscal and external imbalances could precipitate external financing stress and complicate monetary policy execution under the leu's managed float regime. These risks are pronounced, especially in the context of still-meaningful euroization. Elevated exchange rate volatility could have repercussions on public- and private-sector balance sheets because about half of Romania's government debt and an estimated 35% of financial sector deposits are denominated in foreign currency.

Consumer price inflation has accelerated over 2021, rising to 5.3% in August year on year, driven by elevated growth in energy prices, and core price pressures. To curb inflationary developments, and conscious of the risks stemming from a persisting political deadlock pressuring the currency, the NBR hiked its policy rate by 25 basis points to 1.5% on Oct. 6.

In annual average terms, we project headline inflation will remain above the NBR's target band of 2.5% plus or minus 1 percentage point, prompting the central bank to continue normalizing its policy over the first half of 2022.

We expect the NBR will uphold its policy credibility, retain its independence, and anchor inflation expectations while keeping a tight rein on the exchange rate. The NBR's foreign exchange reserves stood at a high €46 billion (19% of GDP) in September 2021, providing plenty of room to assist the currency if needed. The NBR showed its support of government financing efforts as it deployed and executed government bond purchases in March 2020 that provided liquidity to the market and helped unfreeze the erratic domestic government bond market at that time.

The NBR again demonstrated its attentiveness as it returned to the secondary markets in March 2021 to smooth out the tendencies of bond selloffs. We estimate that the central bank holds 2.5% of total domestic government commercial debt on its balance sheet. Although we anticipate that the NBR will absorb additional government debt via secondary market purchases in extraordinary circumstances, we do not expect any move toward full-scale monetary financing of the government's budget.

Romania's predominantly foreign-owned banking sector remains sound, in our view, and we see it as a limited contingency risk for the government. Nevertheless, 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 26.4% of GDP in August 2021, the Romanian banking sector ranks last in Europe in terms of financial intermediation.

The system is largely deposit-funded, with a sectorwide loan-to-deposit ratio of 68.6% in June 2021 (compared with its peak of 131% in 2008). We anticipate that the system is likely to absorb lower profitability owing to the Ministry of Finance's loan moratorium that extended to March 2021. The system also benefits from low levels of nonperforming loans, which, at 4%, are markedly lower than the over 21% reached in June 2014. However, some deterioration in asset quality might be inevitable as support measures are withdrawn over 2021."

(1 euro=4.9484 lei)

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