Fitch Affirms Romania at 'BBB -' with stable outlooks

Fitch Ratings has affirmed Romania’s Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at ‘BBB-‘ with Stable Outlooks. The issue ratings on Romania’s senior unsecured foreign – and local-currency bonds have also been affirmed at ‘BBB-‘/F3. The Country Ceiling has been affirmed at ‘BBB+’ and the Short-Term Foreign- and Local-Currency IDRs at ‘F3’.

According to rating agency representatives, Romania’s investment grade rating is supported by its still moderate level of public debt, stable banking sector, GDP per capita and governance indicators that are in line with ‘BBB’ range medians. However, the rating is facing an increase in downside risks owing to a substantial pro-cyclical fiscal loosening and rapid increase in wages in excess of productivity growth, which pose risks to macroeconomic stability.

Romania’s general government budget deficit widened to 3 percent of GDP in 2016 from 0.8 percent in 2015, despite the booming economy. The increase was due to large tax cuts and increases in public wages and social welfare payments. Fitch projects the deficit will widen to 3.7 percent of GDP in 2017, above the government’s target of 2.9 percent owing to further cuts in VAT and excise rates, and increases in public wage, pensions and other measures. Outturns for the first five months of 2017 show an underperformance in tax receipts of goods and services and corporate income, and the budget deficit (cash basis) RON 1.4 billion wider year-on-year, despite rapid economic growth and low execution of capital expenditure.

The structural budget deficit is set to widen to 3.9 percent of GDP in 2017, according to the European Commission, which would represent an expansion of 3.3 percent of GDP in two years, contrary to national and EU fiscal rules. Romania is at risk of re-entering the EU Excessive Deficit Procedure this year, having only exited it in 2013.

In Fitch’s view, there is a high level of uncertainty over the outlook for the budget deficit over 2017-2019 owing to an incompatibility between further expansionary fiscal measures in the government’s programme and its budget deficit targets of 2.9 percent in 2018 and 2.5 percent in 2019. The recently approved Unified Wage Law involves a 25 percent hikes in public sector wages (more for the health and education sectors), albeit potentially partially offset by a shift in social security contributions to employees from employers effective January 2018.

Nevertheless, Romania’s general government debt/GDP ratio remains in line with the median 41 percent ratio of ‘BBB’ rated peers. Fitch forecasts it to increase to 39.9 percent of GDP by end-2017 from 37.6 percent in 2016. Debt repayments are moderate, averaging 3.5-4.0 percent of GDP annually up until 2019, and the government holds an adequate cash buffer equivalent to 3.6 percent of GDP, covering 5.1 months of gross financing needs.

There is a risk of the economy overheating, although inflation and bank credit growth are currently subdued, Fitch said. The National Bank of Romania estimates that the economy is already operating around 2 percent above potential and this will increase as actual GDP growth outstrips potential growth, which most independent institutions estimate at around 3.5 percent. The labour market is tight, with unemployment at a record low and hikes in the minimum wage and public wages have contributed to average wages outstripping productivity growth by a large margin leading to rising unit labour costs. Against this background, Fitch forecasts the current account deficit to widen from 2.3 percent of GDP in 2016 to 3.1 percent in 2017 and 3.3 percent in 2018.

Romania’s ratings are supported by a stable banking sector, Fitch said. Banks are well capitalised (sector capital adequacy ratio 18.8 percent, 2016), sufficiently funded by local deposits and their balance sheets continue to improve as the share of non-performing loans declines. Legislative risks to the sector have stabilised following a favourable ruling by the Constitutional Court on the Debt Discharge Law and CHF loan conversion, diminishing the risk of a large financial cost for the sector.

However, recent political developments risk weakening governance indicators and government policy direction, Fitch said.