Unicredit estimates economic slowdown in Romania, higher taxes and risk of budget deficits exceeding 3% of GDP in 2018-19

Sorin Melenciuc 12/04/2018 | 11:03

The economic growth rate in Romania will slow down to 4.4 percent in 2018, from close to 7 percent last year, and  the government risks to register budget deficits exceeding 3% of GDP in 2018 and 2019, due to further populist spending, Unicredit economists estimate in CEE Quarterly Report. 

“Economic growth is expected to slow to 4.4 percent in 2018 and 3.6 percent in 2019, with consumption and investment affected by slower wage growth, fiscal uncertainty and rising borrowing costs. Romania is facing two clashes with the EU on judicial and fiscal issues. The risk of a return to the Excessive Deficit Procedure (EDP) in 2019 remains high,” says the report, signed by Dan Bucsa, Chief CEE economist at UniCredit Bank.

The economists forecast two potential clashes with European institutions in the second quarter of 2018, one on judicial and one on fiscal issues.

“The two are connected. The clash between the executive and legislative branches of government on the one side and the judicial branch on the other side could intensify. The governing coalition are trying to bring some judicial changes which attracted criticism,” Unicredit indicates.

The bank’s economists see rising risks of political clashes in Romania with impact on the economy.

“As long as President Klaus Iohannis opposes these changes, one of the few solutions available for the governing majority would be to impeach the president1. However, this may backfire because the president has the support of European and US officials and a majority of voters may back Mr. Iohannis in a referendum,” Unicredit economists said.

The report reminds that a draft of controversial laws passed by parliament at the end of 2017  eroded the government’s popularity at home and cost PSD the support of the socialist group in the European Parliament.

“This increases the risk of an Article 7 procedure against Romania (implying the suspension of the voting right in the European Council) if the PSD-led coalition implements the unpopular judicial changes,” Unicredit estimates.

According to the economists, the second potential clash between Romania’s goverment and EU refers to loose fiscal policy and the risk of budget deficits exceeding 3% of GDP in 2018-19.

“The governing coalition is trying to keep its voters happy amid political turmoil by repeatedly increasing wages and pensions. However, the scope for further populist spending is very limited without incurring larger budget deficits or raising taxes,” the report said.

The goverment transfered all social security contributions from employers to employees from the start of this year, slowing the rise in net wages, and cancelled the bureaucrats’ wage increase in 2018.

“This stealth tax increase will not be sufficient to keep the budget deficit below 3% of GDP in 2018-19 because higher social spending was coupled with a cut in the personal income tax from 16% to 10%. The government did not implement any of the offsetting measures recommended by the European Commission in December,” Unicredit points out.

Last year, the budget deficit was close to 3 percent of GDP (2.83 percent on cash), after 3 percent of GDP in 2016, and Romania risks to return to the excessive deficit procedure.

“The government may try to keep the budget deficit in check by cutting public investment for a fifth year in a row and by increasing taxation. (…) Last year’s discretionary wage increases for local administration may be covered out of higher local taxes this year. In addition, a growing number of PSD leaders favor scrapping the flat personal income tax rate and replacing it with a progressive system,” Unicredit estimates.

Unicredit’s economists forecast that Romania’s GDP will grow to EUR 201.2 billion (EUR 10,275 per capita) in 2018 and to EUR 213.7 billion (EUR 10,946 per capita) in 2019, from close to EUR 188 billion (around EUR 9,500 per capita) last year.

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