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Down but not out, Romania is just a riskier bet

The cards have been stacked against Romania in a turbulent year

Analysts have downgraded Romania in Euromoney’s country risk survey according to preliminary results for Q1 2019 to be officially released next week.

The country has come through a turbulent year, characterized by political and social instability stemming from the pursuit of legal reforms, and anti-government protests against endemic graft by government officials.

The ruling Social Democratic Party is led by Liviu Dragnea, who is barred from becoming prime minister for vote rigging. However, he is still pulling the strings of the government led by Viorica Dancila, pressing for changes to the rule of law to allow pardons and amnesties he would personally benefit from.

Corruption was one of four political risk factors downgraded in 2018, and the one that is still receiving the lowest score of any risk factor from contributors to the survey.

There are also institutional risk concerns, and a downgraded outlook for the government finances working against Romania achieving a higher credit rating:

In November, the IMF warned Romania that it risked missing its fiscal target for 2018, set in accordance with the EU’s goal of achieving fiscal stability, defined as a deficit no greater than 3% of GDP.

The difficulty the coalition government has had meeting the target is not because of slow growth. Romania’s economy, like others in central and eastern Europe, has been booming, with real GDP increasing by a seasonally adjusted 4.0% year-on-year in the fourth quarter of 2018.

Industrial production rose by 3.5% in 2018, retail sales by 5.4%, and the unemployment rate fell to 3.9% (seasonally adjusted, harmonized rate) as of January, with the registered unemployment rate at 3.3% boosting wages and inflation (now 4%).

Economists at the European Bank for Reconstruction and Development taking part in Euromoney’s survey state in their latest economic outlook that GDP “will continue to be supported by investment linked to EU funds and consumption linked to the tightening labour market”.

The government has also resorted to fiscal stimulus measures, including higher minimum wages and increases in old-age pensions, upholding strong private consumption.

Standard & Poor’s sees the headline general government deficit widening to 3.3% of GDP in 2019 and to 3.5% in 2020, given the prerogative to maintain popular spending in the run-up to presidential and parliamentary elections later in 2019 and 2020, respectively.

Risk experts suggest that with the dire need for improving infrastructure the government will have difficulty lowering, say, investment spending co-financed using EU structural funds, or making vast improvements to VAT collection to keep its finances under control.

The predicted outcome, if correct, would then invoke the EU’s excessive deficits procedure.

Consequently, Romania’s risk score is lower, putting further space between the country and both Hungary and Croatia, which is receiving a credit rating upgrade in line with its improving country risk score:

The latest downgrade follows implementation of the so-called “greed tax” on banks which the government has now said it will soften by lowering it from 1.2% to 0.4%, and from 100% of bank assets to 20%, to avoid Standard & Poor’s adjusting its stable BBB- outlook to negative (putting it out of line with the Fitch and Moody’s equivalents).

The move was motivated by the desire to see lower lending rates, but was poorly devised, creating uncertainty over the business environment and angering commercial banks, investors and the central bank in equal measure.

Romania lies 61st out of 186 countries in Euromoney’s global risk rankings – three places below Croatia and four below Hungary – towards the bottom of the third of five categories of risk containing investment grades, while one place above Turkey.

“Downside risks to the outlook include further worsening of labour shortages, domestic political and reform uncertainty and changing global investor sentiment towards emerging markets”, says the EBRD.

In perspective

Still, it is difficult to be overly negative. Indeed, the one thing that Euromoney’s survey contributors generally agree on is that the country continues to enjoy favourable economic conditions and a low debt burden.

Unlike its contemporaries in western Europe, business confidence is improving, according to the economic sentiment indicator published by the European Commission.

In February, the indicator for Romania rose to 102.2, from 101.5 in January, extending the rising trend to three months, and recently ING reported on strong bank lending growth “keeping alive hopes that the economic slowdown will not turn into a hard landing”.

Political risks will remain heightened, but the effects will be limited by economic growth and some fiscal wriggle-room.

Indeed, if there is the one indicator justifying Romania’s investment grade ratings alone, it must be the gross debt burden, which fell to 33.9% of GDP at the end of September according to Eurostat.

It shouldn’t be forgotten it is still one of the lowest in the region, on a par with Czech Republic.

Financial markets will only begin to worry if the economy slows more sharply and the government does little to tailor its fiscal stimulus ambitions.

The bank tax alone is no reason to become overly concerned.

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