Romania’s economy is cooling down and the accelerating political turmoil and inefficient public administration are now jeopardising the country’s economic performance.
The public support for the ruling coalition has plunged but the opposition has so far failed to come up with a more attractive alternative, as shown by the failure of a no-confidence motion against Prime Minister Viorica Dancila on December 20.
Dancila is widely seen as a proxy for Social Democratic Party (PSD) leader Liviu Dragnea, who successfully saw off an attempted rebellion by senior members of the ruling party in autumn 2018.
Dragnea’s fate will prove critical for further political developments in the country. The PSD leader was sentenced to three years and six months in prison for instigation to abuse of office in June. His appeal has dragged on, but should he end up serving the sentence — despite all the ruling coalition’s machinations — this would trigger convulsions within Romania’s senior ruling party.
Business representatives have repeatedly bemoaned the policy confusion since the current ruling coalition came to power in December 2016, as well as its populist rhetoric which at times has targeted multinational investors. This reached a frenzy on December 19, when the government announced new plans to tax banks and energy companies, aimed at boosting revenues to rein in the budget deficit.
These included a so-called “tax on greed” targeting banks, a cap on the price gas companies charge households, and a 3% turnover tax for energy and telecoms companies.
On the same day, the parliament passed a package of measures introducing new restrictions on banks, as well as a controversial pension law.
This added further fuel to the ongoing intense antagonism between the ruling coalition led by Dragnea and President Klaus Iohannis.
Romania takes over the presidency of the Council of the EU in the first half of 2019, which should in principle result in a temporary ceasefire among political rivals, but the series of elections coming up in 2019-2020 will have the opposite effect. Elections will be held in spring 2019 for the European Parliament, followed by presidential elections in the autumn of the same year, while 2020 will bring local elections (in the spring) and parliamentary elections toward the end of the year.
Romania’s economic performance has been particularly good over the past five years: GDP increased by 5% p.a. over the five years to Q3 2018, and was 24% above the GDP in Q3 2008 (before the recession). The 2.2% average rise over the past decade is, however, not likely to support quick convergence to the EU average. Independent analysts see the potential growth at this moment around 4% p.a., somewhere between the government’s more optimistic estimate (around 5% p.a.) and the more cautious view of the central bank.
GDP growth is expected to remain above the long-term average. Romania’s economy lost momentum during 2018, from a record 7.0% y/y growth rate in 2017. But it remained robust at a 4.9% y/y annual advance posted in the rolling four quarters ending September 2018.
The main growth drivers remain the same: private consumption fuelled by households’ rising incomes. More recently, firms’ investments in technology have increased as the labour market tightened. The full-year performance is heading toward 4% y/y in 2018. The projections for 2019 range from 3.3% (pessimistic, independent scenarios) to 5.5% (the government’s bullish scenario). The performance was better than expected in Q3 (latest available data), but this was amid large output in agriculture and a continuous build-up of inventories, both of which create high base effects and expectations for a steeper deceleration in the coming quarters. The government’s projection for 5.5% growth in 2019 and 5.7% in 2020 remain on the optimistic side.
The economic slowdown is putting pressure on internal and external balances. Amid the economic slowdown and moderate expectations, overheating risks have diminished. But the inherent negative effects of the slowdown (higher deficit ratios, exchange rate corrections) are enhanced by the government’s pro-cyclical fiscal policy: the budget for 2019 might be tighter than envisaged by the populist ruling coalition in case the fiscal slippage is visible at the end of 2018 (triggering the excessive deficit procedure). The executive have reportedly submitted plans to mitigate the fiscal slippage to the European Commission, but are hoping for the best while using all available resources to observe the 3%-of-GDP deficit limit at the cost of backloading.
In fact, the government’s policies (fiscal, income, regulatory in general) have constituted the major internal risk over the past couple of years. The 2019 budget had not been published as of mid-December, and the authorities’ sparse comments on this topic confirm the lack of efficiency demonstrated by the ruling coalition’s governments over the last two years.
Fitch Ratings affirmed Romania's long-term foreign-currency issuer default rating (IDR) at 'BBB-' with a stable outlook in November.
“The deficit targets outlined in its letter of October 18, 2018 to the EU were 2.4% for 2019, 1.8% for 2020 and 1.5% for 2021, based on its view of potential real GDP growth of around 5%,” the rating agency commented when affirming rating. In Fitch's view, these will not be possible to meet without new fiscal consolidation measures. “There is a limit to how much further the government can squeeze capital expenditure and rely on ad hoc measures,” the agency commented.
Fitch forecast deficits of 3.5% of GDP in 2019 and 2020. The general government debt will start rising from 2019 (from 35% of GDP at the end of 2018) as the budget deficit widens, growth slows and interest costs rise. GDP is expected to expand 3.5% in 2018, 3.2% in 2019 and 3.0% in 2020, reflecting a slowdown in EU growth, monetary tightening, a fading of the fiscal stimulus and lack of spare capacity, according to the macroeconomic scenario of Fitch.
While Romania’s deficits are widening, they have not reached yet alarming levels. What matters more is the lack of major infrastructure programmes, and the weak use of funds from the EU budget, the poor quality if public services that encourages migration of diverse segments of the population leaving the economy without valuable human capital.
The public debt service for 2019 is estimated by the finance ministry at €12.2bn, including short and long term debt, on the local and foreign markets. Out of the total, one-third is the external debt service, namely some €4bn. This is slightly more than the €12bn service in 2018.
On top of this, the government has to finance the budget deficit that it envisages at 2.5% of GDP, or €5bn. Financing half of this from the external market would result in total external borrowing needs of €6.5bn, which is less than in 2018. However, borrowing costs are rising and this might have unpredictable effects on the overall cost and the distribution (domestic versus external markets) of the borrowing through the year.
After the government listed the shares of several major energy companies in the past years, it shifted the focus to setting up the sovereign investment and development fund (FSDI) that will bring together what was left in the state's portfolio out of the major companies. Furthermore, the ruling coalition’s rhetoric goes against privatisation and in favour of consolidation of the state’s intervention in the real and financial sectors. Thus, the listing of Hidroelectrica’s shares, expected by investors, is not likely until the FSDI is set up. In the meantime, the restitution fund Fondul Proprietatea might consider selling its stakes in some major companies including Hidroelectrica.
Romania adopted a new law setting the tax regime for offshore oil and gas. The law endorsed in October by the Chamber of Deputies stipulates higher taxes compared to the version endorsed earlier this year but returned by President Klaus Iohannis. The tighter taxation regime can be seen as the natural price of the predictability inked in the bill — one of the main concerns voiced by companies developing Romania’s offshore gas resources (OMV, ExxonMobil, Carlyle).
In the banking sector, consolidation continues gradually. The sale of Banca Romaneasca, part of the National Bank of Greece (NBG) group, to Hungary’s OTP was blocked by the regulator in 2018, after which a new attempt to sell the bank was launched. Suitors lining up for Banca Romaneasca reportedly include state-owned bank Eximbank and US investment fund JC Flowers.
High tech investment continues apace in Romania, which is an attractive destination for shared service and outsourcing but also, increasingly, for more sophisticated operations.
In the industrial sector, Romanian chemical company Oltchim, which is currently under insolvency procedures, announced on December 10 that it has completed the procedures to sell the largest part of its operating assets to Chimcomplex Borzesti, the sole bidder for the assets. Chimcomplex is looking to build up its business into a regional chemicals giant.