1. EXECUTIVE SUMMARY
A new centre-right government led by former finance minister Florin Citu was appointed at the end of December.
The European Commission forecasts 3.3% GDP growth in Romania in 2021, which would put GDP at 2% below the 2019 level. Growth is expected to accelerate to 3.8% in 2022.
Budget and debt outlook
The new government has promised credible fiscal and budgetary strategies and thorough institutional reforms in the public sector to support them. The first steps (freezing wages in the public sector) were cautious and close to austerity, but the detailed 2021 budget is expected for end-January or early February.
The industrial recovery depends on the resumption of activity in Europe and the latest developments are encouraging.
The sector of services to households, encompassing hospitality and retail, is expected to recover in the second half of 2021.
Construction, IT&C and real estate are likely to remain significant growth drivers in 2021.
The Bucharest Stock Exchange (BVB) held its first session as an emerging market on September 21, thus entering the universe targeted by a wider category of investors.
2. POLITICAL OUTLOOK
The Romanian parliament endorsed former finance minister Florin Citu as prime minister and his government in their respective positions on December 23.
President Klaus Iohannis had designated Citu to form a new government on behalf of a centre-right coalition of three parties formed around the National Liberal Party (PNL).
Backed by a fragile majority of 52.4% in parliament, the PNL, reformist alliance USR-PLUS and the Democratic Alliance of Hungarians in Romania (UDMR) sealed a ruling agreement expected to remain in force for the coming four years.
This was despite the disappointing outcome of the 2020 general election for the two major partners in the coalition, the PNL and USR-PLUS, which got scores that were around 5pp lower than expected, while the Social Democrats (PSD) won biggest chunk of the votes and are in control of just over one third of the MP seats — a blocking minority that is of practical importance only in the case of major decisions such as the indictment of the president or amendment of the constitution.
The PNL now controls traditionally important ministries including the ministries of defence, interior, finance, energy and foreign affairs. It also appointed ministers of education, culture, agriculture and labour. The choice of ministries is consistent with Iohannis’ main strategic projects including the strategic partnership with the US in the energy and defence sector.
The USR-PLUS controls ministries with the potential to boost the development of the public sector: justice, European funds, health, transport, research and development and economy.
The UDMR was assigned key ministries as well: the development ministry that promotes regional development financed from national budget and environment, which is supposed to intermediate major financing for the Green Deal, as well as the ministry of youth and sports.
After a complicated 2020, when a minority government had to manage the health crisis while at the same time organising local and general elections, Romania needs credible, farsighted and agile governance to address urgent vulnerabilities (fiscal and budgetary, essentially) and capture the opportunities created by the European Union’s reconstruction plans: €80bn of cohesion funds, grants and soft loans from the EU over the coming four years.
The country was under excessive deficit procedures when the pandemic hit in March, which hindered (and still hinders) the government’s capacity to support the economy at the intensity other European countries did. This is why the economic recovery in Q3 (to -6% y/y) failed to meet expectations. Since part of the losses incurred by the real sector in 2020 were frozen (deferred) rather than avoided or settled, they will surface in 2021 at a time that depends on the phasing out of public support and the timing of the global recovery. 15% of bank loans (€8.8bn, over 4% of GDP) were deferred and, separately, the government deferred nearly €3bn (1.5% of GDP) of dues owed by companies.
The fiscal slippage and the non-linear effects of the rising public debt (that is migrating in the 45-60% region up from 30-40% before the crisis) are the main priorities on the government’s macroeconomic agenda starting with the first day in office, as well as in the coming years. The health crisis forces the new executive to accommodate short-run (fiscal stimulation and social support) and long-run (addressing structural rigidity) processes under circumstances that remain highly unpredictable, judged by pre-crisis terms. But the threats posed by the vulnerabilities accumulated in Romania’s public finances in previous years (particularly in 2020) are balanced by the opportunities offered by the Resilience and Recovery Plan that comes on the top of EU’s regular budget. Romania’s weak capacity to absorb EU funds needs urgent consolidation in this regard, as the strength provided by the still robust public finance metrics are gradually fading.
The 2021 budget (due immediately), the medium term fiscal strategy (the measures aimed at addressing structural factors), the Recovery and Resilience Plan and the first moves in the public sector restructuring are essential drivers of medium-term sustainable economic recovery.
3. MACROECONOMIC OUTLOOK
The EC revised in November 2020 its estimate for Romania's GDP growth from a 6% contraction projected in July to a milder 5.2% decline in the Autumn Forecast. Standard & Poor’s (S&P) made the same estimate in early December. Along with a milder GDP contraction this year, the EC says that the recovery will also be slower in 2021 — only 3.3% compared to the 4% forecast in July. It is a conservative forecast as S&P sees a 4% recovery in 2021. The EC’s two revisions balance each other and overall this means the Commission has not changed its forecast for Romania's GDP in 2021, estimated at 2% below the 2019 level. The EC expects Romania's GDP growth to accelerate to 3.8% in 2022.
Romania's GDP increased by a real 5.6% q/q in Q3, in seasonally adjusted terms. In unadjusted terms, country’s economic output in Q3 was 6.0% lower than in the same period of 2019.The partial economic recovery in Q3, after the deep 12.2% q/q contraction in Q2, fell short of analysts' expectations. A significant part of the 6% annual contraction, namely 2.7pp, is explained by the outstanding plunge in agriculture where the value-added generated was 29% lower in a quarter when this sector usually holds significant weight in the total GDP.
On the demand side, domestic consumption dropped only by 3.3% y/y in Q3 while gross fixed capital formation advanced by 2.3% y/y. Domestic demand thus demonstrated milder deterioration compared to domestic supply, but the external demand plunge was steeper.
In the first eight months of the year, Romania’s current account (CA) deficit narrowed by 11.3% to €6.30bn. For the entire January-September period, the €7.74bn CA gap (3.8% of 2020's projected GDP) still maintains a 2.6% annual contraction.
For the whole year, the EC expects a 4.6%-of-GDP CA gap, to gradually widen to 4.8% in 2021 and 4.9% in 2022. The International Monetary Fund’s (IMF’s) 5.3%-of-GDP estimate for 2020 CA gap is rather pessimistic, but the Fund’s expectations for a thinner deficit in the years to come (3.9% of GDP in 2025) are supported by the expected transfers from the EU budget.
S&P expects Romania's current account deficit to average 5% of GDP through 2023. In its view, the widening trade deficit demonstrates the underlying competitiveness problems.
In the third quarter of the year, the trade deficit widened moderately by 1.2% y/y to €4.38bn, as exports partly recovered after the deep dive taken in Q2.
The performance of Romanian exports (-4.3% y/y in 3Q20) has been problematic since before the crisis that pushed them down 33.6% y/y in Q2. Their recovery to positive growth rates is uncertain, depending on both the recovery in external markets and domestic investments. Imports (-3.2% y/y in Q3), stimulated up by the net public spending (budget deficit) and by households maintaining a certain confidence, are more likely to return to positive growth rates.
The Romanian banking system’s net profit contracted by 10.5% y/y to €936mn in January-September 2020 — which is an outstanding performance considering that repayment was suspended for loans accounting for 15% of the bank loans portfolio since April-May. Furthermore, the non-performing loan (NPL) rate as of the end of September 2020, 4.1%, was lower than one year earlier — also reflecting the facilities extended by banks. The loans suspended are not subject to reclassification. But the worst is still to come as the hidden deterioration of the loan portfolio will surface in 2021 after the end of the loan repayment moratorium.
The volume of new corporate loans denominated in the local currency surged by 50% y/y in October. The rise, attributable to the disbursements under the government-backed IMM Invest lending programme, comes after sluggish corporate lending in the first months after the lockdown: corporate lending contracted by 15.6% y/y in Q2. It may intensify as the programme advances — but banks have already been instructed by the central bank to readjust lending terms and risk assessment to the new situation created by the crisis.
The stock of loans granted by banks to companies and households in Romania rose by 4.1% y/y (up 1.8% y/y in real terms) to €57.3bn in October. The rise largely reflects the loan repayment moratorium.
Romanian banks plan to tighten lending terms for SMEs. The tightening will be selective, with some sectors facing higher risk.
4. BUDGET AND DEBT OUTLOOK
The new government that resulted from the general elections on December 6 promised credible fiscal and budgetary strategies and thorough institutional reforms in the public sector to support them. The National Liberal Party (PNL) and USR-Plus have both pledged to implement gradual fiscal consolidation but there is no consensus around the scope and timing of immediate measures given the continuing health and economic challenges from the pandemic. Longer-term plans are equally unclear — except for the informatisation of the fiscal system that has the potential to unlock revenues amounting to 2% of GDP. The two parties also agreed on cutting labour taxation particularly for low wages — but neither of them went as far as proposing gradual taxation. Property taxation is also on the agenda, given its robust potential to boost revenues — but it has been for years with no political agreement so far.
Romania's 2020 public deficit reached 9.8% of GDP in 2020, according to independent estimates, double the gap in 2019. Unlike elsewhere in Europe, even under an optimistic scenario, the gap will not close quickly. A 7%-of-GDP gap in 2021 is the baseline scenario, but it assumes quick settlement of the pension hike dispute and here the expectations are diverse. The EC projects the fiscal trajectory for a conservative scenario (no reversal of the 40% pension hike) and sees the gap at 11.3% of GDP in 2021 and 12.5% of GDP in 2022. The rating agencies, including S&P on December 4, assumed the government will succeed in pursuing a 2pp fiscal consolidation in 2021 and bring the gap down to 4% of GDP on medium term.
The starting point for calculating the 2021 gap, in the absence of any fiscal consolidation policies, is estimated at 9% of GDP, according to the Fiscal Council. The estimate is based on the government’s plans for gradual increase in pensions. The IMF sees moderate consolidation to 8.1% of GDP in 2021, from an estimated 9.6% in 2020.
Fitch forecasts the general government deficit to narrow modestly to 7.1% of GDP in 2021 from a record high of 9.8% in 2020, but it says that risks are still predominantly on the downside. S&P also projects the government deficit will stand at 7.2% of GDP in 2021 and decline to 5.5% in 2022.
“A balanced and credible fiscal agenda will be crucial,” an S&P statement on December 6 read, indicating that such an agenda should go well beyond reversing recent one-off measures (like the 40% pension hike). Most of Romania's key budgetary allocations are structural and this inflicts further medium-term strain on an already rigid budget structure, S&P’s analysts argued.
5. REAL ECONOMY OUTLOOK
Industry contracted by only 6.6% y/y in Q3, resulting in a 1.5pp negative contribution to the quarter's economic decline. The industrial recovery depends on the resumption of the activity in Europe and the latest developments are encouraging. Romania's industrial production returned in September to the level seen in the same month of 2019, while the manufacturing sector's output increased marginally by 0.4% y/y. This was the best annual performance after 15 months of negative growth rates.
Under a combination of a tight labour market, a shift to higher value-added production segments and sluggish external demand, Romania's industrial production started to decline in mid-2019, a trend that accelerated during the crisis months of April-May.
The post-crisis recovery began in June 2020, and in September the overall industrial production (extractive, manufacturing and utilities) nearly returned to the pre-crisis level: it was only 4.4% lower compared to February in seasonally adjusted terms. In the manufacturing sector, the lag was only 3.9%. However, there are wide variations across manufacturing industries.
The sector of services to households, which aggregates the HoReCa segment's negative dynamics and the retail segment's positive evolution, was down 3.2% y/y in terms of gross value added in 3Q20 and dragged down the GDP by 0.5pp. The sector is expected to recover in the second half of 2021.
Only the construction (+9.8% y/y in Q3, 2020), IT&C (+6.5% y/y), and real estate (+1.2% y/y) sectors recorded positive dynamics in the third quarter of the year. They are likely to remain significant growth drivers in 2021.
6. MARKETS OUTLOOK
The Bucharest Stock Exchange (BVB) held its first session as an emerging market on September 21, when the first two Romanian companies were included in the FTSE Global Equity Index Series (GEIS).
This was an important moment for Romania and its capital market, which thus entered the universe targeted by a wider category of investors. The two Romanian companies to be included in the FTSE Global All Cap Index, and three other indexes, are lender Banca Transilvania (TLV) and energy producer Nuclearelectrica (SNN).
Romania needs to aim for an MSCI upgrade because more than 80% of passive funds invest in emerging markets through the MSCI benchmark, said Mark Davis, the European Bank for Reconstruction and Development’s (EBRD’s) regional director for Romania and Bulgaria, one day after the BVB was upgraded by FTSE Russell to the emerging market category.
The Bucharest Stock Exchange recorded a strong recovery in November 2020, after the dip in October, amid positive macroeconomic readings and better than expected results reported by some of the biggest listed companies. The BET index gained more than 11% from October 30 until December 4, one of its best performances of the year. The BET gained over 30% from its yearly low in March, determined by the COVID-19 selloff.
Starting with December 1, 2020, MSCI moved Kuwait to the emerging markets league, which increased the share of companies from Romania’s BVB in the MSCI Frontier Markets 100 index. Their weight in the MSCI index will rise from 8% to 10.26% in five stages over a year, starting wth the first step in December 2020. Thus, exchange traded funds (ETFs) that follow this index will acquire Romanian shares to reflect the new structure of the stock basket.