On November 22, 2013, Standard & Poor’s Ratings Services affirmed its ‘BB+/B’ long- and short-term foreign and local currency sovereign credit ratings on Romania. The outlook is positive.
According to Standard & Poor’s, Romania is steadily making progress in adjusting external demand, fiscal consolidation, and financial sector stability. The rating agency is therefore affirming the ‘BB+/B’ long- and short-term foreign and local currency sovereign credit ratings on Romania. The positive outlook incorporates the possibility that Standard & Poor’s could raise the ratings on Romania if the government sticks to its fiscal and reform programs. The decision follows Romania’s steady progress in adjusting the economy toward external demand, consolidating the fiscal accounts, and bolstering financial sector stability.
Standard & Poor’s believe Romania’s GDP growth will gradually strengthen over 2013-2016, helped by the continued rebalancing of its economy toward external demand. Over 2013-2016, the agency projects that Romania will post an average annual current account deficit of about 1.6% of GDP. The shift to external demand over the past five years has occurred primarily due to higher exports, leaving the expected 2013 trade deficit at between 3% and 4% of GDP, versus 14% of GDP in 2007. This adjustment has made Romania a more open economy, with exports that we project to exceed 45% of GDP in 2016, versus 30% of GDP in 2009. The export growth reflects Romania’s improved cost competitiveness against that of most of its trading partners. In this context, the agency believes Romania’s 2011 labour market reform has improved the economy’s flexibility and facilitated the swing toward export-led growth.
At the same time, domestic demand remains subdued, constrained by public-sector spending cuts, modest wage dynamics, and weak investment activity, resulting from banking sector deleveraging and negative credit growth to the private sector, among other things. As of September 2013, credit growth was still negative by slightly more than 3% annually in nominal terms.
In the coming years, Standard & Poor‘s expects the currently low capacity of the government to deploy EU Structural and Cohesion Funds to continue improving, which could lead to an increase in investment activity. It considers that the key deterrents to foreign direct investment (FDI) stem from judicial and bureaucratic uncertainties. With net FDI having declined from an average of 7% of GDP before the 2008-2009 financial crisis to below 2% of GDP per year since 2010, the agency views the government’s progress on making the business environment more transparent and predictable, alongside the reform of state-owned enterprises and judicial reform, as key to how fast the economy can grow. That said, Standard & Poor’s also acknowledges that much of the decline in net FDI flows is linked to the current weak EU economic recovery.
The International Monetary Fund (IMF) agreed to extend a new two-year precautionary Stand-By Arrangement to Romania in September 2013, which combined with the precautionary financial assistance approved by the EU in October 2013 amounts to equivalent of almost €4 billion, while €300 million remain available under a EUR 1 billion World Bank policy loan. Standard & Poor’s views the agreements with the IMF and the EU as a positive development, both to bolster the government’s resolve as it presses forward with its pro-growth structural reforms and to serve as a backstop if Romanian banks’ external rollover rate remains below 100% (as it has since 2010) or if the country’s broader external financing conditions deteriorate.
On the budgetary side, the agency expects authorities to meet their own revised 2013 general government deficit target of 2.6% of GDP this year, despite some revenue underperformance so far and an increase in the discretionary government wage bill. This would represent a consolidation of almost 6.5% of GDP since 2009. It is expected the deficit to decline further in 2014. In light of the fiscal constraints and commitment to meet the budgetary target, the government has in the revised 2013 budget trimmed domestic capital expenditure, which in our view could detract from Romania’s long-term economic growth prospects. On the other hand, the government has increased its budgetary flexibility in case of a faster-than-planned increase in the absorption of EU funds.
Standard & Poor’s also understands that general government arrears have declined substantially and are now mainly at the local government level. Still, it estimates public enterprise arrears at about 2.5% of GDP. A renewed accumulation of government arrears could pose a risk to fiscal consolidation, as would further significant discretionary increases in current spending, such as on the public sector wage bill or other line items. It anticipates that net general government debt will begin to stabilize just below 35% of GDP during 2013-2016 before declining. During the same period, is to expect general government interest payments to represent about 5.6% of general government revenues annually.
Standard & Poor’s believe there is a risk that the Romanian government could deviate from its budgetary and structural reform plans in the run-up to European and presidential elections in 2014. It recognises, however, that Romania benefits from buffers that should help to maintain investor confidence and keep borrowing costs down. These cushions include a flexible exchange rate regime, which helps the central bank pursue an independent monetary policy, foreign exchange reserves that currently exceed short-term external debt by remaining maturity, and potential financial support from official creditors.
Outlook
The positive outlook indicates the estimate that there is at least a one-in-three possibility that Standard & Poor’s could raise its ratings on Romania in the second half of 2014. It could raise the ratings if the planned program of budgetary consolidation, public finance reform, and public enterprise restructuring is implemented in line with our expectations, while keeping external imbalances and financial sector stability in check.
The agency could revise the outlook to stable if – against its expectations and perhaps in the run – up to the 2014 elections -the budget deficits widen significantly or the government pulls back from the restructuring of the public enterprises. The ratings could also come under downward pressure if Romania’s external imbalances re-emerge or if stability in its financial sector weakens.
Source: Standard & Poor’s