ACRA has affirmed and withdrawn the following credit ratings of the Government of Romania (hereinafter, Romania, or the country) under the international scale:
- Long-term foreign currency credit rating at BBB- and local currency credit rating at BBB-;
- Short-term foreign currency credit rating at S3 and local currency credit rating at S3.
The outlook on the long-term foreign currency credit rating is Stable and local currency credit rating is Stable.
The credit ratings are unsolicited and ACRA has withdrawn them for a business reason.
Credit rating rationale
Romania’s BBB- sovereign credit ratings are supported by the country’s low level of public debt, strong GDP growth in recent years, and diminished external debt of the economy. The ratings are constrained by the unsustainability of economic growth in the medium and long term, growing rigidity of budget expenditures, and low external debt coverage. Weak institutions is also a constraining factor.
Following robust growth in GDP, which has averaged 5.1% since 2016, the third highest in the EU, the country is expected to experience an economic downturn. ACRA expects Romania’s GDP to drop by 5–10% in 2020 and then recover to 2-4% in 2021. The downturn is due to the COVID-19 pandemic, which affects the country internally via quarantine measures and externally through its trade partners. ACRA notes that Romania’s relatively closed economy is likely to be impacted less by an economic downturn in its major EU trade partners than its Central Eastern European (CEE) peers.
As the rapid economic growth in recent years was partly attributed to one-off administrative measures that provided for a strong increase in public sector wages and the minimum wage, which has doubled since the beginning of 2016, we expect medium-term economic growth to be lower than in the pre-COVID-19 period. Another factor that may compromise the sustainability of economic growth is overreliance on external funding, a vulnerability during the crisis due to a potential reversal of investors’ sentiments toward financing Romania’s “twin deficits” of the general government and the current account. Though the latter is expected to stay unchanged in 2020 compared to the previous year, the former is likely to widen. Thus, in ACRA’s view, the sustainability of medium-term economic growth compared to previous years is questionable without a significant improvement in productivity.
In the long term, Romania’s growth potential is likely to be constrained by poor demographics coupled with a high emigration rate and the low innovative capacity of the economy. A mitigating factor, if it proves to be permanent due to the weakening of economic conditions in host countries, is a noticeable reversal of Romanian migrant outflows since the pandemic. While in the short term, ACRA does not foresee a risk of a substantial loss of competitiveness resulting from high wage growth due to a low share of compensation of employees in gross value added and low nominal labor costs compared to the country’s EU peers. In the long term, the economy must boost its innovative potential in order to sustain higher wage growth.
The country’s monetary policy may have been somewhat loose in recent years. According to the National Institute of Statistics of Romania, the CPI inflation rate was 4% in December 2019, which is higher than the upper bound of the target range (2.5%+/-1 p.p.). The National Bank of Romania (NBR) has faced a challenge in keeping inflation within the target range in recent years due to frequent changes in the tax regimes. However, constant tax rate inflation, which smooths the impact of tax rate changes, has also overshot the upper bound of the band (3.7% in December 2019). Recently the NBR reduced the monetary policy rate from 2.5% to 2% and narrowed the symmetrical corridor, which is defined by interest rates on standing facilities, around the monetary policy rate to ± 0.5 p.p from ± 1 p.p. in response to the crisis caused by the pandemic. However, in our view, this will not push short-term inflation up due to the significant disinflationary pressure of the negative demand shock. Annual inflation declined to 3.05% in February 2020, thus returning within the variation band of the target, and remained unchanged in March 2020. The European Commission (EC) expects the harmonized CPI to be within the target range this year (2.5%). The NBR has swiftly responded to the pandemic and the measures it has adopted should help to contain the negative impacts of the crisis on the economy.
ACRA expects the country’s fiscal position to deteriorate in 2020. The EC expects the budget deficit this year to widen to 9.2% of GDP compared to an already high 4.3% of GDP in 2019, which was the highest among the EU countries. The primary reasons for the deepening deficit are key tax and spending measures of around 2% of GDP, loss in tax revenues due to the decline in GDP, and a possible increase in pensions on the back of the 2019 pension reform. However, the deficit may be lower if the projected 40% pensions increase is canceled or decreased; in this case we estimate it to be about 7.5–8.5% GDP. The total fiscal package is about 3.5% of GDP (including loan guarantees and subsidized interest for working capital of 1.5% GDP). According to the EC, the high deficit may push public debt up to around 46.2% of GDP in 2020 (this will possibly be lower without the pensions increase), depending on the depth of the economic downturn. The share of public debt held by non-residents and denominated in FX was 39.8% as of February 2020, and the FX component of general government debt was 118% covered by the country’s international reserves as of February 2020. However, the expected increase in public debt is likely to worsen the coverage ratio.
Going forward, the recovery in budget position could be constrained by the relatively high share of inflexible items in the budget expenditure. In 2019, wages, social transfers, and interest payments made up 74% of total revenues, up from around 60% in 2014–2015. In the longer term, debt sustainability will be challenged by increasing aging-related costs. According to the EC, Romania may need upfront and permanent fiscal measures worth 8.8% of GDP to stabilize its debt to GDP ratio in the long term. This value has increased to the highest in the EU due to pension system changes.
ACRA believes that the government will encounter no problems financing its deficit on affordable terms to withstand the shock. The NBR’s pledge to buy government bonds on the secondary markets has contributed to the government’s bond auctions. The government is raising funds with sufficient demand and favorable costs. In addition, the EC will allocate more than EUR 1 bln (0.4% of 2019 GDP) to Romania to help it mitigate the effects of the COVID-19 pandemic, while the World Bank aims to provide financial support worth EUR 0.4 bln (0.2% of 2019 GDP) for the same purposes.
The risk of contingent liabilities related to the financial sector is contained. Moderate euroization and banks’ relatively high exposure to domestic government bonds are mitigated by strong banking sector metrics and low private sector debt. The absence of any recent bank bailouts is also a risk-mitigating factor.
Risks associated with the country’s external position are moderate. External debt to GDP has been declining since its peak of 77.5% of GDP in Q2 2011 to 47.4% in Q4 2019 thanks mainly to robust GDP growth and stagnating external debt. However, the currency structure and coverage of external debt is a concern. In Q3 2019, the share of FX debt in external debt stood at 85%, making it the third highest among the non-Eurozone EU CEE countries, whereas the reserve coverage of FX debt was 44%. The country’s international reserves only covered 81% of the external debt maturing in 12 months starting from Q3 2019. The latter, though, is somewhat mitigated by the breakdown of external debt by sectors. Only 31% of external debt is held by banks and private non-financial sector companies, which are prone to refinancing, whilst more stable sectors like corporates with their intercompany lending and general government accounted for 31% and 37%, respectively as of Q4 2019.
The current account deficit stood at 4.6% in 2019 and is likely not to change significantly this year due to an expected decrease in imports. The current economic halt and instability have led to “flight to quality,” which adds pressure on the currencies of developing countries. The currencies of Romania’s non-Eurozone peers have depreciated by 6–7% on average since the beginning of March, while the lei has only depreciated by 1–2%. This is likely to be partly attributed to the country’s FX regime (managed float) and the NBR’s support. International reserves declined by 4% in March.
The average score for Romania’s Worldwide Governance Indicators is only slightly above the global average and is the worst in the EU. Romania is lagging behind, especially in the Government Effectiveness and Control of Corruption categories, which could imply misallocation of resources in the economy with a potentially negative impact on economic growth. Political stability, for which Romania has the second worst score among the EU countries, is constrained by frequent changes of government and a strongly divided electorate resulting in large-scale protests against corruption and abuses of power.
Sovereign model application results
Romania has been assigned a BBB+ Indicative credit rating in accordance with the core part of ACRA’s sovereign model. A number of modifiers in the modifiers part of the model allow the Indicative credit rating to be decreased. These include the following, which are determined by the Methodology for Credit Rating Assignment to Sovereign Entities under the International Scale:
- Potential economic growth;
- Sustainability of economic growth;
- Efficacy of structural, economic and monetary policies;
- Market access and sources of funding;
- Fiscal policy framework and fiscal flexibility;
- External debt sustainability.
In view of the abovementioned modifiers, Romania’s Indicative credit rating has been reduced by two notches. A Final credit rating of BBB- has been assigned. There are no extraordinary factors that could result in an adjustment of the Final rating. In connection with this, the Assigned credit rating remains at BBB-.
Issue ratings
No outstanding issues have been rated.
Regulatory disclosure
The sovereign credit ratings have been affirmed to Romania under the international scale based on the Methodology for Credit Rating Assignment to Sovereign Entities under the International Scale and the Key Concepts Used by the Analytical Credit Rating Agency Within the Scope of Its Rating Activities.
The sovereign credit ratings of Romania were first published by ACRA on November 13, 2019.
The sovereign credit ratings were affirmed based on information from publicly available sources, as well as ACRA’s own databases. The sovereign credit ratings are unsolicited. The Government of Romania did not participate in the credit rating affirmation.
ACRA provided no additional services to the Government of Romania. No conflicts of interest were discovered in the course of the sovereign credit rating affirmation.
