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Fitch affirms Romania at 'BBB-'; Outlook Negative
* Fitch Ratings has affirmed Romania´s Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'BBB-' with a Negative Outlook.
KEY RATING DRIVERS
Credit Fundamentals: Romania's 'BBB-' rating is underpinned by EU membership and EU capital flows that supports investment and macro-stability, and GDP per capita, governance and human development indicators that are above 'BBB' category peers. These are balanced against larger twin budget and current-account deficits than peers, a weak record of fiscal consolidation and high budget rigidities, and a fairly high net external debtor position.
Negative Outlook: The Negative Outlook reflects continued uncertainty regarding the implementation of policies to address structural fiscal imbalances over the medium term and the impact from the Ukraine war and energy crisis on Romania's economic, fiscal and external performance.
Heightened Short-Term Challenges: The Russian invasion of Ukraine represents a significant macro headwind, as it will heighten short-term risks to growth and inflation, and to a lesser extent, to public and external finances. Trade and export links with Russia—as well as Ukraine and Belarus—are very limited (exports to the three countries accounted for only 2.3% of the total in 2020), and unlike other countries in the region, Romania imports only a modest share of its gas from Russia (20%, the is rest domestically produced).
However, steep increases in commodity prices, supply side disruptions and weaker growth in Romania's main trading partners (mainly the eurozone) will have significant spill overs, heightening short-term risks.
Public Investment Key Growth Driver: Fitch expects GDP growth to slow to 2.1% in 2022 (from 5.9% in 2021), primarily reflecting a slowdown in private consumption and exports. Although the government has put some measures in place to offset higher energy costs, they will likely be insufficient to prevent a loss of purchasing power. We expect public investment to provide some momentum in 2H22, in line with higher absorption of the 2014-2020 Multi Annual Financing Framework and from the Recovery and Resilience Fund (RRF).
In 2023 we expect investment dynamics to further accelerate, which combined with our assumption of a normalisation of external trade and supply chains, will lift growth to 4.8%.
Inflation Higher for Longer: We forecast the harmonised index of consumer prices (HICP) will average 10% in 2022 (the highest rate since 2004), with inflation likely to reach double digits in 2Q22 and possibly 3Q22 (from 7.9% in February), reflecting significant pass through from higher energy and commodity prices as well as second-round effects.
The government has placed a cap on electricity and gas prices for households and some companies until April 2023, which should limit inflation pressures somewhat. Unlike other countries in the region, wage growth appears moderate (largely due to restraint on public wages), but pressures are likely to rise as the labour market continues to tighten and employees feel a squeeze on their living standards. Fitch expects inflation to soften to 5.5% in 2023, in large part reflecting base effects.
Central Bank's Multiple Priorities: The National Bank of Romania (NBR) has tightened its main policy rate by 1.75bp since September 2021 (to 3% in April) and increased its interest rate corridor in an effort to tackle rising inflation. The authorities have also focused on exchange rate stability to limit inflation pass-through, with the currency maintaining broad stability in 1Q22 following interventions by the central bank.
We expect the tightening cycle to continue but at a modest pace to prevent an even faster economic slowdown. The NBR reactivated its programme of government bond purchases in March to improve liquidity and limit volatility in domestic bond yields, a tool we expect to be used only sporadically. However, if volatility persists and macro-challenges accentuate, the NBR might find it more challenging to balance multiple policy priorities, raising the risks of a sharper adjustment on the growth or fiscal side.
Challenging Public Finance Outlook: The government overperformed its budget targets in 2021 (we estimate the accrual deficit at 7.5% of GDP versus 8% in budget) thanks to strong revenue performance and capex under-execution. This better-than-expected starting position, as well as the government's commitment to adhere to wage and pension spending limits in 2022 (as was the case in 2021), will help the authorities manage increasing expenditure pressures stemming from rising macro-challenges.
The energy cap will have a modest net cost to the budget (most of it will be financed by taxing profits of energy producers) and the authorities estimate costs for Ukrainian refugees to total at least EUR1 billion (0.4% of GDP). However, we believe there are likely to be additional demands for support measures, the scope of which will largely be dependent on access to funding.
Overall, and despite expectations of solid revenue growth due to a high deflator, we expect the fiscal deficit to reach 7.1% of GDP this year, compared with the budget target of 6.3%.
The ruling coalition remains committed to medium-term fiscal consolidation and implementation of ambitious revenue measures to boost tax collection and expenditure reforms tied to the RRF. However, this will require difficult political compromises and the passage of key pension and wage bills by mid-2023, just before the busy 2024 electoral cycle begins. Romania has a very weak record of adopting structural fiscal reforms, often relying on under-execution of investment to meet deficit targets.
Broadly Stable Debt, Financing Pressures: Under our baseline scenario, strong nominal growth and a modest reduction in the primary balance will keep the public debt/GDP trajectory on a very gradual upward trend, rising from an estimated 48.9% in 2021 to 51.3% in 2023 (and compared with a 'BBB' median of 55%).
The strong commitment to exchange rate stability somewhat moderates the potential risks from high foreign-currency exposure (50% of total debt). Financing needs will remain large in 2022 (at around 11% of GDP), requiring significant domestic and external issuances. This will heighten the risks around financing flexibility, in particular in the event of additional domestic or external shocks.
Large External Imbalances: Fitch expects Romania´s current account deficit (CAD) to average 6.8% of GDP in 2022-2023, down slightly from a 13-year high of 7.0% in 2021 and compared with the current 'BBB' median of 1%. Some of the improvement will be due to a weakening of domestic demand in 2022 (which lowers import demand), followed by our expectations of a recovery in manufacturing exports in 2023.
Foreign direct investment picked up in 2021 but in conjunction with capital transfers only covered around 66% of the CAD last year. We expect this ratio to remain broadly constant in 2022-2023, even as EU flows accelerate. High public external debt issuances will keep the net external debt position at around 22% of GDP over the forecast period, compared with the 'BBB' median of 5%.
Political Stability: The grand coalition of the centre-left PSD and centre-right PNL has proven remarkably stable since taking power in December, despite various areas of policy disagreement and confrontational stance in the past.
The coalition government has turned its focus to dealing with Ukrainians and the cost of living crisis while fully supporting the EU stance against Russia. There are few risks around short-term stability, in particular as parties want to focus on meeting RRF milestones to unlock generous funding. Nevertheless, public discontent could increase rapidly if the cost of living crisis accentuates, potentially risking more populist policies or sharpening internal divisions within the coalition.
ESG - Governance: Romania has an ESG Relevance Score (RS) of 5[+] for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. Theses scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model (SRM). Romania has a moderate WBGI ranking at 59.2 percentile, reflecting a recent record of peaceful political transitions, a moderate level of rights for participation in the political process, moderate institutional capacity, established rule of law and a moderate level of corruption.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to negative rating action/downgrade:
-Fiscal: Reduced confidence in the capacity to implement fiscal consolidation that undermines fiscal policy credibility, leads to faster-than-projected increase in public debt, reduces financing flexibility or increases risks to macro-economic and external sector stability.
-External: A sustained deterioration in the balance of payments, for example, reflecting a sharper widening in the CAD and/or failure to attract non-debt financing flows.
-Macro: Weaker growth prospects, for example reflecting a more pronounced or longer period of economic slowdown that leads, for example, to increased fiscal pressures.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
-Fiscal: Improved confidence that the government´s fiscal strategy will lead to a narrowing fiscal deficit and broad stabilisation of general government debt/GDP over the medium term.
-External: Evidence of increased economic and external resilience to tighter financing conditions and geopolitical risks.
SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns Romania a score equivalent to a rating of 'BBB' on the Long-Term Foreign-Currency (LT FC) IDR scale.
Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to SRM data and output, as follows:
- External Finances: -1 notch, to reflect Romania's higher net external debtor and net investment liabilities positions than the 'BBB' median, as well as higher external vulnerability than implied by the SRM model, given adverse policy developments in recent years that have impacted external competitiveness and aggravated its exposure to shocks.
Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG CONSIDERATIONS
Romania has an ESG Relevance Score of '5[+]' for Political Stability and Rights as WBGI have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and a key rating driver with a high weight. As Romania has a percentile rank above 50 for the respective governance Indicator, this has a positive impact on the credit profile.
Romania has an ESG Relevance Score of '5[+]' for Rule of Law, Institutional & Regulatory Quality and Control of Corruption as WBGI have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight. As Romania has a percentile rank above 50 for the respective governance indicators, this has a positive impact on the credit profile.
Romania has an ESG Relevance Score of '4[+]' for Human Rights and Political Freedoms as the Voice and Accountability pillar of the WBGI is relevant to the rating and a rating driver. As Romania has a percentile rank above 50 for the respective governance indicator, this has a positive impact on the credit profile.
Romania has an ESG Relevance Score of 4[+]' for Creditor Rights as willingness to service and repay debt is relevant to the rating and is a rating driver for Romania, as for all sovereigns. As Romania has a record of 20+ years without a restructuring of public debt, which is captured in our SRM variable, this has a positive impact on the credit profile.
Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or to the way in which they are being managed by the entity.