Scope Ratings says recent budget revision could prompt reassessment of Romania's sovereign credit rating

The Romanian government has adopted a first revision of the 2019 budget in response to the increase of the budget deficit and effective measures are needed, considering the pro-cyclical fiscal policies and the upward trajectory of Romania's public debt, German agency Scope Ratings notes in a report this week.

The agency remarks that Romania's budget deficit has continued to widen to an annualised 5.5 percent of GDP during the first quarter of 2019, by far the highest among EU members, which have an average budget deficit of 0.6 percent - despite annual real GDP growth of 5 percent.

Scope Ratings analysts project Romania's mid-year budget deficit at close to 2 percent of GDP, which increases the government's challenge in the next six months to achieve its self-imposed budget deficit ceiling of 2.76 percent of GDP.

"More efficient tax collection, additional levies on consumption and better cost control are key for a more sustainable budget," says Bernhard Bartels, Scope Ratings lead analyst for Romania.

In the opinion of Scope Ratings analysts, Romania's public finances face two structural challenges over the medium-term: more effective revenue collection and keeping pension and wage growth under control. Fiscal revenues are among the lowest among CEE countries (32 pct of GDP) and on a downward trend with low tax revenues (25.4 pct of GDP), while expenditures have grown strongly on the back of higher public sector wages (up 24 pct from last year). The adoption of the new pension law in June this year, which becomes effective in September, will further increase the fiscal cost by an estimated 0.8 pct of GDP. The National Fiscal Council projects the deficit to increase to around 4 percent of GDP in 2020 and 5 percent by 2021 if fiscal policies remain unchanged, the cited experts say.

Also, Scope Ratings expects Romania's public debt, which currently stands at 36 percent of GDP, to increase towards 40 percent by 2020. Currently, the share of debt denominated in foreign currency is at 57.1 percent (17 percent of GDP), which could lead to a more pronounced debt-to-GDP increase if the monetary policy remains expansionary, resulting in depreciation pressure for the Romanian leu against the euro once economic activity abates.

"At this stage of the economic cycle, the government faces a trade-off between stabilising the budget and avoiding a recession through large expenditure cuts. Its strategy seems to boil down to a mix of revenue-increasing measures and cuts to selected ministries' budgets," says Bernhard Bartels.

The rating agency emphasizes that the government has the benefit of higher-than-expected growth, supportive monetary policy and low refinancing rates, which help contain the budget deficit. However, on the back of higher import growth, Romania's current account deficit has widened to EUR 9.4bn in 2018, a level not seen since 2012.

"We expect that the government will succeed in achieving a 2019 deficit close to the 3 percent of GDP limit through short-term adjustments, but it faces a bigger challenge next year given a growing pension burden and likely slowing growth," Bartels further notes.

Scope's concerns about the outlook for Romania's public finances were reflected in the downgrade of the country's credit rating in October 2018 to BBB- from BBB, with a Negative Outlook. The agency said that Romania's sovereign outlook could be stabilised if effective policymaking led to a strong improvement in the government's fiscal framework and/or a firm downward path for the public debt trajectory.

Based in Berlin, Scope Ratings is the leading European credit rating agency, specializing in analyzing and providing ratings for financial institutions, corporations and public institutions.