COMMENT: Romania – an emerging market not fitting the EU-corset

COMMENT: Romania – an emerging market not fitting the EU-corset
By Gunter Deuber of Raiffeisen Research January 19, 2016

The Romanian economy is continuing its decent recovery, posting the strongest GDP growth rates in Southeast Europe. Given our current forecast set, Romania will post a cumulative real GDP growth of 14% from 2013 to 2016, and is possibly even outpacing the previous regional “tiger” and investor favourite, Poland. Therefore, one should not be surprised to read about Romania becoming the next European growth champion.

Romania's economic growth is increasingly being driven by domestic factors, which bodes well for Romanians as well as foreign investors, who are trying to tap the potential of the domestic market (in retail or the financial sector, for example). Up until 2013, economic growth was mainly export-led and therefore did not reach out to larger parts of the Romanian population. But as domestic demand is growing, imports are surging and net exports might even turn into negative territory next year. Increasing imports are likely to support a gradual widening of the currently very narrow current account deficit, growing from around 1.0% of GDP in 2015 to around 2.5% or 3.0% over the next two years. In 2016 and 2017, we expect an additional boost to the aforementioned positive economic trends coming from the increasingly expansive and pro-cyclical fiscal policy. Therefore, we recently upgraded our near-term economic growth forecasts and now expect 4.0% for next year and 3.6% for 2017.

Real GDP growth (% yoy)

On the back of positive economic developments, Romania has profited from positive investor sentiment over the last few years. The conservative economic policymaking (by and large in line with IMF and EU requirements), as well as relatively stable politics (at least by Romanian standards), were encouraging. Moreover, macro-financial vulnerabilities were reduced substantially. Today, external debt is significantly lower than some years ago. In the banking sector the loan/deposit ratio is even below 100%. However, the perks of solid growth, stable politics and reasonable economic policymaking seem to have come to an end.

Recently, the political noise has increased once again. Until the next parliamentary elections in autumn 2016, a caretaker government is running the country. Furthermore, medium-term implications of the gradual departure from stability-oriented economic policymaking have to be assessed very cautiously.

We now expect Romania to be in breach of some EU economic governance indicators (eg. the fiscal deficit criterion) in 2016 or 2017. Moreover, we see gradually increasing macro-financial imbalances emerging. Although we expect no outright tightening of monetary policy throughout 2016, the National Bank of Romania (NBR) could come under increasing pressure to react to the gradual increase of macro-financial imbalances (eg. via tightening domestic liquidity conditions first to prepare rate hikes later). Hence, foreign investors should start to factor in more hawkish central bank rhetoric in 2016 and possibly more outspoken comments about the lack of appropriate monetary and fiscal policy coordination.

Fiscal deficit (% of GDP)

From a long-term perspective, the pro-cyclical fiscal policy and the lack of long-term planning are major weaknesses of economic policymaking in Romania. Now we are back to fiscal loosening. But is it already time to turn bearish on Romania? Possibly not!

The deterioration in the fiscal and current account balances comes from still modest levels and are not seriously in breach with EU economic governance. Despite a modest deterioration in flow variables, a lot of stock variables, like public or external debt levels, are still at very solid levels. Therefore, we see the very recent decision by the rating agency Moody’s Investors Service to change the rating outlook to positive – despite recent negative market news flow – as very reasonable. Moreover, the reasonableness of the limits of the EU economic governance for its poorest and fastest growing members is debatable. Given the nominal GDP growth outlook of at least 4.5% to 5.0%, Romania should be able to easily stabilize its public debt levels with budget deficits slightly above the 3% deficit criterion.

Not to mention that increasing talk about Romania as the “new European growth champion” is supporting expectations that there should be also something in it for the Romanians. This holds especially true following the years of ultra-restrictive fiscal policy, resulting in a drop of the public deficit from 7.1% of GDP back in 2009 to around 1.2% in 2015. Just for comparison, in the Eurozone budget deficits have just fallen from some 6.2% at peak levels to around 2.7% in 2015.

Furthermore, Romanian government revenues and expenditures are just around 30% of GDP, whereas Eurozone countries show readings well beyond 40% for both indicators. Therefore, a return to strong growth and income convergence could also support a certain approximation of state revenues and spending to Eurozone levels from a long-term perspective (although fully converging to the “benchmark” Eurozone should not be considered as an optimal strategy).

Moreover, a current account deficit (possibly even beyond 4% of GDP on a temporary basis) is not per se a bad thing for an emerging market like Romania – neither are certain frictions between fiscal policymakers and central bankers, as long as the latter have the courage and mandate to turn hawkish. Hence, we do not see the current developments in Romania as negative as some other market watchers. Nevertheless, the trend worsening comes at a time with a more fragile political situation, where political noise may have a larger and temporarily negative impact on the market.

For the time being, the positive macro-story seems to remain legit. Contrariwise, the return to a growth-friendly economic policymaking setting that is more typical for an emerging market – not a highly developed EU country – could be even interpreted as slightly positive, as long as certain limits are respected and the ability to cut in tougher times remains intact. To put it in a nutshell: following years of very conformist economic policies – also in line with EU policymaking and IMF orthodoxy – the ongoing economic recovery has supported an increasing confidence among Romanian policymakers to focus once again more on convergence expectations among their voters. Such a policy orientation may not fully respect all limits of EU economic governance, but is not necessarily bad for an emerging market.

Therefore, one could even say that with its more expansionist economic policies, Romania is just transferring into a more mature market phase. So is the Romanian banking sector – following years of de-risking and consolidation, bankers in Romania now have to work on putting all the liquidity and gathered deposits to work on a growth agenda, ie. to put deposits into interest bearing assets.

Cumulative real GDP growth 2013-2016f