Romania is expected to be one of the fastest growing economies in Europe this year, as the government’s expansionary fiscal policy stokes a consumer boom, but this has raised concerns about the swelling budget deficit.
The European Commission forecasted in February that the Romanian economy would expand by 4.2% in 2016; the second highest figure in the EU after Ireland. Growth is being driven by domestic consumption. Recent data on retail sales show it has exploded following VAT cuts and hikes in public sector wages. In January 2016, retail sales grew by 15.6% year-on-year, the highest annual increase since the global financial crisis hit in 2009. Sales of both food and non-food products grew in the double digits, according to the national statistics office.
Retailers are cashing in on Romanians’ increased appetite for consumption. In the food segment, Carrefour announced in December it had struck a deal to take over rival Billa’s operations, while Delhaize’s Mega Image and local supermarket chain Profi are both planning organic growth. Mega Image in particular is expanding rapidly, with plans to spend €50mn to open up to 100 stores in 2016.
It is a similar story for non-food retailers. Electronics and domestic appliance retailers Altex and Flanco both posted record figures in 2015, and Altex, the largest player in the sector, plans to increase sales by a further 10%-15% this year. Fashion retailers are also growing, with Turkish chains Colin’s and LC Waikiki among those that announced expansion plans recently. Ikea is planning to open a second store in Bucharest, because of the overwhelming numbers of shoppers at its existing outlet.
Retail growth started to accelerate with the decision to slash VAT on food from 24% to just 9% in June 2015. This was followed by the lowering of the standard VAT rate from 24% to 20% in January.
Meanwhile, salaries in the state healthcare system were raised by 25% in October and teachers got a 15% pay rise two months later, while other public sector employees had their salaries increased by 10%.
The changes were initiated under former prime minister Victor Ponta’s Social Democrat (PSD) led government, with one eye on the parliamentary elections due to take place in autumn 2016. After the collapse of his government, the interim government that took office in late 2015 decided not to reverse the plans despite fears about their impact on Romania’s budget deficit.
The government is targeting a deficit of 2.8% of GDP this year, based on a forecast of 4.1% GDP growth. However, the deficit is expected to rise substantially in 2017. Romania’s independent fiscal council expects the deficit to reach 3.7%, while the European Commission’s forecast is for 3.8% - both well above the 3% threshold set by the EU, which puts the country in danger of entering the EU’s excessive deficit procedure. The current account is also growing as local production is unable to keep up with consumer demand, resulting in rising imports.
“The fiscal stimulus is difficult to justify at a time when economic growth is already strong,” the International Monetary Fund warned in a March 14 report.
At a press conference in Bucharest, the fund’s new Romania director Reza Baqir praised Romania’s “impressive fiscal consolidation” since 2008 but warned that Bucharest now risks squandering its “hard won gains”.
“The 2016 budget inappropriately give stimulus when consumption growth is already strong,” the IMF report said. “If no measures are taken, next year’s fiscal deficit will exceed the authorities’ target and there is a risk that further deficit-increasing measures may be passed in an election year that would put debt on an upward trajectory.”
The governor of the Romanian central bank, Mugur Isarescu, has also been highly critical of the government’s fiscal policy, warning that the rising budget deficit will threaten macroeconomic stability and convergence with the eurozone.
“Personally, I have never seen in the past 25 years greater dangers to the economic and financial stability of Romania,” Isarescu said in a strongly worded statement to journalists on March 15, news agency Agerpres reported. The expected rise in the budget deficit in 2017 “shows us that we have not learned enough from the principle according to which in economic growth periods we have to save. When we have more, we don’t have to spend everything, we need to make reserves,” he added.
Cause for concern
However, some analysts take a more generous view. Gunter Deuber, Raiffeisen head of CEE research in Vienna, argues that there was a strong rationale for the VAT cuts and wage hikes. Romania had a “rather tough period of consolidation” lasting several years, and while this was in line with EU and IMF requirements, “the recovery was not really felt domestically, and now the government has to deliver something the people on the street will feel. There was a rationale to do something now that things have stabilised from a macro-financial perspective.”
Raiffeisen analysts are “not overly concerned” about the economic situation in Romania, which in terms of growth potential - of around 3% - is “more like an emerging market”, so there is less urgency to bring down the deficit than in slower-growing West European economies.
The decision to cut VAT on food both reduced tax evasion and had a positive social impact, points out Erste’s chief economist in Romania, Radu Craciun. “If the government had stopped there, it would have been excellent, but they decided to go further with the pro-cyclical fiscal policy. With one of the highest growth rates in Europe, it’s strange to have a fiscal stimulus.”
The double-digit growth in retail sales is reminiscent of the unsustainable wage and consumer-driven consumption before the crisis, which required significant adjustment. However, Craciun says, “definitely Romania is much more balanced than before the crisis, though the overall trend is still a cause for concern”.
The current rapid pace of growth is not expected to continue indefinitely; GDP growth is expected to moderate to 3.7% in 2017 according to the EC, while y/y retail sales growth will decline from June, one year after the initial VAT cut.
For sustained growth in the longer-term, Romania still has to address its investment problem and lack of long-term planning.
“Romania’s development over the last decade has been quite chaotic and the government has lacked a proper development strategy,” Craciun says. “Instead, there has been spontaneous development during which investors grabbed whatever opportunities Romania could offer.”
This lack of planning has resulted in an influx of investors to Romania’s western borders, the areas closest to Hungary’s excellent motorway network, and to traditional manufacturing centres. Meanwhile, areas with poor road transport connections, particularly the eastern Moldavia region, have been left behind. This has resulted in a country “spotted with pockets of wealth and extreme poverty”, Craciun says.
Romania has also struggled to utilise EU structural funds. Despite a recent push that could bring the absorption rate for the 2007-2013 budget period to 74%, Bucharest will still lose out on at least €5bn of the €19bn earmarked.