COMMENT: A concerning increase of Romania’s foreign debt

COMMENT: A concerning increase of Romania’s foreign debt
Clouds gather over Bucharest: the last two years have seen Romania's foreign debt approach the dizzy heights of €102.7bn reached in April 2013.
By Alexandru M. Tanase in London September 28, 2018

Romania’s foreign debt has not received proper attention since 1989. On June 3, 2016, I signalled in a comment for bne IntelliNews (Is the level of Romania’s foreign debt a cause for concern?) that the level of external debt was high and close to the brim. However, instead of an improvement, the last two and a half years saw an increase of total foreign debt from €92.9bn as of end-2016 to €97.6bn as of end July 2018. This is very close to the dizzy heights of €102.7bn reached in April 2013. This is a very concerning trend, especially so when compared to other heavily indebted countries in the region (Greece) or with other countries in transition to a market economy such as Bulgaria, Hungary, Poland or Ukraine. 

As previously mentioned, Romania started its transition to a market economy from a very favourable position from an external debt point of view: no external debt and almost $2bn in foreign reserves. Access to basic consumer goods was one of the key demands of the people involved in the revolution of December 1989 in the context of the sharp decrease of manufactured products in Romania. A way out of this situation was to borrow in order to massively increase imports, but a managed process of the pace of indebtedness would have been highly recommended. Basically, in those days, the pace of increasing foreign debt was more or less at $1bn per year. As of end-1996, Romanian had already accumulated debt of $6.9bn. By the time Romania managed to become a full member of the European Union (EU) on January 1, 2007, its foreign debt was already at the level of €58bn. Hopes that Romania would improve its external position after this key event were dashed rapidly as the country did not focus (as Poland did) on the absorption of the EU funds available to it in accordance with the EU’s budgets. Moreover, if a simple comparison is made between the previous years and the last two and a half years, some concerning trends would be easily noted. First of all, during this latter period, almost €4.7bn were added to the total foreign debt, according to the figures published by the National Bank of Romania (NBR), as presented in the graph below. 

Source: NBR Interactive Data Base - September 2018

The rate of the increase was amazing and, amongst other factors, has to do with the populist promises made during the last general elections two years ago. High increases of salaries for the public sector’s staff and, moreover, higher pensions (and more troublesome, special pensions, some which are yet to be properly taxed) promised to millions of voters have negatively impacted on the level of the foreign debt. The bottom line is that Romania borrowed heavily, both internally and externally, during the last two and a half years for consumption and not that much (if at all) for investment. This is not new. The most striking period was actually 1990-1992, when more than 60% of Romania’s imports were basic consumption goods. During recent years, Romanian continued to accumulate large current account deficits, as a result of its very unbalanced external trade. For instance, the net balance of exports-imports of goods increased from €1.5bn during the first seven months of 2017 to €2.8bn during the same period of this year. 

The second concerning trend, apart from the rising level of total foreign debt, is the structure of this key macroeconomic indicator. As presented in the graph, the share of the long term foreign debt decreased from 80.41% as of end-2013 to 68.62% as of July 2018. This is not a feature of a properly controlled indebting process, with the share of short term external debt (outstanding short term debt plus the instalments for the next 12 months on long term debt) increasing from 19.59% to 31.38% during the same period. In one year (July 2017- July 2018) the short term foreign debt increased by €5.8bn. This is not sustainable in the long term and bears risks of uncontrollable behaviour by international creditors, especially in periods of financial crisis such as the one registered 10 years ago (the sub-prime mortgage crisis of August 2008). One other key indicator which shows the risk is the coverage of the short term foreign debt with international reserves (total foreign currency reserves plus gold). This decreased to 70.5% as of July 2018 from 87.2% as of end of the last year. Also, as of July 31, Romania had a level of coverage of its imports with international reserves of 4.7 months of imports, as compared to 5.4 months of imports at end-2017. While in absolute terms these two indicators are not very bad, their trends are quite concerning.

Quo Vadis?

Romania is currently mired in two parallel streams of debts (internal and external), which could pose a material risk for the macroeconomic stability of the country. 

It is true that in accordance with the data published by the International Monetary Fund (IMF) in its report “Central, Eastern and Southeastern Europe — How to get Back on the Fast Track” in May 2016, Romania is not a heavily indebted country (HIC), especially when compared to Greece, Moldova, Ukraine and other indebted countries. Euromoney’s estimation as of July 31, 2017 for this rate was at 55%. However, the key question still remains, namely is Romania controlling its external debt properly? Judging by the developments of the last two and a half years, the answer is no. 

There are many measures which are required now, starting with the re-launching of a national investment programme which should lead to economic growth based on production and services, not on consumption (as was the case in 2017). Current account deficits should be controlled by increasing exports and bringing more tourists into the country and by attracting more foreign direct investments. Relations with the large Romanian community living and working abroad should be much improved (the events of August 10 were poorly handled by all parties involved) in order to keep the flow of remittances. Political corruption and populism should be avoided as a matter of urgency. The young workforce should be offered better opportunities to remain in the country instead of emigrating and special pensions (if maintained) should be properly taxed. Absorption of EU funds should be accelerated, privatisation should continue and agriculture should be revived, to name just a few immediate calls for action.

Moreover, Romania has started preparations to become a member of the eurozone. This is very ambitious under the current circumstances, but the process should be led by the monetary authorities of the country not by politicians. Strict control of the foreign debt (in absolute terms and as a ratio to GDP) will be a key criterion for admission to the “euro club”. If eventually admitted, Romania will no longer have one of the key tools at its discretion, namely the depreciation of the national currency. If the “ghost” of the last 10 painful years of Greece’s economic fate is to be avoided, Romania should start now to control its foreign debt.

Alexandru M. Tanase is an independent consultant and former associate director, senior banker at the EBRD and former IMF advisor. These are personal views of the author. The assessments and views expressed are not those of the EBRD and/or of the IMF and/or of the NBR and/or of any other institution quoted. The assessment and data are based on information as of mid-September 2018.