Romania: Weaker growth without reforms

After the peak in job creation in mid-2016, the Romanian economy expanded robustly on fiscal stimulus. Though some inertia remains, growth could be strangled by a lack of structural reforms.

2020: glass half full or half empty?

The economy is still running on borrowed time, supported by generous fiscal and wage policies. Fiscal consolidation is unavoidable after the elections, regardless of their outcome, and implies short-term cost in terms of GDP growth, although structural reforms (i.e. public sector digitalization, education, labor market, healthcare) could mitigate it in the medium term.

After a tumultuous 2019, the political scene is warming up for another two rounds of elections in 2020: local in mid-2020 and general in late-2020. We expect the latter to break the political deadlock and bring more policy consistency, with four years then ahead without any elections in sight.

Last year, the economy shrugged off the political noise and managed to expand at a robust pace of 4.1%, a mild slowdown from the year before. We expect the growth deceleration to continue into 2020 to 3.5%, as external demand is unlikely to quickly recover, while domestic labor resources are stretched. Consumers are in pretty good shape. Unless shaken by an external shock, confidence should remain high, as the tight labor market and social policies are likely to lead to a nearly double-digit rise in wages this year. For 2021, we forecast 2.0% growth, assuming fiscal adjustment of 1pp of GDP. Depending on the size and timing of the fiscal consolidation, we stand ready to revise it.

For 2020, strong consumption remains the full half of the glass. The economy running out of resources – labor and capital – is the empty half. Labor is scarce due to migration, low labor force participation, and outdated education curricula. Public capital expenditure has been trimmed down in recent years, while private investments posted sluggish growth rates. The central bank is constrained by the divergent twin deficit story and subsequent RON weakening pressures. Higher RON interest rates vs. peers to fend off RON softening, given the relatively high FX pass-through, lead to higher cost of capital. We forecast a CPI of 3.4% by end-2020 and 3.1% by end-2021, assuming a relatively stable real exchange rate.

Regardless of the election outcome, we expect meaningful fiscal consolidation in 2021 due to three main constraints: (i) excessive deficit procedure (EDP); (ii) possible action from the rating agencies (S&P has a negative outlook since late-2019 and the government has 24 months to take action before the subsequent rating action); (iii) and relatively high government borrowing costs vs. countries with similar nominal GDP growth rates. Hence, the overdue fiscal correction (post-election) is likely to be gradual, assuming a benign global backdrop. Some frontloading could be optimal from the budget deficit/GDP growth trade-off perspective. Romanian politics is known for its unpredictability. A hung parliament is the main risk to our forecast scenario. Stay tuned for updates!

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