Moody’s changes Romania’s outlook to stable from negative, affirms Baa3 rating

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BUCHAREST (Romania), October 16 (SeeNews) – Moody’s Investors Service said it has changed the outlook on Romania to stable from negative and affirmed the Baa3 foreign and domestic long-term issuer and senior unsecured ratings.

One of the key drivers for the change of the outlook to stable is the country’s solid economic growth prospects, which will rely on dynamic private sector and use of Next Generation EU funds, Moody’s said on Friday evening in a press release.

The other key factor in improving the outlook was the existence of a excessive deficit procedure, which is expected to act as a key policy anchor on fiscal strategy, the ratings agency added.

According to Moody’s, the affirmation of Romania’s Baa3 ratings balances the country’s strong growth potential and expectation of a gradual improvement in the fiscal metrics against a large current account deficit of 5% of GDP in 2020 and policy inconsistency resulting from unstable government coalitions.

The rating is supported by Moody’s expectation that Romania’s post-coronavirus growth potential will remain underpinned by a dynamic private sector including through the presence of long-standing foreign-owned companies focused on medium to high value-added activities in the manufacturing sector. The affirmation of Romania’s Baa3 rating also reflects the country’s moderate institutions and governance strength.

Moody’s last rated Romania in April 2020, when it changed the outlook to negative from stable and affirmed the Baa3 foreign and domestic long-term issuer and senior unsecured ratings.

Also on Friday, S&P Global maintained Romania’s outlook to stable, while affirming its long-term foreign and local currency issuer default ratings (IDR) at ‘BBB-‘.

In a statement issued on Friday evening, Romania’s finance ministry said that decisions of the two rating agencies are proof of the government’s sound economic measures. “The announcements are a sign of confidence in our fiscal consolidation policies, in our possibility of achieving assumed targets and of implementing reform through the Recovery and Resilience Plan, PNRR. At the same time, the reconfirmation of Romania’s rating is a proof of our external partners’ confidence in the government’s capacity to implement reforms laid out in the PNRR,” finance minister Dan Vilceanu said.

Moody’s also said in the statement:

“RATINGS RATIONALE

RATIONALE FOR CHANGING THE OUTLOOK TO STABLE FROM NEGATIVE

FIRST DRIVER: SOLID ECONOMIC GROWTH PROSPECTS TO RELY ON DYNAMIC PRIVATE SECTOR AND UTILISATION OF NEXT GENERATON EU FUNDS

The first driver of the action relates to Romania’s favourable medium-term growth prospects. After a sharp but short-lived contraction concentrated in the second quarter of 2020 in the context of the coronavirus pandemic’s outbreak, Romania’s real GDP accelerated in the second half of 2020, which led to a limited contraction on a yearly basis (-3.9% on average in 2020), one of the mildest in the EU and a smaller contraction compared to the Baa3 median. Considering the strong first half in 2021, with Romania’s real GDP level already exceeding its pre-crisis levels by 4%, Moody’s expects GDP growth to reach 7% this year. For 2022, 2023 and 2024, Moody’s forecasts growth rates of 4.6%, 4.1% and 3.6%, respectively.

In Moody’s baseline scenario, growth will be driven by robust domestic demand. Private consumption will benefit from the recovery in the labour market, as wages accelerate, and activity normalizes. Investment is also forecasted to sustain economic activity, with stronger public as well as private activity in the context of the Next Generation EU programme and the need for firms to expand productive capacity. By contrast, net exports should continue to contribute negatively to growth, as structurally high import content would outpace export growth. Risks to the macroeconomic outlook are tilted to the downside: Romania’s still relatively low vaccination rate could hamper economic activity should new containment measures be taken by the authorities to curb the pandemic’s rapid progression in October 2021.

Estimated at around 3-4% by the European Commission and the IMF, Romania’s potential growth is one of the highest in the European Union. Dynamic potential growth relies on positive contributions from total factor productivity and capital deepening, as the economy continues to converge towards the EU27 average. The presence of large and international firms will support Romania’s efforts to increase its presence in higher value-added activities. A growing information and technology sector (around 7% of GDP) is also likely to sustain economic activity. By contrast, adverse demographics and net migration outflows already weigh on labour’s contribution, and Moody’s expects this negative trend to persist and accelerate in the coming years.

Already solid, Romania’s growth prospects will further benefit from the EU’s Next Generation programme. Romania has applied to the full allocated envelope of the Recovery and Resilience Facility (RRF), with EUR 14.2 billion in grants and EUR 14.9 billion in loans, i.e. 13.7% of 2020 GDP when considering the two components. From an investment perspective, more than half of funds are targeted to the “Green Transition” that will include investment in rail infrastructure and rolling stock as well as in electric vehicle recharging stations. Romania’s plan also includes a commitment to phase out coal and lignite power production by 2032. Finally, the plan contains a number of structural reforms in areas such as health and education, governance, climate and public administration.

The Romanian government estimates that the programme will boost real GDP levels somewhere between 3.4 percentage points-5.4 percentage points over the 2021-26 period [1]. The IMF estimates that the RRF could lift GDP growth by around 0.3 percentage points per year between 2021 and 2026, which would raise the level of Romania’s GDP by almost 2 percentage points in 2026[2]. Under Moody’s baseline scenario, the gradual implementation of the recovery and resilience programme will support economic activity, primarily via the investment channel, while the impact of reforms will take longer to materialize. Over the medium-term, reforms in the areas of digitalization and education will boost the Romanian economy’s supply-side. The extent to which the use of RRF funds lifts economic activity will crucially depend on Romania’s ability to absorb large inflows of funds in a limited period. In the recent past, relatively low absorption rates (MFF 2014-2020) as well as limited administrative capacity and uneven government effectiveness have slowed implementation.

SECOND DRIVER: EXCESSIVE DEFICIT PROCEDURE TO ACT AS A KEY POLICY ANCHOR ON FISCAL STRATEGY

The second driver of the action is Moody’s expectation of a consistent and sustained fiscal consolidation strategy by the Romanian government in the three years to come. In June 2021, the European Council recommended that Romania corrects its excessive deficit to below 3% of GDP by 2024. Under an excessive deficit procedure, a country benefitting from European structural and investment funds may face a temporary suspension of financing in case of failure to act. The existence of the Recovery and Resilience Facility adds incentives to conduct prudent fiscal policies.

To achieve the fiscal consolidation requested by the European authorities, Romania is expected to prepare, legislate, and implement reforms in the areas of pensions and the public administration. In particular, the Romanian government has committed in its National Recovery and Resilience programme to conduct a comprehensive pension reform to be concluded by March 2023. The focus on sustainability and pension adequacy will enhance predictability in the system, moving away from ad hoc mechanisms.

Coming after a clear pro-cyclical fiscal stance during the 2016-2019 period, which led to a marked deterioration in Romania’s structural deficit,…

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