A noisy end to the election cycle

A noisy end to the election cycle


THE PNL GOVERNMENT FACES A CHALLENGE TO   ITS   DECISION   TO   SCALE   BACK   THIS   YEAR’S  PENSION  INCREASE  FROM  40%  TO  14%.   The   Constitutional   Court   (CC)   is   expected to rule on this issue before mid-January. We assume that the pension increase will remain at 14% this year, which would cap this year’s budget deficit at around 9.5% of GDP and, more importantly, allow next  year’s  deficit  to  fall.  In  order  to  reduce  the  budget  deficit  below  5%  of  GDP  in  2021,  the  next  government  will  need  to  cut  the  expenditures  or  to  boost  revenues.  This  year’s  deficit  could  be  lower  if  fiscal  reserves  are  used,  while  the  Fiscal  Council’s  estimate  is  at  9.8%  of  GDP  according  to  the  cash  methodology.

So    far,    the    government’s    support    measures    including    tax    breaks    and    direct    support    for    furloughed workers, poor households and SMEs fall slightly  short  of  2%  of  GDP.  In  addition,  the  loan  guarantee program supporting SMEs exceeded RON 12bn  (1.2%  of  GDP)  by  the  end  of  August.  Other  programs, including support for leasing and factoring BY UNICREDIT BANKfor large companies affected by the pandemic, were launched  later  this  year.  In  mid-September,  Finance  Minister Florin Cîțu estimated existing support lines at  RON  61.8bn  (6%  of  GDP).  Some  of  the  support  measures   were   already   extended.   For   example   employees  and  the  self-employed  whose  activity  is  affected  by  COVID-19  will  benefit  from  furlough  support  until  the  end  of  the  year.  In  our  view,  the  government might have to extend the direct support programs beyond the end of this year.

Next year’s efforts to reduce the deficit would need to  go  beyond  capping  the  2020  pension  increase  at  14%.  The  Fiscal  Council  estimates  the  2021  budget  shortfall at 8% of GDP (or even 9% of GDP considering that  some  of  the  one-off  measures  to  combat  the  effects    of    the    COVID-19    pandemic    could    be    prolonged)   without   corrective   measures.   In   our   view, public-sector wages will have to be at most flat compared  to  2020  and  transfers  will  have  to  fall  to  close to 2019 levels if pensions are to increase by up to 8%. Preventing a sharp increase of the public debt above  50%  of  GDP  would  leave  leaving  Romania under the BBB median debt thresholds for all three rating   agencies   and   thus   supporting   Romania’s   investment-grade    rating.    This    year’s    economic    contraction could be close to 5% if the recovery loses speed in 2H20. Due to needed fiscal tightening, next year’s recovery is likely to be incomplete.

Romania  stands  out  in  EU-CEE  due  to  the  sharp  widening in its trade deficit in goods. One reason for this is falling demand for cars, clothing and apparel, all  of  which  are  important  export  staples.  However,  the  crisis  exposed  the  lack  of  competitiveness  for  some  of  Romania’s  industrial  sectors.  Most  low-value-added  sectors  suffered  more  than  average,  which  may  indicate  that  their  small  margins  could  not  accommodate  weaker  demand.  The  overvalued  RON  also  played  a  role,  as  did  the  rise  in  minimum  and average wages that has outpaced productivity in the past six years. Meanwhile, the trade balance with services improved due to fewer Romanians travelling abroad.

Income  transfers  are  likely  to  fall  further  amid  lower corporate profits, offsetting lower remittances and  the  higher  trade  deficit.  As  a  result,  the  C/A  deficit  could  remain  stable  this  year,  declining  only  marginally in 2021. FDI was hit hard in 7M20 as new equity  inflows  fell  fivefold  yoy  and  debt  flows  were  down a third compared to 7M19. The improvement in  2H20  is  likely  to  be  only  marginal.  At  the  same  time, transfers from the EU could rise to close to EUR 4bn  this  year,  as  Romania  benefitted  from  support  funding from the EU in addition to larger inflows of structural and investment funds at the end of the EU budget  2014-20.  Next  year,  we  expect  Romania  to  borrow from the EU, starting with SURE support for employees   and   companies   (country   allotment   of   EUR  4bn),  but  also  from  the  NGEU.  The  authorities  submitted  the  absorption  frameworks  for  the  EUR  13.7bn  in  grants  and  EUR  16.6bn  in  loans.  These  loans  may  help  Romania  cover  the  negative  EBB  in  2021. This year, part of the coverage will come from the  cash  brought  back  by  Romanian  workers  who  returned  home  during  the  pandemic.  In  May,  the  government  estimated  the  number  at  1.3  million.  If  every    returning    person    spends    EUR    2,000    (a    conservative assumption) two thirds of the negative EBB could be covered in 2020. Many of these workers will not return quickly to their previous jobs in Italy and Spain, with those working in care homes and in tourism worst affected. Thus, the authorities expect 500-600,000     of     these     workers     to     add     to     unemployment, which could exceed 6.5% in 1Q21.

Higher unemployment and lower wage growth are likely to weigh on core inflation from 4Q20 onwards. This  may  keep  headline  inflation  inside  the  target  range  in  2020-2021,  despite  pressure  from  higher  excise    duties.    If    the    budget    deficit    remains    manageable, the NBR could cut the policy rate twice more to 1%, to smooth the end of the moratorium on loan repayments, which is currently covering 20% of private-sector loans.

While   elections   are   likely   to   result   in   a   pro-European        parliamentary        majority,        reform        momentum  is  unlikely  to  pick  up  if  the  coalition  comprises more than two parties.