The Manufacturing industry and the IT and Business Support services still have potential for further growth given their strategic importance which continues to attract new EU funds and FDI. Agricultural production has had two excellent years in 2013 and 2014, therefore we expect a slight correction in 2015, but not significant to drag down the total output. Retail trade and consumption overall should be stimulated by the historically low inflation, cheap financing environment and higher wages. The VAT cut on food products should also stimulate consumption. The stake for 2015 remains the construction sector that should accelerate both in the private and public sectors. We see construction on the recovery this year, as buildings construction is on the upward trend since the second half of 2014, while for infrastructural works 2015, there is only a modest improvement although it is the last year to draw EU funds from 2007-2013 allocation.
Regarding the new fiscal code, the most visible impact in 2015 is expected to be on inflation with less damage on the budget. Nevertheless, a stronger impact of the announced fiscal measures is expected on the 2016 budget deficit. Fiscal relaxation is also expected to lead to a higher consumption-driven GDP growth.
Domestic demand to remain the main driver in 2015
The main driver of the Romanian GDP in 2014 changed from external demand to domestic demand, and more exactly private consumption, which explains the 2.6 percentage points of the 2.8% GDP growth in 2014. Both private and public sector investments dropped for the second year in a row, representing the major sore spot of the economy.
The GDP growth rate came out at 4.3% yoy (1.6% qoq) in Q1 2015. Based on the shortterm indicators, industrial growth accelerated at 3.3% yoy in Q1 2015 from 2.4% yoy in the previous quarter. Moreover, a positive surprise, besides construction (+13.4%) driven by the buildings segment, came from the transport activity, which advanced (10.7% yoy) nearly twice faster than in the previous quarter. The good dynamics is in line with higher international trade volumes, especially from the eurozone. Industry and the IT and Business services, the fastest growing components of 2014 GDP, registered double digit growth in their turnover during the first quarter of the year (+24% yoy in case of IT services) and have potential for further growth during 2015. Nevertheless, we expect a negative correction of agriculture in 2015 after two exceptional years (+29% yoy in 2013 and additional +1.5% in 2014).
On the demand side, the real wage growth (+6.4% yoy in Q1 2015) continues to be supportive for demand acceleration. The VAT cut is expected to further boost consumption and GDP, but rather to be visible in 2016 (additional 1 percentage point growth in GDP), while for 2015 the impact we project is at around additional 0.2 percentage point growth in GDP.
Economic recovery amid balanced macro policies rewarded by rating agencies, but worries are related to the new fiscal code
At the moment, all rating agencies put Romania in the investment grade category. The 5Y EUR CDS fell to all-time lows, bellow 100 bps starting February 2015 and reaccelerated starting mid-June at 115 bps, on the back of the European context, but still significantly below 400 bps seen in 2012. The improved risk perception about Romania and its peers has been also facilitated by the increased liquidity in the euro area. S&P affirmed Romania’s stable outlook on the 10th of April 2015, after lifting Romania’s rating to investment grade status in May last year. While there is a robust growth outlook for Romania amid the stable macro environment in terms of price stability, external and budget balance with public/foreign debt at sustainable level, there is a clear increase of risk in terms of fiscal consolidation under the announced new fiscal code. They warn of growing deviation from the medium-term objectives.
Based on the new fiscal code, as of June, VAT for foods has been cut to 9% from 24%. In 2016, fiscal stimulus is planned by the government to be continued with the general VAT cut from 24% to 19%. Based on our calculations, the total impact of food and general VAT cut is around RON 17 billion or 2.4% in GDP. Other approved changes under the new fiscal code are the lower dividend taxation(1) and lower excises to be implemented next year.
At the moment, the government expects deficit at 2.9% of GDP in 2016, relying on improved collection revenues (of around RON 14 billion annually). ANAF said that VAT collection rose by 20% yoy in the first 4 months and that RON 6.4 billion (0.9% in GDP) was collected, more than in Jan – Apr 2014. Looking behind the favorable picture, however, we should bear in mind that only a part of this amount is due to better collection and a part is generated by the economic growth. So, if we make a simple proxy and adjust the growth of revenues with the nominal growth of GDP (at 7.4% yoy in Q1), the additional revenue of this period coming from the better collection would be around RON 3 billion. This means the annualized figure is RON 9 billion, if the current pace of improved collection is maintained. Overall, this figure implies that, theoretically, Romania could have a deficit lower than 3%, but only if we preserve the advantage on the collection data.
The risks that we see are in the area of capital expenditure where we have seen continuous cuts in the past years, unsustainable in the future (-26% or around RON 1 billion less than a year earlier, in 2014). Therefore, these expenditure items should increase strongly in the next period, fuelling higher deficit. In the end, the fiscal relaxation measures are expected to have positive effects on the economic growth, stimulating consumption and job creation. The fiscal package could lift GDP growth by around 1 percentage points per year between 2016-2019.
The International Monetary Fund and the EC visited Bucharest in June but Romania did not finalize the aid review because of disagreements on the new Fiscal Code. Romania has a stand-by agreement of EUR 4 billion with the IMF and the European Commission, the third since 2009, and it closes in September. Under this circumstance, the current agreement will likely remain suspended and the probability of a new precautionary agreement is very low. Although there is no need for real financing from the IMF, the maintenance of international agreements is a cushion against internal or external shocks.
Still, the optimistic macro environment amid balanced macro indicators creates the favorable condition to absorb possible shocks at least on the short to medium term. Regarding the international context, on the 22nd of April 2015, Moody’s(2) highlighted that the steady economic growth and stable debt levels of Romania should help offsetting the external risks, like the diverging global monetary policies, a potential Greek exit from the euro area, deflationary pressures and geopolitical uncertainty stemming from Ukraine.
The contagion to a possible Greek default and/or exit from euro area is expected to be limited and controlled. The strongest link is through the banking system, since 12% of the Romanian banking system is controlled by Greek banks, while international trade linkages are small (below 2% of both export and imports). However, based on the NBR’s Governor’s announcement, the Greek banks present in Romania do not depend on the parent funding. They have solvency rate at 17.6% as of March 2015(3) and liquid assets at an adequate level. The liquidity risks of Greek banks are lower due to compensation agreements made with their shareholders, based on which Greek banks can refuse to give back deposits to parent banks if capital controls are introduced. Moreover, they have eligible assets in their portfolio almost twice higher than their liquidity needs that may appear if funds expiring in 2015 are not renewed from their parent banks. The impact of negative events is rather expected through a selling pressure on the government bond market and national currency. Nevertheless, RON’s evolution should move in line with regional peers and any stronger movement is expected to be smoothed. Moreover, the pressure to raise debt through new issuance is rather low since the Government managed to sell more than 90% of its planned issue in the first half of the year and it has a strong FX buffer that covers around four months of financing needs.
Inflation and interest rates are at historically low levels
Inflation remained below target band almost the entire 2014 and ended 0.8% yoy in December 2014 (average 2014 at 1.1% yoy). The VAT cut on food products from 24% to 9% strongly influenced this year’s inflation outlook since it affects around 30% of the CPI basket. This would mean a total lowering impact on CPI inflation of around 3 percentage points in 2015.
Nevertheless, fruits and vegetables prices are expected to climb again due to some drop in production, after two years of good agricultural output. Regarding other components, gas prices are expected to rise by 13% as of July 2015 as part of the gas price liberalization process which was interrupted in October 2014. Tobacco prices have been increased due to excise regulation by 3% as of 1st April, while fuel prices should be lifted by the recovery of the oil price on the international market.
We currently expect a 0.1% yoy end of year inflation for 2015. The core 3 measure is seen in the negative territory starting June 2015 until the end of 2015 and even further if additional VAT cuts are implemented at the start of next year.(4)
As inflation was persistently below expectations and NBR target of 2.5% (+/-1%), the Central Bank cut its policy interest rate by 1.25 percentage points in 2014 and by additional 1.0 percentage point in four steps until the level of 1.75% as of May 2015. At its latest monetary policy meeting held in July 2015, NBR decided to maintain its policy rate at 1.75%. Although inflation (at 1.2% yoy in May) is below the NBR target of 2.5%, it might position above the expected level (end-of-year inflation expected by NBR at 0.2%) given the stronger price hike of fruits and vegetables during 2015. Moreover, another upward risk might be channeled through the RON depreciation driven by the prolonged uncertainty on the outcome of negotiations between Greece and its creditors. Looking forward, on the one hand, we can say that less space remains for further key rate cut, and a ‘wait-and-see’ attitude of NBR is rather expected for the next couple of months. On the other hand, inflation should stay below target until the end of 2016, driven by further VAT cuts for all products, so we do not expect any rate hike for this time period.
The restart of the financial cycle has begun
The first signs of lending revival are here. For the first time post crisis, the volume of new loans is advancing at double digit pace compared to previous years, when it dropped or stagnated. The annual new loans volume stood at RON 51 billion in 2014 and it was 15% higher than in 2013. During the first 5 months this year, this trend continues and the rhythm is the same (+15%yoy). The household loans enjoy the most rapid increase, due to the exponential growth of mortgage loans (+60%yoy). New corporate loans are increasing too (+19%yoy). Improved consumer and business confidence, as well as lower interest rates, contributed to this observed evolution.
However, the stock of loans continues to decline because the dynamics is affected by the sales of non-performing loans. We believe we will see a positive growth rate of the stock as well in 2016, as most of the portfolio cleanup would have already taken place in previous years. Moreover, we noticed the euro-area private lending entering the positive territory on March 15 and, based on existing patterns, Romania should also follow.
1) The dividend tax is cut to 5% down from the current 16%.
2) Moody’s improved outlook on Romania’s Baa3 rating to stable from negative on the 25 April, 2014.
3) The minimum imposed at European level is 8%.
4) The general VAT is planned to be cut from 24% to 19% in 2016.