- Short-term indicators suggest weak activity was preserved in Q4 2012 and we look for flat dynamics in real GDP. We don’t expect a visible improvement in activity in Q1 2013, while we see more chances for growth to gain momentum in the second half of the year.
- Annual inflation rate stood at 5% yoy in December last year, fuelled by a large contribution from volatile food prices (1.3 percentage points). Adverse statistical base effect would be preserved in H1 2013, keeping headline annual inflation between 5.4-5.8% yoy. When adjusting for contribution of volatile food prices, advance in consumer prices would remain close to 4% yoy throughout 2013 (even close to 4.5% yoy in H1 2013).
- Central bank remained on hold at the last monetary policy meeting on 7 January (key rate unchanged at 5.25%), but it hinted at easing control over liquidity conditions in the money market. With headline inflation rate at 5.4%-5.8% yoy in H1 2013 and medium-term trend in inflation at 4.0%- 4.5% yoy, we don’t see room for key rate cuts in the coming quarters. But we see more room for central bank to ease liquidity conditions in the market, which means ROBOR rates might fall in the following period.
- Planned inclusion of RON T-bonds in its EM Local bond indexes by JP Morgan boosted interest of foreign players for RON T-bonds. Non-residents might have increased their stake in such assets by at least EUR 2.4 bn equivalent in Dec 2012 and Jan 2013. Yields for T-bonds plunged by 100bp in Dec-Jan. These large inflows of foreign capital also resulted in an appreciation of the leu (+2.7% against the euro during Dec-Jan).
- The final review under the precautionary SBA agreement with the IMF showed Romanian authorities missing quantitative targets and failing to implement structural reforms. Romanian authorities asked for a 3-month extension in order to put some reforms in place.
Romanian authorities ask for a 3-month extension of precautionary SBA agreement with the IMF
Targets for end-2012 were missed. At the end of December 2012, Romania did not achieve the targets for budget deficit (on cash basis), arrears of central and local government and net foreign assets, while reforms of SOEs (privatizations, private management) were delayed. Romania has received waivers for not fulfilling the arrears criterion in the past, but meeting the budget deficit was the bright spot of previous reviews. Missing the budget deficit target (cash definition) was related to some extent to suspension of EU funds disbursements and according to ESA 95 methodology, the budget shortfall is estimated to be below 3% of GDP (as agreed). The ‚very stubborn to get down? arrears and poorer than expected performance of reform implementation and EU funds absorption were the negatives of the press conference of the IMF representative following the review.
Romanian authorities ask for more time to implement reforms. The review was focused also on this year’s budget plan, and policies and reforms to be implemented in the following period (an agreement was reached at staff level). IMF considers the budget plan for 2013 (targeting a cash budget deficit of 2.1% of GDP) as balanced on measures on the expenditure and revenue side. Romanian authorities will ask for an extension of their program with the IMF by three months (from end-March to end-June). During this time, the authorities should implement the structural reforms (restructuring and privatization of SOEs), lower arrears and avoid fiscal slippages. The program with the European Commission will end on 31 March, as scheduled.
While desired, a new deal with the IMF is not fully guaranteed. IMF representatives said discussions about a new deal should take place only after the current arrangement is completed (we read if Romanian authorities implement the agreed reforms until end-June). As time passes, we would not rule out a scenario of not signing a new program with the IMF. There could be also administrative issues about a new program (type of program, participation of the European Commission). A failure to sign a new deal might not be the worst thing to happen, provided that authorities avoid fiscal slippages (keep the budget deficit below to 3% of GDP in ESA terms) and remain committed to structural reforms.
Ongoing fiscal consolidation in 2012
The positive facet: ongoing fiscal consolidation in 2012. Consolidated budget deficit computed according to the national methodology (cash definition) amounted to RON 14.77 bn in 2012 or 2.5% of government’s projection for nominal GDP. This is well below the level recorded in 2011 (RON 23.9 bn or 4.3% of GDP). So, 2012 was the third year in a row with a sustained decrease in the public budget deficit. Core public revenues (main taxes and social contributions) went up by 6.7% in 2012, slightly faster than official estimates for nominal GDP growth (5.1%). Core public expenses went up only by 1.5% in 2012, which reflect a tight control over their dynamics.
Unfortunately, no data are yet available with regard to dynamics of arrears of the public sector for the full year 2012. It is not clear yet if small advances in public expenses were achieved while reducing also the stock of public arrears.
Budget deficit target negotiated with the IMF was marginally missed. Romanian authorities pledged to maintain the consolidated budget deficit in a limit of RON 13.66 bn (or RON 14.66 bn when including expenses with National Program for Infrastructure Development (PNDI)). In this context, the effective budget deficit (RON 14.77bn) outpaced both targets (by a margin depending on the amplitude of PNDI expenses). It seems that the freeze in EU funds disbursements by the European Commission in the second half of 2012 had a material impact on the budget deficit (as we stressed the issue in our report 9/2012). The government spent money with advances towards the final beneficiaries (especially in the first half of the year) and it was unable to recover them in time from the European Commission. The budget execution showed a gap of 0.9% of GDP between public expenses for EU programs and public revenues from EU programs. This accounts for 35.5% of the total budget deficit. For reference, the initial plan at the beginning of 2012 implied a surplus (+0.3% of GDP) for this segment, while the last budget revision in October 2012 foresaw only a deficit of 0.4% of GDP.
Some weaknesses behind budget execution. Budget execution reveals several weaknesses about which we have talked many times in our reports throughout 2012:
- Expenses with goods and services in 2012 (RON 34.44bn) outpaced all targets set during the year (initial plan of RON 31.7bn and even the most recent revised target from October of RON 33.7 bn). This development could be favorable only if these were the result of a decrease in the stock of public arrears (which seems to be the case).
- Total investment expenditure in 2012 (capital expenses and similar spending, part of it funded from EU funds) of RON 35.5 bn was below the targets set during the year. Capital expenses – which are funded only from the national public budget and which account for a large part of public investment expenditure – were also at their lowest level since 2009. So, the fiscal consolidation was also achieved by a reduction in investment spending (-14.9% for capital expenses and -6.1% for total investment expenditures). In this case, an increase in investment spending efficiency (if any) could be the only positive development.
- Our estimates suggest that growth of public revenues slowed down in the second half of the year. For instance, while public revenues went up by 9.2% yoy in H1 2012, they advanced only by 4.2% yoy in H2 2012.
Once budget deficit has fallen below 3% of GDP, room and incentives for additional consolidation are decreasing
The pace of the fiscal consolidation in Romania was one of the fastest among the EU member countries. According to European Commission’s estimates, the structural budget deficit was reduced by 7.4 pp of GDP between 2009 and 2012 (from 9.2% of GDP to 1.8% of GDP). The headline public budget deficit in ESA 95 standards was reduced also from 9.0% of GDP in 2009 to 3% of GDP in 2012. Adjustment was achieved mainly on the expenditure side (64% of adjustment in case of cash budget deficit). This should not be a surprise given fast increase in expenditure was the main cause of the deficit in the pre-crisis period. But it seems that have not remained too many resources this year to push up forward the fiscal consolidation. The budget plan for 2012 (cash definition) envisages a budget deficit of 2.2% of GDP, only a bit below 2012 level.
The government was somewhat prudent by assuming an increase of core public revenues of 7.0% (a bit above the projected dynamics of nominal GDP of 6.5%). But at the same time, public expenditures are planned to increase at their fastest pace since 2009 (+5.9% yoy for core expenses) as the government has to accommodate for: (1) increase in public sector wages with 7% in Dec 2012 following an increase of around 8% in Jun 2012; (2) indexation of pensions by 4% as of Jan 2013; (3) a requirement to pay faster its invoices; and (4) a requirement to pay other arrears (due to the enforcement of the EU directive no 7/2011). Such kinds of measures imply additional EUR 2.5 bn to public expenditures in 2013 compared with 2012. In fact, the government even had to introduce some new taxes in the energy sector to collect additional revenues.
Very likely, the main focus for government in 2013 would be to keep the budget deficit below 3% of GDP in ESA 95 terms (the Maastricht criteria). With the economy officially projected to expand by 1.6% in 2013 which is below the potential growth rate of 2.2% (European Commission’s estimate), the structural budget deficit should decrease further in 2013 and reach the MTO – medium term objective of 1% of GDP in 2014 (from 1.9% of GDP in 2012 – the EC estimate) in line with EU requirements (Fiscal Compact).
Long road to growth
Most likely, economic activity was flat in Q4 2012. Available data tracking the dynamics of economic activity in Q4 2014 paint a mixed picture.
There were both positive and negative developments, but all of modest amplitude. The Economic Confidence Index (an aggregate index for confidence among consumers and companies) showed timid signs of improvement in November-December after it declined in the previous five months. Except for the construction sector, modest improvements were recorded in all other segments. Average level of the ESI in Q4 2012 (94.4) was almost unchanged from the previous quarter’s level (94.7). Both total industrial and manufacturing output declined in October and November, pointing to a new contraction in the activity in industry in Q4. However, the increase in exports and turnover for external markets in manufacturing sector from October was not reverted in November as we expected, which suggest some sectors were still resilient to the slowdown in activity on external markets. Data for October and November point to a marginal positive quarterly growth rate for construction output. Retail sales fell by 2.1% qoq in Q4 2012. While activity remained weak in Q4 2012, it appears that Romania has not underperformed the region.
The statistical office would release the GDP figure for Q4 2012 (as well as the full year 2012 GDP figure) on 14 February. Both figures would incorporate the revisions in GDP data for 2010 and 2011 already announced at the end of last year.
We expect the weak activity to be preserved in Q1 2013. Recent data revealed a better than expected performance for external markets. However, the expectations are for fragile growth in Q1 2013. Moreover, European Union, the key trade partner for Romania, would be a laggard. So, fragile external environment would further weigh on Romania’s exports and activity of export driven sectors. The pace of growth in domestic demand slowed down in the second half of 2012 and we do not see reasons for a quick revival in Q1 2013. We see chances only for a marginal positive (still in the vicinity of zero) quarterly GDP growth rate in Q1 2013.
Activity on an upward trend in 2013, with recovery more visible in the second half of the year. At the moment, we look for real GDP to expand by 1.5% in 2013. Part of the increase (0.3 percentage points) reflects a statistical favorable base effect due to agriculture (plunge in output in 2012, recovery to trend level in 2013). In the baseline scenario, we project real GDP excluding agriculture to expand by 1.2% in 2013, the same dynamics as in 2012. Improvement in the activity would remain marginal in the first half of the year, while growth is expected to gain momentum in the second half of the year. Both fiscal and monetary policies should offer more support to activity compared with 2012. Public budget deficit would remain unchanged in 2013 after it had been cut substantially in the previous three years (2010-2012). Public expenses are planned to advance also at their fastest pace in the last four years, supporting households’ budgets (increase in public wages, indexation of pensions). The room for central bank to provide more liquidity in the market has increased, and this might determine interest rates to resume their downward trend this year. An expected improvement in external environment in H2 2013 should also offer more support to industry and exports at that time.
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