Romania’s path to economic recovery

Moody’s improved the outlook on Romania’s credit rating from negative to stable and has confirmed the lowest level of investment grade of - Baa3, while S&P improved Romania’s long-term foreign currency sovereign debt by one notch to BBB- to investment grade, with stable outlook.

In March 2014, the structure of the government was changed. Nevertheless, the governing program remained in place.


The newly formed Ponta III Government, after the break of the Social-Liberal Union (USL) political alliance, has around 60% support in the Parliament, which reduces the chances of further political turbulences or early parliamentary elections. Still, this year the focus continues to be on the political events related to the EU Parliament elections and referendum on constitutional change to be organized at the end of May, and on the Presidential elections in November 2014.


The market was impacted less visibly by the recent political events with no deterioration in the country risk and only a minor volatility of the currency (depreciation of the EUR-RON in Q1 compared to the end- 2013 level reaching a maximum of 1.3% and appreciated back afterwards). This was also due to the fast and relatively smooth change of the government composition. Moreover, after an initial dispute between the President and the Prime Minister, the IMF letter of intent was signed and sent for approval to the IMF Board, confirming the assistance of international lenders in the country’s structural reforms.


The strongest contributor to the GDP growth in 2013 was the industrial sector, coming exclusively from export-oriented segments. Despite the expected deceleration, the industrial output will likely remain the strongest contributor to GDP in 2014.  We expect the construction segment to turn slightly positive, benefiting from the support provided by the increased absorption  of EU funds for infrastructure. The trade segment should also bring a slight positive contribution in 2014, since the purchasing power of the population is stimulated by the low inflation. Overall, we expect a recovery of domestic demand, resulting in GDP growth of around 2.9% yoy.


The growth should be stimulated by the low interest rate environment. The NBR key rate reached 3.5% in early 2014 and is expected to stay at this level until the end of the year. Further monetary easing might be implemented through release of  liquidity from minimum reserve requirements with one more cut of its rate after the reduction in January 2014.


Domestic demand expected to accelerate

In Q4 2013, the GDP growth accelerated to 5.4% yoy (1.6% qoq), from 4.2% yoy (1.8% qoq) in Q3, resulting in a full year 2013 growth above expectation at 3.5% yoy.


Just as expected, the good harvest had a strong contribution in Q4 (38.2% yoy resulting in 1.7 percentage point contribution to the GDP), while the positive surprise came from the even stronger industrial production (12.2% yoy and 3.4 percentage point contribution).


During 2013, the value added of agriculture increased by 23.4% yoy, while the industry expanded by 8.0% yoy. The retail and  financial sectors had slight negative contributions to the GDP formation last year.



On the expenditure side, the net exports and household consumption had the largest contributions to the GDP growth, offsetting the decline of investments. Net exports had a 4.4% positive impact in the GDP formation, given the 13.5% real increase of Romania’s exports last year and smaller (2.4%) growth in imports. The household consumption grew by 0.9% in 2013, while the investments declined by 3.3%.


GDP growth in 2014 is expected to decelerate to 2.9% from 3.5% in 2013. However, if we exclude agriculture, we are actually expecting an improvement of the GDP growth from 2.4% yoy to 2.8% yoy. After the good harvest in 2013, we expect the contribution from agriculture to be slightly negative (-2.2% yoy and -0.1 ercentage point contribution). However, for the moment, we do not expect any  major negative shock in this respect, but rather a continuous improvement in harvest compared to the historical longerterm average.




The car industry in 2013 registered a record production mainly for exports: 410,000 units (343,000 Dacia cars, with 12% growth and 68,000 Ford B-Max, 100% growth). Motor vehicles’ exports increased by 35% in 2013, representing 7.7% of total export (from 6.3% share one year ago).


On the other hand, except for these export-oriented sectors, the economy was functioning on a lower capacity just as shown by the energy resources and electrical energy consumption. The major energy-dependent companies like chemical companies Oltchim and Azomures and companies from metallurgy industry AcelorMittal, Alro used less energy due to lower production since they were the worst performing industries in 2013.



While the H1 was marked by low construction, in H2 the drop in investment was mainly driven by the investments in  equipment. We expect the construction segment to accelerate slightly in 2014, benefiting from the support provided by the EU funds.


In 2013, Romania paid to beneficiaries structural funds amounting to EUR 2.4bn (36.5% absorption rate) and EUR 1.6bn funds for the agricultural and rural development (75% absorption rate). In 2014, the 2007-2013 payments will still be allocated, while the new period of 2014-2020 will probably have the first payments in early 2015. We expect a significant improvement on the Transportation operational program, for which the allocated funds amount to around EUR 4.5bn and only EUR 1.1bn have been paid to the beneficiaries until the end of 2013. Therefore, we can expect a structural fund allocation of around EUR 3.5bn for 2014 (out of which EUR 1.5 might be allocated for infrastructural projects) plus around EUR 1.5bn of  agricultural funds. Overall, we expect the absorption of EU funds to be around EUR 5bn in 2014. On the longer term, Romania is supposed to get a EUR 39.7bn for the 2014-2020 period, but this will probably start to become operational towards the end of 2014.



The Economic Sentiment Indicator for Romania improved in February by 3 points to 97.7 and kept this relatively higher figure till April 2014, the best figure since May 2012, and finally joining the positive European trend. The consumer morale might receive some further boost during the first half of the year, as the purchasing power is increasing through lower inflation and cheaper financing in local currency. The minimum wage was also increased to RON 850 in January 2014 and another RON 50 hike will be implemented in July 2014 to 900 RON (200 EUR), while the pension benefits were indexed this year by 3.76%.

We can see some improvement on the evolution of average wage, that accelerated to 5.5% in March 2014 from 3.7% at the end of 2013.VAT in some food products, such as meat, might be further reduced, following a VAT drop on bread and bakery products from 24% to 9% in 2013.



Moody’s improved the outlook from negative to stable, while S&P improved Romania’s rating to investment grade

On 25 April, Moody’s rating agency improved the outlook on Romania’s credit rating from negative to stable and confirmed the lowest level of investment grade of - Baa3. Moreover, on 16 May, S&P rating agency upgraded Romania’s rating to investment grade BBB- with a stable outlook from BB+ (sub-investment grade), highlighting the improvement in the fiscal consolidation and external imbalances. S&P also believes that Romania will maintain a steady economic growth of around 3% over 2014-2017, which would be above any regional peer. Further upgrade is conditional on fiscal consolidation and the implementation of planned reforms of the public sector and state owned companies, while a downgrade would happen in case of the re-appearance of fiscal or external imbalances.



In February 2014, the first two reviews of the IMF deal ended successfully. Four out of the five performance criteria have been fulfilled, while the goal of reducing the arrears assumed for the last quarter of last year was not fulfilled (mostly due to state-owned transportation companies). Additionally, the good news is that after a temporary blockage and the dispute between the President and the Prime Minister, the letter of intent to IMF was signed by President Basescu and this way, the implementation of structural reforms should continue under the assistance of international lenders. Furthermore, after the successful listing of Romgaz, Nuclearelectrica (IPO) and Transgaz (SPO) in 2013, two major IPOs are scheduled this year, namely Hidroelectrica and CE Oltenia. The listing of the 15% stake in the Romanian state-run energy holding CE Oltenia has been postponed from June - as initially agreed with the International Monetary Fund – to September or October, since more  time is needed in order to assess the company’s coal reserves. Meanwhile, the 15% listing of Hidroelectrica is blocked for the moment, since the company re-entered insolvency in February 2014, following the request of some energy distributors. Additionally, CFR Marfa and Oltchim, the two failed privatizations, are again on the 2014 list, looking for strategic investor.  Overall, the outlook for Romania is positive, with a stabilized country risk, cheaper financing and an improved business  environment that might attract investors, thus resulting in a positive surprise to our GDP outlook.



CPI outlook for 2014 slightly improved in April

The CPI annual Inflation reached 1.2% (0.3% mom) in April, rising from 1.0% the previous month and below the market expectation of 1.5% yoy. This is the first acceleration after the historically low inflation registered in Q1 2014, driven by the hike on excise duties on fuel (+3.2% mom price increase) and tobacco (+1.8% mom price increase). The positive surprise is  coming from the downward correction on vegetable prices (-1.3% yoy) after a significant increase in the first quarter (+6.7%  compared to the Dec. 2013), but also from the lower service prices related to the RON appreciation and the lower than  expected impact of excise duty hike on fuels (3.2% compared to the expected 5% increase). The Core inflation (excluding volatile food prices, fuel, administrated prices, tobacco and alcohol) re-entered negative territory (-0.1% yoy) driven by the weak domestic demand, but also influenced by the VAT cut on bread in September last year.


The major price increase in 2014 was already implemented through the excise duty indexation by 4.77% as of January 2014 (1.1% mom in fuel prices) and the additional excise duty hike on fuels as of April 2014 (which results in a 3.2% increase in the final price of fuels). Despite of the recent improvement in the inflation outlook (NBR adjusted in May its end of 2014 inflation forecast at 3.3% compare to the initially expected 3.5%), we keep our inflation forecast at 3.5%, also having in mind the upside inflationary risk of the upcoming period.


The electric energy and gas price liberalization is expected to have less inflationary effects in 2014 compared to 2013 (around 6% increase in energy prices compared to the 9% increase in 2013), given the lower energy prices on the free market (OPCOM). Nevertheless, there are some disputes between the Prime Minister and the President regarding the postponement of the green energy support until 2017. In case of no delay, the prices of electrical energy might increase by additional 5%, which means an increase of the inflation by around 0.3 percentage point. Additional inflationary risk is related to the food price evolution in H2 2014, strongly related to the 2014 harvest.


Monetary Policy: no more rate cuts this year

Just as we expected, NBR cut the key interest rate in its January and February meeting by 0.5 percentage points in two steps, to 3.5%.


Rates on minimum reserve requirements have also been lowered in January from 15% to 12% and from 20% to 18% for local and foreign denominated liabilities, respectively, providing additional liquidity of the system (RON 4bn and EUR 0.5bn). The banking system has been registering a liquidity surplus since August 2013, which pushed inter-bank rates even 2 percentage points below the key rate. At the beginning of February 2014, there was a temporary tightening in the liquidity through the selling of a substantial amount out of the Ministry of Finance’s FX buffer. This action pushed the interest rates temporary  higher, but they stabilized back to around 1-1.5 percentage points below the key rate.


During the second part of 2014, we expect to see a continuous good interbank liquidity with interest rates still below the key  rate, but closer to it compared to the historically low rates during December-January. No more key rate cuts are expected this  year on the back of reaccelerated inflation, while one more reduction in the rates of reserve requirements remains a  possibility conditioned by the FX evolution.