Scope confirms and publishes Romania’s BBB credit rating and changes Outlook to Negative
Scope Ratings AG has today confirmed Romania’s long-term local-currency rating at BBB, following the release of its revised sovereign rating methodology, and has converted its status from subscription to public. The agency has also assigned a long-term foreign-currency issuer rating of BBB, along with a short-term issuer rating of S-2 in both local and foreign currency. The sovereign’s senior unsecured debt in local and foreign currency was also rated at BBB. The Outlook on the long-term issuer and senior unsecured debt ratings has been set to Negative. The Outlook on the short-term issuer rating is Stable.
Scope’s affirmation of Romania’s BBB rating reflects the country’s European Union (EU) membership and the resulting wealth- and institutional convergence underpinned by high actual and potential growth rates as well as the sustained reduction in fiscal and external imbalances since the 2009-2011 EU/IMF balance of payments financial assistance. However, the rating remains constrained by the country’s still relatively weak institutions, evidenced by the low adherence to fiscal rules, short-comings in judicial reform and the fight against corruption. The Negative Outlook indicates the rising risk from Romania’s expansionary/pro-cyclical budgetary policies, in particular, the considerable tax cuts and wage increases in a high-growth environment, which could lead to a re-emergence of significant fiscal and current account imbalances.
Romania’s growth outlook is robust and expected to support the on-going wealth convergence process with the rest of the EU over the coming years. Romania has been one of the fastest growing economies in the EU, with real GDP growth averaging 3.8% over the last four years and even accelerating to 4.8% in 2016. However, current growth rates of around 5% appear unsustainable and, over the medium-term, Scope expects growth to slow down to below 4%. Scope notes that while the growth potential could be higher – in case the authorities implemented reforms to boost the absorption of EU funds – the recent wage increases, particularly in the public sector where wages have doubled since 2012, have outpaced labour productivity gains and risk undermining Romania’s cost competitiveness. In addition, the country’s cumbersome business environment, due to complex administrative procedures and an inefficient public administration, is underscored by Romania’s relatively poor competitiveness rankings as well as its weak public investment management, resulting in one of the lowest absorption rates of EU funds.
In Scope’s assessment, Romania’s comprehensive fiscal framework is not fully enforced. While the country achieved its medium-term objective during 2013-2015 – i.e. a structural deficit of 1% of GDP, or on the path towards it – the government departed from this target in 2016. This deviation broke the rules of the Fiscal Responsibility Law and Romania’s obligations under the Stability and Growth Pact and the Fiscal Compact. In fact, Romania’s limited adherence to fiscal rules and recent pro-cyclical fiscal stance underpin Scope’s Negative Outlook. In 2016 the government’s fiscal policy turned pro-cyclical, reversing the consolidation trend of previous years through various tax cuts, including the large VAT rate cut, which was reduced initially from 24% to 20%, then to 19% as of January 2017, and significant wage increases. This increased the deficit to 3.0% in 2016 from 0.8% in 2015. Both the IMF and the EC expect further fiscal loosening going forward, challenging the government’s target of staying below the 3% Maastricht criterion. The EC projects a deficit of around 3.5% in 2017 and 3.7% in 2018, while the IMF’s October World Economic Outlook expects a deficit of 3.0% in 2017 but 4.4% in 2018.
Such budgetary developments motivated the EC to give warning already in May 2017 that Romania is at risk of re-entering the Excessive Deficit procedure. In addition, in September 2017, Romania’s Fiscal Council highlighted that even the government’s revised budget will not succeed in keeping the deficit within the ceiling of 3% of GDP, unless investment expenditure is further revised downward and the discretionary request for an extraordinary dividend distribution from state companies is implemented. Scope notes that the Negative Outlook captures the risk of rising fiscal deficits above the 3% Maastricht criteria, the government’s use of temporary one-off measures to cover longer-term budgetary pressures and the change in the composition of the budget due to shrinking revenues as a result of tax cuts and higher wages and pensions at the expense of needed investments.
While Romania’s debt-to-GDP ratio is expected to increase to around 40% in 2018, in line with the Maastricht criterion of 60%, Scope is mindful that Romania lost market access in 2009 with a debt-to-GDP ratio of around 25%. While the structure of Romania’s debt has improved over the past few years, increasing the average maturity for issued securities to around 5 years up from about 3 years in 2013, the share of foreign-currency-denominated as well as debt held by non-residents, remains elevated at around 50%. While the authorities’ FX-cash buffer stands at about 5 months of gross financing needs, above the 4-month threshold defined under the balance of payments assistance programme, Scope points to the importance of maintaining market confidence for Romania’s ability to service its debt.
In this context, while the current account deficit narrowed significantly from approximately 13% of GDP in 2008 to around 2% in 2016, driven mostly by a decrease in the balance of goods deficit and a rising surplus in the services balance, going forward, Scope expects the current account deficit to widen to above 3% of GDP in 2018. This adverse development is mostly driven by the increase in domestic demand due to the recent wage increases. However, Romania’s gross international reserves are stable at around EUR 40bn, short-term external debt coverage is comfortably above 300%, in line with Bulgaria and Croatia and markedly above Hungary, and foreign direct investment is again the main source of external funding for the economy since 2014. Still, while the exchange rate has been relatively stable since 2009, Scope is mindful that a sharp currency depreciation, caused, for example, by heightened domestic political risks or a change in global market sentiment, could expose the economy to sudden interest rate shocks.
Finally, in Scope’s assessment, Romania’s rating remains constrained by shortcomings in judicial reform and the fight against corruption as identified in the EC’s Cooperation and Verification Mechanism reports. In addition, corruption allegations and the infighting within the Social Democratic Party could result in on-going political uncertainty despite the coalition government’s comfortable majorities in the Chamber of Deputies and the Senate, which could weigh on investment and market confidence.
Sovereign rating scorecard (CVS) and Qualitative Scorecard (QS)
Scope’s Core Variable Scorecard (CVS), which is based on relative rankings of key sovereign credit fundamentals, signals an indicative “BBB” (“bbb”) rating range for Romania. This indicative rating range can be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the size of relative credit strengths or weaknesses versus peers based on qualitative analysis. For Romania, the following relative credit weaknesses have been identified: i) economic policy framework, ii) vulnerability to short-term shocks, and iii) recent events and policy decisions. The following relative credit strengths have been identified: i) growth potential of the economy. The combined relative credit weaknesses indicate a sovereign rating of BBB for Romania. A final rating of BBB was assigned to Romania.
For further details, please see Appendix 2 of the rating report.
Outlook and rating-change drivers
The Negative Outlook reflects Scope’s view that risks to the ratings are tilted to the downside over the next 12 to 18 months.
The rating could be downgraded if: i) the government’s expansionary fiscal policy continues, worsening the composition of the budget due to shrinking revenues and higher wages at the expense of needed investments, resulting in high and rising deficits and a significant increase in government debt; ii) the current account deficit widens significantly while at the same time being increasingly financed by portfolio as opposed to FDI inflows; and iii) investor sentiment turns, leading to capital outflows and a marked depreciation of the exchange-rate. The outlook could be stabilised if: i) fiscal slippage is reversed in line with Romania’s and the EU’s fiscal framework; and ii) public-administration reforms improve the business climate and public investment management, increasing the absorption of EU funds, and thus sustaining the high real GDP growth outlook.
For the detailed research report, please click HERE.
The main points discussed by the rating committee were: i) Romania’s economic growth potential, ii) macroeconomic stability and imbalances, iii) EU membership and institutional framework, iv) fiscal framework, performance and budget, v) market access and funding sources, vi) public debt sustainability, vii) external debt structure and reserve adequacy and viii) peers.
The methodology applicable for this rating and/or rating outlook, ‘Public Finance Sovereign Ratings’, is available at www.scoperatings.com. The historical default rates used by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default and definitions of rating notations can be found in Scope’s public credit rating methodologies at www.scoperatings.com. The rating outlook indicates the most likely direction in which a rating may change within the next 12 to 18 months. A rating change is, however, not automatically a certainty.
This credit rating and/or rating outlook is issued by Scope Ratings AG.
Rating prepared by Rudolf Alvise Lennkh, Lead Analyst
Person responsible for approval of the rating Dr Giacomo Barisone, Managing Director
The ratings/outlook were first assigned by Scope as a subscription rating in January 2003. The subscription ratings/outlooks were last updated on 05.05.2017.
The senior unsecured debt ratings as well as the short-term issuer ratings were assigned by Scope for the first time.
As a "sovereign rating" (as defined in EU CRA Regulation 1060/2009 "EU CRA Regulation"), the ratings on Romania are subject to certain publication restrictions set out in Art 8a of the EU CRA Regulation, including publication in accordance with a pre-established calendar (see "Sovereign Ratings Calendar of 2017" published on 21.07.2017 on www.scoperatings.com). Under the EU CRA Regulation, deviations from the announced calendar are allowed only in limited circumstances and must be accompanied by a detailed explanation of the reasons for the deviation. In this case the deviation was due to the recent revision of Scope’s Sovereign Rating Methodology and the subsequent placement of the ratings under review, in order to conclude the review and disclose ratings in a timely manner, as required by Article 10(1) of the CRA Regulation.
Solicitation, key sources and quality of information
The rating was initiated by Scope and was not requested by the rated entity or its agents. The rated entity and/or its agents did not participate in the ratings process. Scope had no access to accounts, management and/or other relevant internal documents for the rated entity or related third party. The following material sources of information were used to prepare the credit rating: public domain and third parties. Key sources of information for the rating include: Ministry of Finance of Romania, National Bank of Romania, BIS, European Commission, European Central Bank, OECD, IMF, WB, and Haver Analytics.
Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Prior to publication, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds upon which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.
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