Scope affirms Romania’s credit ratings at BBB- with a Stable Outlook
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Scope Ratings GmbH (Scope) has today affirmed Romania’s long-term issuer and senior unsecured debt ratings at BBB- in both local and foreign currency, with Stable Outlooks. The short-term issuer ratings have been affirmed at S-2 in both local and foreign currency, with Stable Outlooks.
Summary and Outlook
Romania’s BBB- ratings are underpinned by the following credit strengths: i) strong medium-term growth potential, which Scope estimates at 4% annually; ii) EU membership and hence access to significant EU structural and recovery fund inflows in the coming years; and iii) Romania’s moderate general government debt, which Scope estimates at 51% of GDP by end-2023.
Despite these credit strengths, significant challenges affect Romania’s ratings. Firstly, a rigid budget structure and a weak tax base constrain the budgetary outlook and have resulted in structural budget deficits. Secondly, Romania has high current-account deficits, due in part to fiscal imbalances and weaker competitiveness relative to regional trading partners. Lastly, Romania’s available international reserves are moderate in covering foreign-currency liabilities under more stressed economic scenarios, representing a balance of payment risk.
The Stable Outlook balances the risks from high budget and current-account deficits against ongoing access to EU structural and recovery funds and strong growth prospects in the medium term.
The ratings/Outlook could be downgraded if, individually or collectively: i) weaker fiscal metrics resulted in a substantive deterioration of the medium-term debt outlook; ii) the ability to effectively absorb EU investment funds weakened, undermining macroeconomic and public finance outlooks; and/or iii) external vulnerabilities increased, including via large current account deficits, intensified financing pressures and/or shrinking international reserves.
Conversely, the ratings/Outlook could be upgraded if, individually or collectively: i) fiscal consolidation policies were sustained and strengthened, anchoring Romania’s debt-to-GDP trajectory; ii) external sector risks were curtailed, for example via a sustained reduction in current account deficits, a build-up of foreign exchange reserves and/or tangible steps taken in the adoption of the euro; and/or iii) the government’s capacity for reform were strengthened, including improvements in EU fund absorption.
Romania’s BBB- ratings are anchored by the country’s strong economic growth potential in the medium term, which Scope estimates at 4% annually, bolstered by the considerable allocation of EU investment funds. Scope expects that the Romanian economy will continue to grow in 2023 by 2.2% in real terms, after an estimated growth of 4.8% in 2022, which represents a more moderate slowdown than that of most peer economies. The economy is much less dependent on imported energy, including Russian energy, than its peers in Central and Eastern Europe. The domestic production of natural gas could cover up to 90% of annual domestic consumption. This indicates that Romania is better positioned to adjust to the disruptions of European energy supplies due to the cut-off of Russian energy.
Headline inflation (HICP) likely peaked at 14.6% YoY in November 2022, with the February figure at 13.4% YoY. However, Scope expects strong inflationary pressures to persist in the near term due to highly volatile European commodity prices. Average headline inflation is forecast at 10.6% in 2023, after 12% in 2022, falling to 6% in 2024, thus remaining above target (2.5% ± 1 pp) for the forecast horizon.
Consistently high inflation has created a challenging environment for the Romanian central bank (NBR) amid moderating economic growth. The NBR adequately initiated a rate-hike cycle in October 2021, raising the policy rate to 7% as of January 2023 from 1.25%1. Additional rate hikes are not excluded if prices grow faster than expected and depending on the terminal interest rates of the European Central Bank and the Federal Reserve.
Romania stands to receive EUR 27.1bn (9.5% of 2022 GDP, of which EUR 12.1bn in grants and EUR 14.9bn in loans) via the EU Recovery and Resilience Facility2, alongside EU structural funds of around EUR 50bn (17.5% of GDP) until the end of 2027. This substantial allocation of EU funds enhances the authorities’ reform agenda and anchors strategic medium-term investment projects, including the development of physical infrastructure and the digitalisation of the economy, while reducing near-term pressure on public finances. Scope, however, notes the moderate historical absorption rate of EU funds (only 73% of 2014-2020 European structural and investment funds3 were spent by end-2022), which remains a bottleneck. The ability to utilise this considerable EU investment will be a key determinant of Romania’s medium-term socio-economic development.
Romania’s BBB- ratings are further supported by moderate but vital fiscal consolidation measures introduced in the budget since 2021, mostly on the expenditure side with respect to public sector pensions and wages, which have reduced immediate fiscal policy risks. This reverses multiple years of strongly expansionary fiscal policy, which has improved Romania’s otherwise challenging fiscal outlook, the latter which is actively supported by good economic growth prospects in the medium term.
The government plans to reduce the budget deficit to 4.4% of GDP in 2023 (in European system of accounts terms) and further to 3% of GDP in 2024 from 6.2% of GDP4 in 2022 by means of fiscal consolidation through comprehensive fiscal reform, which the government hopes would enable Romania to exit the Excessive Deficit Procedure. Scope, however, views these fiscal plans as ambitious given the challenging economic environment and projects a more gradual narrowing of the budget deficit, to 5.4% of GDP in 2023 and 4.6% of GDP in 2024.
Scope notes that a comprehensive implementation of the planned pension reform by 2023 and the rise of tax revenue by at least 2.5 pp of GDP by 20255, which are key components for unlocking the generous EU funding under the EU Recovery and Resilience Facility, will be crucial for Romania’s fiscal trajectory and a credible commitment for budget consolidation. The pension reform should aim at correcting inequities in the pension system and improving the indexation of pensions to make the system more financially sustainable in the context of an ageing population.
Under Scope’s baseline, the gradual budget deficit reduction is forecast to result in a measured increase in Romania’s government gross debt-to-GDP ratio, to 51% by end-2023 and 53% by end-2024, up from 48.9% in 2021, before stabilising at close to 55% in the medium run, thus remaining below a euro convergence criteria ceiling of 60%. Scope thus assumes a scenario broadly in line with the government’s medium-term fiscal consolidation plan, but slightly more conservative as the government assumes debt to remain below 50% of GDP over the medium run.
The fiscal outlook is supported by enhanced near-term political stability under the majority coalition government led by the Social Democrats and the Liberals, which strengthens the credibility of the government’s medium-term fiscal programme with a higher likelihood that this programme could see a lengthier period of implementation.
The affirmation of the BBB- ratings furthermore reflects Romania’s established access to domestic and external funding sources on relatively favourable terms in current difficult market conditions. As of end-February 2023, Romania has managed to frontload more than 35% of the financing planned for 2023 via bond issuances on both domestic and external markets.
Scope estimates gross government financing needs for 2023 at over 10% of GDP, which remains large but lower than the IMF’s 15% high-risk benchmark. Most of the borrowing will be done in the domestic market, despite already substantial exposure of the sovereign to the banking system, with local banks holding around half of the government’s domestic securities6. Romania’s banking system remains stable and well-capitalised with a tier 1 capital ratio of 18.8% at end-2022 and an NPL ratio at a historical low of 2.7%. Elevated financing needs will nonetheless require substantial foreign debt issuances, around EUR 8.5bn or 2.7% of GDP this year, out of which near EUR 6bn were already financed in January. Scope views the treasury’s plans to issue Romania’s inaugural green or sustainable Eurobond in the second half of 2023 as positive.
The NBR has used monetary space to support capital markets since the Covid-19 crisis through purchases of leu-denominated government bonds in the secondary market, which, however, were much smaller compared to neighbouring EU peer central banks. Scope does not expect a return to any sizeable purchasing programme in the near term and notes risks associated with such policies in the case of non-reserve-currency central banks.
Despite the affirmation of the ratings, significant challenges remain that affect Romania’s BBB- ratings.
Firstly, a rigid structure of fiscal accounts and a weak tax base constrain the medium-term budgetary outlook and have resulted in structural budget deficits (estimated at 5.7% of GDP in 2022). Spending on public pensions and wages together accounts for more than 90% of tax revenue. Without a significant expansion of the tax base (total receipts from taxes and social contributions, at 26.4% of GDP in 2021, are the EU’s second lowest after that of Ireland), the medium-term fiscal outlook will remain overly contingent upon sustained high economic growth.
Romania’s uneven track record with respect to sustained fiscal consolidation, governance bottlenecks in spending control and short-lived governments, which increase the risk of expansionary fiscal policy around electoral cycles, present risks to the fiscal outlook. These challenges are further underscored by an unfavourable demographic profile due to an ageing population and continued net emigration. Acknowledging risks, any reversal in fiscal discipline and/or renewed challenge to the outlook for debt sustainability could see renewed risk for the BBB- ratings.
Secondly, Romania is set to post another elevated current account deficit, projected by Scope at 7.5% of GDP in 2023 after 9.3% of GDP in 2022, affected by highly volatile energy and agricultural commodity prices in the context of the Russia-Ukraine war. Such external deficits are partly the result of fiscal imbalances and high investment needs of the economy with relatively low domestic savings. In the past three years, the current-account deficit has been increasingly covered by debt-financing inflows. However, Scope projects that non-debt-financing inflows will cover most of the current-account deficit in the medium term, benefiting from a front-loaded absorption of EU grants and resumed foreign direct investment.
As a result of large current-account deficits, Romania’s net external debtor position (negative net international investment position) stood at 40% of GDP as of Q4 2022 and remains higher than that of other central and eastern European EU member states. At the same time, 54% of Romania’s gross external liabilities relate to inward foreign direct investment, up from just 38% in 2012. This curbs the risk of external balance sheets deteriorating extensively during periods of global stress and supports the long-term sustainability of Romania’s external position.
Thirdly, the Covid-19 and energy crises have exposed Romania to higher exchange rate risk. While the NBR’s foreign exchange reserves cover 82.7% of short-term (by remaining maturity) external debt7 as of end-2022, up from 79.4% one year earlier, the coverage ratio remains below the IMF adequacy threshold of 100%. The NBR’s foreign exchange reserves stood at EUR 52bn in February 2023, compared to EUR 41.9bn a year earlier. Romania’s available reserves could thus come under pressure in more stressed economic scenarios, representing an ongoing balance of payment risk. Scope expects the NBR to continue its measured interventions in the foreign exchange market, if needed, to ensure currency stability. About half of Romania's government debt and a third of banking sector deposits are denominated in foreign currency.
Scope notes positively that the ECB and the NBR agreed on a euro liquidity line of up to EUR 4.5bn (nearly 9% of the NBR’s foreign exchange reserves), extended8 to January 2024, which serves as a buffer for addressing possible liquidity needs due to market instability and regional spillover risks in the context of the war in Ukraine.
Core Variable Scorecard (CVS) and Qualitative Scorecard (QS)
Scope’s CVS, which is based on the relative rankings of key sovereign credit fundamentals, provides a first indicative rating of ‘bbb’ for Romania. Romania receives no up-notching to this indicative rating under the reserve currency adjustment following the methodology. As such, the ‘bbb’ indicative rating can be adjusted under the QS by up to three notches depending on the size of relative qualitative credit strengths or weaknesses against a peer group of countries.
For Romania, the following QS relative credit strength has been identified: growth potential of the economy. The following QS relative credit weaknesses have been identified: i) fiscal policy framework; ii) debt sustainability; iii) current account resilience; iv) resilience to short-term external shocks; v) social factors.
Combined relative credit strengths and weaknesses identified in the QS generate a one-notch downward adjustment and indicate BBB- long-term ratings for Romania.
A rating committee has discussed and confirmed these results.
Factoring of environment, social and governance (ESG)
Scope explicitly factors in ESG sustainability issues in its rating process via the sovereign methodology’s standalone ESG sovereign risk pillar, with a 25% weighting under the quantitative model (CVS) and the methodology’s qualitative overlay (QS).
Regarding governance-related factors, Romania’s performance is weaker than that of central and eastern European EU peers, as assessed under the World Bank’s Worldwide Governance Indicators. Romania has a history of unstable governments, contributing to years of expansionary fiscal policies around electoral periods and a relatively weak absorption of EU funds. Nonetheless, Romania’s EU membership enhances economic governance.
Social factors are characterised by a rapidly increasing old-age dependency ratio, high income inequality and low labour force participation rate (65.6% in 2021). Romania continues to be an emigration country, albeit net emigration declined to a little over 16 thousand in 2021 from 76 thousand in 2016. The CVS, however, also reflects supportive contributions from Romania’s comparatively low rate of unemployment (5.6% as of January). Under the qualitative assessment of social factors, Romania is assessed as weak compared with its sovereign peers due to Romania’s high poverty rate and high risk of social exclusion.
Environment-related credit risks remain material for Romania. The economy displays one of the highest carbon intensities in the EU. The comparative dependence of the Romanian economy on energy intensive production presents a challenge for policymakers under tightening financing conditions and needed economic transitions towards the green economy. Romania has estimated investment needs of around EUR 150bn9 (7% of GDP annually) to achieve climate objectives through 2030. Here, the current long-term EU budget presents a critical opportunity for Romania to increase the production of renewable energies and facilitate the transition to a lower-carbon economic model. Romania is much less dependent on Russian energy sources than its regional peers due to local production and is expected to increase investment in offshore gas production in the Black Sea.
The main points discussed by the rating committee were: i) macroeconomic outlook; ii) fiscal risks and debt sustainability; iii) labour market and demographics; iv) external sector risks; v) financial sector developments; vi) ESG-related risks; and vii) peers.
Rating driver references
1. National Bank of Romania
2. European Parliament
3. European Commission
4. Ministry of Finance of Romania
5. Ministry of Investments and European Projects
6. Ministry of Finance of Romania, Public Debt Bulletin
7. National Bank of Romania
8. European Central Bank
9. The 2021-2030 Integrated National Energy and Climate Plan
The methodology used for these Credit Ratings and/or Outlooks, (Sovereign Rating Methodology, 27 September 2022), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. 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 Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/governance-and-policies/rating-governance/definitions-and-scales. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months.
Solicitation, key sources and quality of information
The Credit Ratings were not requested by the Rated Entity or its Related Third Parties. The Credit Rating process was conducted:
With Rated Entity or Related Third Party Participation YES
With Access to Internal Documents NO
With Access to Management NO
The following substantially material sources of information were used to prepare the Credit Ratings: public domain.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting these Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.
These Credit Ratings and/or Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks are UK-endorsed.
Lead analyst: Levon Kameryan, Associate Director.
Person responsible for approval of the Credit Ratings: Alvise Lennkh-Yunus, Executive Director.
The Credit Ratings/Outlook were first assigned by Scope Ratings in January 2003. The Credit Ratings/Outlook were last updated on 14 May 2021.
See www.scoperatings.com under Governance & Policies/Regulatory for a list of potential conflicts of interest disclosures related to the issuance of Credit Ratings.
Conditions of use / exclusion of liability
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