Romania Economy Briefing: Economic Outlook for the Second Half of 2020 Oana Cristina Popovici

ISSN: 2560-1601

Vol. 30, No. 2 (RO)

June 2020

Romania economy briefing: Economic outlook for the second half of 2020 Oana Cristina Popovici

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Economic outlook for the second half of 2020

Romania had better economic results in the first quarter of this year than those initially forecasted. Yet, a strong contraction up to 15% of the GDP is expected in the second quarter, followed by a similar recovery. The Government hopes in a V-shaped comeback, but in the meantime has to manage high twin deficits, the Excessive Deficit Procedure initiated by the European Commission and a 40% increase in pensions established for September, which could further deteriorate the economy. The support of EUR 33 billion from the EU in the view of the economic recovery could be claimed based on strategic projects for the modernization of the whole economy in the medium and long term.

Romania's economy managed to avoid recession in the first quarter of this year and registered the strongest expansion in the EU, being among the three European countries that reported positive quarterly dynamics. GDP growth registered an advance of 2.7% compared to the first three months of 2019 and 0.3% compared to the last quarter of last year. First official data on the impact of the COVID-19 on the economy turned out to be better than analysts' estimates.

However, the largest economic impact of the pandemic is expected to be seen in the second quarter of 2020, when restrictions have led to a freeze on activity in almost all sectors. The perspectives for the whole year are not as optimistic anymore. The World Bank predicts an economic decline of 5.7% for 2020 in Romania, according to the “Global Economic Outlook” report issued in June. The main reason for such an evolution is Romania’s status as an importing country of goods that are deeply integrated into global trade and value chains. Under these circumstances, the global evolutions risk to have a higher impact on the domestic economic evolution. Last data of the European Commission shows a 6% decrease in the national economy this year.

The Minister of Finance also estimated a strong contraction for this year, but with a recovery that will start in the third quarter. The projections show that GDP is expected to contract by 15% in the second quarter, amid a decline in services and industry, followed by a similar recovery. There are already signs that the economic activity slowed down significantly. In April, new orders in the manufacturing industry decreased by almost 40%, while the turnover

1 in manufacturing saw a drop by more than 38% compared both to March 2020 and to April 2019.

The Government hopes in a “V” recovery of the economy, compensating the shock generated by the pandemic by an equally sustained increase once the activities are resumed. The Government considers that the measures taken during this period would allow for such a recovery. First of all, the measures aimed at maintaining almost intact the liquidity of companies, by paying technical unemployment and state-guaranteed loans. In addition, the National Bank of Romania (NBR) supported the economy by increasing liquidity in the banking system and reducing the reference interest rate. Therefore, these measures should have been “freezing” the production capacity, giving companies the chance to preserve the necessary resources for relaunch. Second of all, the most affected sectors (mainly those in the hospitality industry) have a reduced contribution to GDP formation and economic growth. Some economic analysts are more skeptical and do not endorse this scenario, since the major external partners, such as France, Germany, Italy and Spain will not register a similar evolution. In the context in which future closures of the economies are still possible, given the lack of a cure for the disease, a sinusoidal evolution is rather forecasted.

The “Romania Economic Outlook” report, recently launched by BRD, one of the largest banks in Romania, estimates a GDP contraction of 3.9% in 2020 and a U-shaped comeback starting in the third quarter at best. However, there are some major risks that could led to a more pronounced contraction. Moreover, the report has a pessimistic outlook on the chances of the GDP growth turning positive next year, as the disruption caused by Covid-19 could be longer, while the manoeuvring space for counteracting it is reduced. Therefore, they highlight a higher probability of a slight contraction. Other institutions, such as World Bank, expects Romania's economy to grow by 5.4% in 2021, while the European Commission foresees a return of 4.2%. The Minister of Finance estimate a similar GDP increase, situated between 4-5%.

Romania entered the crisis with some major flaws: very high current and budget deficits, meaning very low reserves for supporting the economy. It was the only EU member state to exceed the fiscal deficit threshold of 3% of GDP in 2019. Moreover, Romania has a very low level of revenues at the state budget, especially tax revenue, as well as a high rigidity of spending, given that most of the revenues cover pensions and salaries. Following the first budgetary adjustment this year, the deficit worsened, being reassessed at 7.6% of GDP (as compared to 3.6% initially), but based on a real GDP drop by only 1.9%. Given the future evolutions, it is possible that the deficit to be higher; BRD estimates it at 7.8% of GDP, while

Standard & Poor’s (S&P) at 8%. At present, all three major rating agencies give a negative outlook to Romania's credit rating, with significant risks for a downgrade.

At the beginning of June, the rating agency S&P confirmed Romania’s rating at BBB- / A-3, with a negative outlook. Romania managed to avoid for the moment a downgrading which seemed very realistic given the expansionary policies carried out so far, which would have had an extremely negative impact over the economic evolution given that this would have meant an increase in financing expenditures. However, the situation continues to be vulnerable and tensed and the rating could be downgraded if fiscal and external imbalances remain high for a longer period and no fiscal consolidation measures are to be applied.

On the other hand, the current account deficit in the first quarter grew by 21.9% on a year- on-year basis, amounting to EUR 1.36 billion. As the current situation is not in the favour of improving the perspectives, managing these twin deficits also put pressure on the general macroeconomic situation. For example, the national currency is more vulnerable than the currencies of other surrounding countries given the size of twin deficits and the increased risks in terms of fiscal policy and public debt sustainability.

Romania also has to deal with the Excessive Deficit Procedure, despite the decision of suspending the fiscal rules in the EU starting with March 2020 due to the pressure caused by the pandemic. The European Commission considered that the breaches of European tax rules were prior to the coronavirus and therefore not due to it. Romania has to provide a set of measures in order to consolidate the fiscal framework through structural reforms, whose sustainability and efficiency will be valued taking into account the economic and fiscal impact of the pandemic and the implications of activating the derogation clause in the Stability and Growth Pact.

Several measures were taken for improving the support towards small and medium-sized enterprises (SMEs), which are meant to continue. The Government supplemented the budget allotted for the IMM Invest programme, which will allow tripling the number of beneficiary companies. Currently, there are over 3,000 beneficiaries, which received financing of almost EUR 520 million. A similar programme for providing financial support to large companies was approved by the Government. In this case, the state is guaranteeing loans up to 90% and is subsidizing the interest rate up to 50%. The initial ceiling of this state aid program is over EUR 1.6 billion. The support scheme will become operational after the approval of the European Commission.

Still, S&P estimates that the fiscal stimulus package including the economic measures taken by the authorities in response to the COVID-19 crisis, which amounts to 3% of GDP, is are among the weakest in the region. However, the measures may reduce the effects of the crisis, but with the effect of raising the budget deficit to around 8% of GDP, including declining revenues due to the economic contraction.

The electoral context of this year could also affect the evolution of the economy. An increase by 40% of the pensions starting with the 1st of September was adopted by the opposition last year, and the Government has to decide whether it will be implemented or not. There are high risks that such a decision could further block the economy, as international financial institutions and rating agencies have shown that they pose a major risk to the health of the economy. So far, in his declarations, the Minister of Finance stated that such a raise would create problems for the budget sustainability in the next two years. He pointed that there are not enough funds for such a law, and in order not to destabilize the economy, other measures must be taken. A potential increase of maximum 10% was envisaged by S&P, in the agency’s report regarding Romania.

Romania will receive EUR 33 billion representing mostly non-reimbursable funds and loans on advantageous terms through the European Commission's recovery plan, in addition to the structural and cohesion funds. However, the effective amount depends on the ability to carry out a national economic recovery plan for absorbing the European money, with effects in the long-term on the economy. The plan should include strategic and modernization projects which should reflect the real needs of the society and based on the European Semester recommendations.