Following 3.8 per cent growth in 2015, economic activity grew by 4.9 per cent in 2016. Private consumption continued to be the major contributor to growth in 2015 and 2016, as consumers’ purchasing power increased on the back of VAT rate cuts in June 2015 and January 2016 and public sector and minimum wage hikes. Investment has also been an important contributor to growth, driven principally by successive interest rate cuts on the back of declining inflation. Private investment has also been boosted by a significant improvement in industrial confidence over the past three years.
Net exports continue to make a negative contribution to growth. Rising consumption has boosted imports, while exports remained constrained due to ongoing weakness in the Eurozone. With 75 per cent of its exports destined for EU countries, Romania remains highly dependent on European export demand.
Source: National Accounts, National Bank of Romania
The successive VAT cuts that have been implemented, alongside falling food and oil prices, have driven inflation well into negative territory, reaching -1.5 per cent in 2016 in spite of inflationary pressures from strong consumer demand. Inflation has been below the lower boundary of the National Bank of Romania (NBR)’s target range of 2.5 ± 1 per cent, for around 2 years. Inflation is likely to turn positive in 2017 as global food and energy prices recover and the VAT cuts of 2016 fall out of the base period.
Following a significant decline since mid-2012, Romanian country risk premium, as measured by credit default swaps (CDS) has stabilized at just over 100bps over the past two years. This has been supported by elevated global liquidity giving rise to strong investment flows to emerging markets, including Romania. At the same time, the solid macroeconomic fundamentals of the Romanian economy also contributed to the stabilisation process. The declining country risk premium helped support the ongoing stability of the currency.
Source: National Bank of Romania
The equity market has been performing well since 2012, outperforming Romania’s regional peers. The Romanian index partly benefited from historically low interest rates, and also from the additional cash in European markets due to the European Central Bank’s stimulus package. As the Romanian index rose, equity and debt holdings of non-residents increased, with debt growing faster than equity.
External imbalances are rising but remain modest. Rising imports, profit repatriation and falling workers remittances have caused the current account deficit to increase to around 2.1 per cent of GDP as at end 2016. External debt has continued on a downward trajectory over the past two years, following repayment of an EUR 13 billion loan to the IMF and EUR 5 billion to the European Commission.
Source: National Bank of Romania
The current account deficit is fully covered by the Foreign Direct Investment (FDI) inflows. According to the provisional data released by the National Bank of Romania, the FDI inflow reached EUR 4.08 billion in 2016, representing an 18 per cent increase year on year. The 2016 FDI inflow level was the highest since 2009 (EUR 3.49 billion), showing an improvement in the foreign investor’s confidence, even though it is far away from the 2008 peak of EUR 9.49 billion.
Source: National Bank of Romania
Source: National Bank of Romania
The banking sector remained well capitalised, with a capital adequacy ratio of around 18.8 per cent as at December 2016. Since 2008 banks have progressively increased their funding from local deposits, and reduced their reliance on external debt. Bank deleveraging continues while the maturity structure of banks’ external funding changing favourably towards long-term funding. The loan to deposit ratio declined from above 120 per cent in 2012 to below 60 per cent in the third quarter of 2016. Asset quality also improved, as banks continued to address non-performing loans (NPLs). Challenges remain, as the recent Debt Discharge Law for mortgage backed loans and draft law on conversion of FX denominated loans to Lei may result in large costs for the sector and give rise to concerns about the stability of the financial system.
Romania has been successful in correcting imbalances arising following the start of the global recession in 2008, bringing the fiscal deficit down to below 2 per cent of GDP in 2014. However, pressures are building as fiscal policy has recently been relaxed. In 2015 the government cut the rate of VAT on food from 24 per cent to 9 per cent, and in January 2016 the standard VAT rate was reduced from 24 per cent to 20 per cent and subsequently to 19 per cent in January 2017. The minimum wage was increased by 19 per cent in May 2016. These measures have increased the fiscal deficit to 3 per cent of GDP in 2016, and further expansive policies are planned for 2017 such as a new increase on the minimum wage of 16 per cent starting with February 1st, which means there is a risk that the EU deficit limits may be breached.
Source: IMF
Source: IMF
Public debt edged up but remains moderate by regional standards, standing at around 37 per cent of GDP in December 2016. Despite improvements over the past few years, a large proportion of debt is still exposed to foreign currency risk. However, the maturity structure of government debt has improved recently, partly as a consequence of favourable global liquidity conditions, with around 85 per cent of total debt stock having a maturity in excess of one year, at fixed interest rates.
A steady fall in inflation, on the back of declining food and oil prices, as well as declining expectations and base effects, gave the NBR the opportunity to cut the policy rate to a historically low level of 1.75 per cent in May 2015. Subsequently, in spite of inflationary pressures generated by wage increases and strong domestic demand, VAT cuts have driven inflation negative, to an average rate of -1.5 per cent in 2016. It should return into positive territory in early 2017 as food and energy prices recover, and the base effect of the VAT cut in January 2016 drops out.
As the policy rate has fallen, so have market rates, with the ROBOR 3m continuing its steady decline to under 1 per cent. In addition to keeping rates at historically low levels, in order to inject liquidity into the foreign currency lending market and revive credit conditions, the NBR also lowered minimum required reserves on foreign exchange-denominated liabilities to 10 per cent from 12 per cent in September 2016. Provided that structural reforms in the country continue, and credible policies anchor inflation expectations, Romania may have a chance to maintain sustainable low interest rates for some time.
Source: IMF
EBRD forecasts GDP growth of 3.7 per cent in 2017, driven by continued strong domestic demand, itself supported by historically low interest rates, the VAT cuts and various wage increases, positive economic sentiment and the low inflation environment. Downside risks including prolonged weakness in the Eurozone, changes in global investor sentiment and domestic political and reform uncertainty. There is also a risk that infrastructure investment may be cut if the promises for fiscal expansion made in the Government’s programme mean the fiscal deficit looks likely to breach the 3 per cent EU limit.
In the medium term, Romania’s growth prospects are favourable, given the country’s high convergence potential, with a purchasing-power-parity-adjusted GDP per capita of 57 per cent of the EU average. If necessary reforms to unlock the country’s growth potential are implemented, the economy could reap the benefits of European and global recovery in years ahead.
To achieve this, Romania needs to further improve its business environment and make it more attractive for investors. Despite recent improvements, the country still ranks lower than most of its regional peers for ease of doing business. According to World Bank’s Doing Business Report Romania showed an improvement in its ranking from 48th in 2015 to 36th in 2016 out of 189 countries, scoring particularly low for obtaining construction permits and obtaining electricity. Similarly, Romania ranks 62nd out of 138 countries in the Global Competitiveness Report 2016-2017, having fallen from 53rd place in the previous year. The country scores particularly poorly on indicators relating to infrastructure, access to finance, tax rates, corruption and inefficient government bureaucracy.
According to the EC Cooperation and Verification Mechanism report published in late-January 2017, Romania continues to make progress in the fight against corruption and protection of the independence of the judiciary. However, there remain a number of issues identified in earlier CVM reports that remain outstanding and need to be addressed before the CVM process can be closed. These mainly relate to the responsibility and accountability required by Romanian authorities and the internal safeguards needed to ensure irreversibility of the results. Political events in early 2017 underscore that these issues remain pertinent.
There are a number of reform priorities for the enhancement of the business environment: