|  14.12.2012

Unicredit: CEE Quarterly

After three years of successful fiscal adjustment, growth remains Romania’s biggest challenge. But with domestic demand hit by austerity, a poor harvest and faltering exports amid weak economic activity in the EU, the country faces stagnation over the coming quarters. GDP contracted by 0.6% yoy in 3Q12 (-0.5% qoq) after drought hit wheat and maize crops and the government stopped infrastructure projects for lack of funding, causing investment to decline after growing 2.6% yoy in 1H12.

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money

ROMANIA

Growth


After three years of successful fiscal adjustment, growth remains Romania’s biggest challenge. But with domestic demand hit by austerity, a poor harvest and faltering exports amid weak economic activity in the EU, the country faces stagnation over the coming quarters. GDP contracted by 0.6% yoy in 3Q12 (-0.5% qoq) after drought hit wheat and maize crops and the government stopped infrastructure projects for lack of funding, causing investment to decline after growing 2.6% yoy in 1H12. Going forward, we expect a 0.1% yoy growth rate in 4Q12 driven by public consumption and rising inventories, bringing the annual growth rate to just 0.2%. On the supply side, the bad agriculture year spurs retail sales (up 3.6% yoy in 3Q12), but industry will not contribute to growth because of weakening activity in Germany.

Gross Domestic Product


GDP growth could pick up gradually in 2013 and 2014 to 1.3% and 1.8% respectively, in line with a slow recovery of economic activity in the euro area. Faster growth will depend on further structural reforms and better EU fund absorption. The former could aim at reducing public sector slack (while leaving more funds available for public investment) and increasing the participation of the labour force. The latter could offset poor foreign direct investment.


Absent such measures, GDP (without agriculture) cannot grow faster than 2% yoy. The current account deficit shrank to 3.6% of GDP at the end of September from 4.4% of GDP at the beginning of the year, but the improvement relies on a narrower income balance deficit, on larger transfers to the government and service balance surplus for a combined reduction of EUR 1.0bn. Despite a weaker RON in 2012, the goods trade balance hovers at EUR 7.0bn FOB-FOB (EUR 10.0bn FOB-CIF) due to inelastic imports of energy and food, coupled with a high content of imports for Romanian exports.

Fund flows


Romania continues to be one of the weakest fund flow stories in CEE. FDI and capital account flows cover the smallest share of the current account among new EU members, leaving a gap of approximately 1.7% of GDP to be financed from more volatile inflows, such as portfolio investment. The latter turned to EUR 2.0bn outflows during this summer’s political crisis and the 10M12 flows amounted to just EUR 1.0bn (0.7% of GDP). The dependence on volatile inflows could be reduced if Romania were to absorb more European funds. At less than 10% of fund allocation, Romania lags all other countries in CEE in terms of absorption of structural and cohesion funds and the country could try emulating Poland and the Baltics who have managed to attract 45%-60% of allocated funds. During the next financial programming period 2014-2020, the country risks receiving fewer funds than its size and needs would entail because European authorities want to punish underperformers.


Romania‘s budget deficit will fall in 2012 below 3% of GDP (based on accruals, ESA 95 methodology) and the country will exit the Excessive Deficit Procedure (EDP). On cash basis, the deficit has been flat at 1.2% of GDP between July and October but local authorities have accumulated arrears following local elections in June.

Fiscal reforms


Further fiscal consolidation in 2013 will necessitate additional reforms in order to meet the deficit target of 2.2% of GDP (too tight a target given the current economic weakness throughout Europe). The Romanian authorities intend to implement a list of reforms with help from the IMF and the World Bank (WB): improving tax collection, simplifying tax payment procedures, better monitoring the tax duties of wealthy individuals, prioritizing capital expenditure through multi-annual investment plans and further reducing the losses of state owned enterprises. The first and last two items on the list have been permanently on the priority list of Romanian governments, with limited results. There are a number of risks to next year's budget. GDP growth could fall short of the government's 2% assumption while the wage bill will rise to 7-7.1% of GDP as wages are returned to June 2010 levels. EU fund disbursements will restart gradually after a negative audit in 2012. Lastly there is likely to be pressure from local administration for higher expenditure. Even if Romania fails to meet the 2.2% deficit target, a gap below 3% of GDP in 2013 will be a positive result. The structural deficit could fall next year below 1% of GDP, approaching the 0.7% medium-term target.

Privatizations


Although all parliamentary parties are committed to the IMF agreement, privatisations and public sector reforms have dragged over the past year. Romanian authorities would like to sign a third agreement when the current one expires in March 2013, but the IMF would like t see more results before that happens. The small amount and volatile nature of FX fund flows are likely to weigh on the RON in 2013. In this environment, the monetary policy will probably focus on the exchange rate, rather than interest rates. Although inflation was at 4.6% in November and will miss the 3% target this year, the National Bank of Romania (NBR) is unlikely to hike in 2013. The inflationary shock is caused by a temporary spike in food prices and the central bank believes it should not squeeze other categories of prices with tighter monetary policy for lack of structural reforms in agriculture and trade. Moreover, the central bank sees inflation returning to the target interval by the end of next year and fears moving against the easing trend in CEE. With limited scope for direct interventions, the NBR has used the supply of liquidity in order to fight depreciation. Since 8 October, one-week repos have been capped at a third of demand, while additional liquidity was provided through bilateral operations. The results are a 1.5% RON appreciation between mid-September and end-November and 3M money market rates above 6%.

Banking


The banking system remains in the red, with the NBR expecting a slow recovery. EUR lending has been capped through a series of regulations aimed at reducing FX risk for unhedged borrowers, while RON lending remains expensive due to the high cost of funds and increasing NPLs (17.3% in September, with further increases expected). Slow deleveraging continues with the foreign liabilities of the banking system declining by EUR 1.5bn between September 2011 and September 2012. The real growth rate of lending turned negative during the autumn, with demand declining as economic prospects worsened.


The MinFin has had its best year on international markets, selling EUR 2.25bn and USD 2.25bn of debt. The MinFin focuses now on local issuance, extending maturities and increasing liquidity to benchmark size for 2Y, 3Y and 5Y bonds, while accepting to pay higher yields (the spread between the average accepted yield and that of all bids has fallen below 20bp for 2 and 3Y from more than 1.5pp earlier this year). Hence, foreign interest in RON bonds has risen, fuelled by the inclusion in the Barclays local bond index from 31 March 2013 and advanced negotiations with JP Morgan. Foreign investors owned just 5.4% of RON marketable debt at the end of September, while the share for FX debt issued locally was 24.9%. During 2013, the MinFin plans to issue the equivalent of EUR 2.25bn in Eurobonds and found demand for 7-10Y debt in EUR and for 10-30Y debt in USD.

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