Romania’s draft 2021 budget and medium-term deficit targets signal a shift from the expansionary stance that characterised fiscal policy pre-pandemic, Fitch Ratings says, but it is still unclear how underlying challenges to public finance sustainability will be addressed.
The draft budget published on 11 February is the first from the coalition government formed by two centre-right groups (PNL and the USR-PLUS Alliance) and the ethnic Hungarian UDMR after last December’s general election.
It targets a fiscal deficit of 8.2% of GDP this year in ESA terms (7.2% in cash terms), down from 9.1% in 2020 (9.8%). The deficit is then forecast to fall below 3% of GDP in 2024. Most near-term adjustment results from winding down some pandemic response measures and controlling expenditure growth in other areas while an economic rebound drives revenues higher.
We noted after the elections that the 2021 budget would provide an early indication of the coalition’s fiscal priorities. The proposed freezing of public-sector pensions and wages until 2022 and cuts to subsidies and government spending on goods and services indicate a greater appetite for expenditure restraint.
Pension spending has been a particularly significant source of fiscal uncertainty in recent years, and the budget incorporates the 14% increase finalised last September (the original proposal was for a 40% rise).
The government also appears mindful of the risks to economic recovery from aggressive fiscal tightening and plans to increase investment spending by nearly 16%, pushing overall expenditure up by 5% this year.
Nevertheless, we think the aim of bringing the deficit below the EU Stability and Growth Pact’s 3% of GDP threshold in 2024 acknowledges the importance of medium-term public debt sustainability. The budget’s annual GDP growth assumptions of 4.3%-5% in 2021-2024 are more realistic than under some previous governments.
The government has yet to spell out plans to tackle budgetary rigidities relating to wages, subsidies and social benefits, although Prime Minister Florin Citu has said it will look to make spending on pensions, salaries and education more flexible and public administration more efficient.
The 2021 budget proposal does not include new taxes or tax increases, with the large revenue rebound (tax revenues are forecast to rise nearly 20%) partly reliant on the boost to VAT, income taxes, excises and social contributions as GDP growth resumes.
EU funds will be a major source of budgetary support. Like other CEE sovereigns, Romania will be a significant beneficiary of Next Generation EU (NGEU) transfers and the government plans to boost absorption rates. Although NGEU transfers will be budget-neutral, they could help reduce financing costs and increase expenditure flexibility.
The government intends to improve tax collection via digitisation and Romania’s high growth potential could support deficit reduction post-pandemic. But without either expenditure or revenue-side structural reforms, fiscal targets are at risk if growth underperforms, for example, due to a resurgence in Covid-19 infections. Making politically difficult fiscal policy choices could also test the cohesion of the coalition.
Weakening public finance metrics due to previous expansionary policy and the impact of Covid-19 are reflected in the Negative Outlook on Romania’s ‘BBB-‘ sovereign rating. The synchronised global impact of the pandemic on Fitch-rated sovereigns means some fiscal metrics have improved relative to ‘BBB’ category medians.
But given Romania’s very weak fiscal record during the strong GDP growth pre-pandemic and its fiscal rigidities, resolving the Outlook will also depend on implementation of current plans and greater confidence that general government debt/GDP will stabilise over the medium term, as highlighted in our rating sensitivities.
