Romania: Fiscal Sustainability Hinges on Pension, Tax Reform as Growth Slows

Reform momentum is important if Romania is to exit the EU’s excessive deficit procedure, maximise its access to international debt capital markets and EU funding, and improve the economy’s longer-term growth potential as Russia’s war in Ukraine weighs down on the outlook for Central and Eastern Europe (CEE).

The government plans to reduce the budget deficit from 6.2% in 2022 to 4.4% of GDP in 2023 (in European system of accounts terms) and to 3% in 2024,. However, GDP growth will slow to 2.2% this year from 4.8% in 2022 amid double-digit inflation.

Scope Ratings forecasts a more gradual narrowing of the budget deficit to 5.4% in 2023 and 4.6% in 2024, which would leave government finances more reliant on domestic and foreign bond markets and EU funds.

The government wants to address the structural budget deficit through pension reform, planned for this year, and by raising tax revenue by at least 2.5pp of GDP by 2025. Progress here would help unlock generous EU funding under the Recovery and Resilience Facility, equivalent to EUR 27.1bn or 9.5% of 2022 GDP until the end of 2026.

Pension reform aims to make the system fairer and financially more sustainable in the context of an ageing population. Increasing the tax base requires more efficient tax administration and collection. At 26.4% of GDP in 2021, total receipts from taxes and social contributions are the EU’s second lowest after that of Ireland (Figure 1).

Figure 1: EU: total receipts from taxes and social contributions, % of GDP, 2021

Fiscal Outlook Depends Heavily on Growth Without Pension Reform, Improved Tax Take

Without pension reform, a significant expansion of the tax base and tighter control of State spending, the medium-term fiscal outlook will remain overly contingent on sustained high economic growth.

In our baseline economic scenario, the gradual reduction in the budget deficit will result in an increase in government gross debt-to-GDP to 51% by end-2023 and 53% by end-2024, before stabilising at close to 55% in the medium run (Figure 2). Debt-to-GDP will remain below a euro convergence criteria ceiling of 60%, but above the government’s assumption of less than 50% in the medium run.

Improved near-term political stability under the majority coalition government led by the Social Democrats and Liberals supports the credibility of the government’s fiscal programme and increases the programme’s chances of being maintained for longer.

Figure 2: Romania: government gross debt, % of GDP

Access to Capital Markets Supports the Investment-grade Ratings

Scope Ratings’ affirmation of Romania’s BBB-/Stable Outlook ratings on 17 March reflects the country’s access to domestic and external funding on relatively favourable terms within currently difficult market conditions. Indeed, Romania has front loaded 38% of financing planned for 2023 via bond issuance in domestic and external markets, one of the highest such figures among CEE countries.

However, the government’s gross government financing needs remain substantial, at around 11% of GDP for 2023 – albeit below the IMF’s 15% high-risk benchmark. Most of this borrowing will be done on the domestic market, despite local banks already holding around half of domestic government securities.

Elevated financing needs will require foreign debt issuance, of around EUR 8.5bn or 2.7% of GDP this year, of which near EUR 6bn was completed in January. The Treasury’s plans to issue Romania’s inaugural green bond in the second half of 2023 would be a good way to raise funds and diversify the investor pool.

That said, Romania has an uneven fiscal record marred by weak spending controls and politically driven pro-cyclical fiscal policies. Any reversal of its commitment to fiscal discipline and/or renewed challenges to the outlook for debt sustainability could put pressure on the BBB- ratings.

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Levon Kameryan is Associate Director in Sovereign and Public Sector ratings at Scope Ratings GmbH.