The budget season in Romania has been an acutely volatile period under the PSD-led government. In 2017, it took a good seven months from the early suggestions of major budget measures reported to the press to when sufficient secondary legislation had been approved to get the full picture of winners and losers. In 2018, most of the standard budget negotiations (September-December in most countries) were surprisingly quiet, but it all fell into a vortex of confusion just in time for Christmas.
The government adopted an emergency ordinance on 28 December, which included several bold and unexpected changes, including: a progressive tax on banks’ financial assets once the interbank rate rises above 2%; a turnover tax on telecoms and energy companies; a cap for energy prices that may lead to a 20% drop in tariffs; and an aggressive rise in the minimum capital requirements for private pension companies operating in the 2nd pillar pension system. The government also pledged a EUR 10bn investment effort in social infrastructure, but it appears to us that the funding for these projects is unclear and improbable, at least in the near term.
Although the emergency decrees are implemented and effective, the budget process is not complete and, in our view, much can still change in the coming months and much is still unclear. The government has pledged to keep the budget deficit under 3% of GDP this year and has signaled that 2018 was also at 3% of GDP, below the Maastricht ceiling limit, but the Eurostat fiscal data available up to 3Q18 raises questions, as the budget shortfall widened to 3.6% of GDP.
The protracted uncertainty about the government’s ultimate fiscal stance poses downside risks to GDP growth in the near term, despite external conditions having stabilized, and growth was probably stable at 3.5-4% in the second half of last year. The RON has already suffered a blow, weakening to 4.75 to the EUR, a level we see as consistent with current fair value. We suspect that further depreciation is likely in the very near term as the combination of continuing changes to the judicial system, poor visibility on the fiscal stance and an implicit, but increasingly evident, attack on the independence of monetary policy and the functioning of the pension system increase the country risk.
The cap on energy tariffs is likely to reduce inflation sharply in the coming year, but this effect is likely to be offset partly by other tariff increases and the RON weakness. In our view, it is plausible that inflation will drop below 2% by the year-end. We suspect that the BNRO will not rush to cut the policy rate in this environment, even under a new governor. However, a mild easing in 2020E is plausible – when fiscal policy is likely to turn tighter and growth slower.