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The Romanian government is raising public-sector wages, the
minimum wage and pensions. As government consumption composition
becomes even more tilted towards consumption rather than
investments, private sector investments are likely to be hit as
well.
IHS Markit analysis shows that new sectoral taxes and changes
to the pension system will be counterproductive due to their effect
on economic activity.
Current economic policy is expected to provide a short-term
boost to growth, but at the expense of lowering long-term potential
growth and sustainability.
At the end of 2018 Romanian government has announced that
Romania is raising sectoral taxes to finance higher public-sector
wages and social transfers. Meanwhile, the pension system takes a
further hit through lower administration fees and by allowing
individuals to opt out. The market reacted with a sharp drop in
equity prices, a sliding exchange rate, and rising bond yields.
Several of the latest government bond auctions were also indicative
of deteriorating investor sentiment. The government was not able to
borrow as much as planned, as yields went up and investors showed
less interest in Romanian sovereign bonds.
Current policy direction is likely to exacerbate the external
imbalances of the economy. Romanian economic growth has already
been fueled mainly by rising consumption as a result of
expansionary fiscal policy. As policy makers are trying to keep
budget balance within 3% of GDP, public investments suffer and poor
infrastructure continue to limit economic growth potential as a
result. Moreover, sudden changes in taxes in particular and
worsening investment climate in general will put a lid on private
investments as well. Moreover, taxes on bank assets are likely to
lower lending volumes further limiting some of potential
investments or forcing to turn to external lending. Without
adequate private and public investments country will not be able to
lift productivity and rising unit labor costs will weaken its
export competitiveness impeding the ability to turn to more
balanced and sustainable growth path in the future. Weakening
external environment, as growth in Europe leveling off, are adding
up to the challenges that Romanian economy will be facing in the
future.
New taxes and weakening of the pension system are also negative
for capital market development in Romania. Although the value of
pension funds' assets might not be huge compared with some other
countries, the local capital market is also quite small. The value
of turnover on the Bucharest stock exchange last year was equal to
1% of GDP. Moreover, only a few sectors, such as energy and banking
- which are likely to be hurt by new taxes and regulations - are
providing adequate liquidity. Banking sector and pension funds are
also significant investors in government bonds.
Lastly, taxes on bank assets, might limit monetary policy
effectiveness and flexibility. Central bank was able to bring down
elevated levels of inflation in the past. However, the concerns
were growing that monetary policy alone will not be able to ensure
balanced growth without more adequate fiscal policy and structural
reforms. Now the risk of possibly constrained monetary policy are
adding up to those concerns.
It is obvious that in the short term further increase in
pensions and public sector wages will contribute to purchasing
power growth, especially if lower commodity prices will not enable
inflation to come back to unsustainably high levels. It is also
true that Romania has a relatively low public debt, and budget and
current account deficit is below levels seen before global
financial crisis. Meanwhile, the banking sector has high liquidity
and capital adequacy, and decreasing levels of NPLs limiting the
risks to the stability of the banking system. However, the proposed
measures in total are likely to provide only a short-term boost for
consumption and budget revenues - most likely below the
expectations of policy-makers - at the expense of medium- and
long-term growth potential and revenues.
IHS Markit expects Romanian economic growth to decelerate close
to 3% in 2019 after surpassing 4% growth last year. The economy
will continue to be flying with only one engine on, as investments
and exports will be facing stronger headwinds. Such a journey,
especially with a reckless pilot, can result in a bumpy ride if the
country is lucky and a crash if stars do not align. This is why we
acknowledge the rising risk of economic growth coming to a sudden
stop as Romania's ability to weather external shocks is
decreasing.
Posted 06 February 2019 by Vaiva Seckute, Principal Economist, S&P Global Market Intelligence
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