BUCHAREST BLOG: New faces, new policies, but the same old uncertainty

BUCHAREST BLOG: New faces, new policies, but the same old uncertainty
By Clare Nuttall in Glasgow December 5, 2019

Romania’s new centre-right government is preparing to undo at least some of the measures taken by its predecessors that have alarmed and dismayed investors over the last three years. 

But with term elections expected in late 2020 — which may be brought forward — and Prime Minister Ludovic Orban’s government backed by a hotchpotch of parties and individuals, even with his party’s candidate Klaus Iohannis returned to the presidency for another term, the much sought after certainty isn’t there. 

Orban’s government was the fourth to be installed in Bucharest in the three years since the December 2016 general election, and followed three governments appointed by the previous majority led by the Social Democratic Party (PSD) that were characterised by political volatility, growing populism, frequent u-turns, a series of measures that severely dented investor confidence, and backsliding on anti-corruption and the rule of law that prompted mass protests. 

This was on top of the lavish spending on public sector salaries, pensions and other benefits that pushed Romania’s budget deficit up as a share of GDP — even at a time when the economy was growing fast — and will almost inevitably see the country enter the EU’s Excessive Deficit Procedure (EDP). 

The new government is now undoing some of the measures taken by its predecessors that are seen as particularly unfriendly to investors, notably the emergency decree 2018/114 that introduced the so-called “greed tax” on banks that caused an immediate stock market collapse when it was announced. 

Orban has indicated he will scrap the “greed tax” on banks and a similar turnover tax on energy companies, and restore the stalled liberalisation of the gas and electricity markets. He is also introducing a package of legislation in the justice sector. His government has already issued a revised budget for what remains of this year, and will announce the 2020 budget within weeks. 

However, despite initial optimism that the new government could herald a return to fiscal prudence, with elections looming Orban has said he will honour promises made by the previous government, including a hike in pensions and further public sector pay rises that will put additional pressure on Romania’s already shaky public finances. 

Instead of taking the electorally unpopular move of cancelling or scaling back on these promises, his government hopes to rein in the budget deficit by improving tax collection and making public spending more efficient — a hope that analysts see as overly optimistic. 

Macroeconomic imbalances will remain Romania’s Achilles heel, Raiffeisen analysts wrote at the end of November. While Finance Minister Florin Citu has indicated that the 2020 budget deficit target could be lowered to around 3.5% of GDP, "we are sceptical that the deficit can be reduced by such a large amount in 2020, because structural forces keep the deficit at a very high level at present … As things look now, the structural deterioration of the government budget is set to be permanent in nature,” Raiffeisen analysts wrote. 

"We think that bold actions/decisions are required to reduce the public budget deficit towards a level of 3% of GDP. In any case, the Maastricht deficit criterion would be violated two years in a row, which could bring Romania an excessive deficit procedure (EDP).”

Affirming Romania’s BBB- rating immediately after the change of government in November, Fitch Ratings wrote that its baseline scenario was for a “further gradual weakening of the public finances over the short to medium term”. 

“The toppling of the PSD government in October has raised political and policy uncertainty at a time when fiscal and external metrics are weakening,” Fitch said. 

Fitch pointed to the “twin budget and current accounts deficits, reflecting pro-cyclical fiscal policy that poses risks to macroeconomic stability, and net external indebtedness that is higher than its rating peers.”

It noted that the fiscal outlook would “become significantly more challenging” in 2020-2021 given the expected weaker macro-economic backdrop and already legislated pension hikes. Fitch says it expects the deficit to widen to 4% of GDP by 2021, provided the government takes at least some corrective measures. 

All this has led to turbulence recently on Romania’s bond and forex markets. Raiffeisen analysts wrote in a recent CEE LCY Bonds Special “Too early to re-enter RON markets” released on November 29 that “fiscal pressure is set to keep adverse pressure on RON markets elevated”. 

“Last week, the 10-year yield of the ROMGB benchmark government bond increased by almost 20 bp, the most in the region, while RON FX temporarily broke the 4.80 level vs EUR before retracing Friday,” Raiffeisen analysts wrote. "Due to the elevated refinancing needs, Romanian debt managers already presented an ambitious issuance plan for December, targeting RON4.3bn in T-bonds and another [RON]1bn in T-bills.”

There has also been concern about the stability of the Romanian leu. There was speculation that the Romanian central bank had spent massively at the end of November to prop up the currency. Later, however, a central bank official, speaking anonymously to Bloomberg, revealed that the intervention was smaller than originally believed, at under €1bn. 

As long as the current hung parliament remains in place, the scope for the government to make deeper reforms is limited. The presidential election was just the first vote in a busy electoral year, with local elections to take place in June 2020, followed by term parliamentary elections in either 4Q20 or 1Q21. While the vote may be brought forward, November 2020 is seen as the most likely election date. 

A comment by the Warsaw-based Centre for Eastern Studies (OSW) pointed out that while the appointment of Orban’s new government had ended the political crisis that started at the end of August when the previous PSD-led ruling coalition collapsed, “it does not mean that the political scene has been stabilised.”

With the focus already on next year’s elections, say OSW analysts, “The new government will de facto be technocratic by nature … and its programme is very limited.”

“The new cabinet’s priorities will include amending the budget law, to ensure the liquidity of pensions and salaries in the public sector, and drawing up a draft budget for next year. In the slightly longer term, the government will also try to start the process of repairing the damage done to the Romanian judiciary by the reforms which the centre-left recently introduced, and which drew sharp criticism from Romania’s Western partners and the European Commission.” according to OSW. 

And even though it received a boost from Iohannis’ re-election by a comfortable margin in the presidential election, the new government’s survival cannot be guaranteed. The PSD, albeit weakened, remains a considerable force thanks to its large organisation. The PNL can also expect pressure from its rival in the centre-right, the Union Save Romania (USR), which is in a similar position on the political spectrum but as new political force has successfully used anti-establishment rhetoric against the PNL. 

Snap elections would be a way to shorten the ongoing period of political uncertainty, but the outcome is hard to predict, making this an option few politicians would be bold enough to risk.