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FITCH Ratings: Romania’s Political Crisis Presents Risks to Deficit Reduction

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Fitch Ratings-London-07 September 2021: The collapse of Romania’s coalition government could disrupt fiscal consolidation efforts, which are key to resolving the Negative Outlook on Romania’s ‘BBB-’ rating, Fitch Ratings says. Buoyant economic growth and Next Generation EU funding still provide a potential path to deficit reduction, but prospects for tackling long-standing fiscal rigidities could deteriorate.

Tensions between the PNL and USR-Plus, two centre-right parties in the coalition that took office in late 2020, have risen in recent weeks over policy priorities, including the scope of a regional investment scheme and delays to judicial reforms. USR-Plus announced on 7th September that they were leaving the coalition alliance, following the dismissal of USR-Plus MP Stelian Ion as Justice Minister on 2nd September. This leaves the government without a parliament majority.

USR-Plus has tabled a no-confidence motion to pressure the PNL to replace Florian Catu as Prime Minister – something the PNL has refused. USR-Plus has received support from the right-wing AUR to proceed with the no-confidence vote, with the opposition centre-left PSD initially signalling its tacit support. These parties would have enough votes to pass the motion, which would force the president to designate a new Prime Minister to form a government. President Iohannis, formerly of the PNL, would likely designate Catu again, who would attempt to form a minority PNL government, as in 2019–2020.

Two failed attempts to form a government would trigger early elections. Recent polls put the PSD in a strong position to form the next government were elections to take place. This could pressure the other parties to compromise in order to retain power.

The coalition’s ambitious reform agenda, anchored in the national recovery and resilience plan (NRRP), already faced mounting obstacles due to difficulty implementing measures during the pandemic. It is uncertain how far a minority PNL-led government or a new PSD-led government would be able or willing to push through politically sensitive reforms to healthcare, wages, pensions and the judiciary. This could further delay European Commission approval of the NRRP, which the government initially expected by end-September.

Political turmoil also clouds the fiscal outlook. The government had planned ambitious expenditure and revenue reforms to reduce the deficit to under 3% of GDP in 2024 from 9.3% of GDP in 2020. The government had expected to propose a unitary wage and a pension bill by end-2021 and had pledged to increase tax compliance to reduce a large VAT revenue gap. But little progress has been made in recent months and now the prospects of rapid implementation have diminished further, although the NRRP could still serve as a policy anchor. Failure to follow the envisaged deficit-reduction path is the main risk to Fitch’s debt projections.

EU funding of commitments under the NRRP will take some pressure off the budget, and, combined with buoyant growth prospects, will underpin deficit reduction through revenue overperformance (as was the case pre-2020). However, without deeper reform, long-standing fiscal challenges – including a very rigid expenditure profile – and broader fiscal and external risks will persist. The current account deficit was 6.3% of GDP on a 12-month rolling basis in June. Failure to moderate the fiscal deficit or attract non-debt-creating inflows (mainly EU Funds) could undermine macroeconomic stability.

Fitch has consistently stated that the evolution of public finances is the main driver of Romania’s rating. Positive rating action would require confidence that the authorities will implement credible fiscal plans that stabilise general government debt/GDP over the medium term. Lack of progress in implementing reforms, leading to a faster-than-projected increase in public debt, could lead to negative rating action. Fitch’s next scheduled review of Romania’s rating is due on 22 October.

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