After growing by a robust 4.1% in 2019, the economy struggled with both the health and the economic effects of the profound and rare crisis triggered by the COVID-19 pandemic.
Preliminary data show that Romania’s economy contracted by -3.9% in 2020. Nevertheless, this strong decline turned out to be less severe than the EU average. Overall, the economic impact was asymmetric across sectors. The closing down of businesses and limits on mobility had a disproportionate impact on the manufacturing sector, hotels and restaurants, entertainment, and retail.
Driven by increases in public wages and a tight labour market that led to a rise in disposable income, private consumption was a major contributor to growth in 2019. However, in 2020 the situation completely changed, with the imposition of lockdowns leading to a -3% fall in domestic consumption.
The reduction in demand, falling energy prices and decelerating wage growth caused inflation to fall from a 5-year peak of 5.4% in 2018 to 2.1% at the end of 2020. Food prices increased the most at the beginning of the year, and were the main inflationary component, but later decreased in the autumn. Nevertheless, core inflation, which excludes the volatile components such as energy prices, remained quite high throughout 2020, reaching 3.5% at the end of the year.
Investment grew significantly in 2019 and made the highest contribution to growth in the last decade, on the back of increased public spending on infrastructure and a booming private construction sector. Throughout the first two quarters of 2020, public investment continued its upward trend, but the Covid-19 crisis forced the authorities to refocus resources on safeguarding jobs and preserving the liquidity of business for the rest of 2020, while the private sector stalled capital spending due to increased uncertainty. Nevertheless, investment still contributed positively to growth in 2020, as construction held up relatively well throughout the year.
External imbalances rose in 2019 and the Covid-19 crisis had little impact on correcting them. The current account deficit has remained above 4% of GDP since the end of 2018, as imports have grown faster than exports. Exports of goods fell by 9.9% in 2020 while imports dropped by 6.6% compared to 2019. A steep fall in foreign direct investment (FDI) inflows at the beginning of 2020 slightly decreased the financial account deficit, but portfolio inflows, as the government borrowed from foreign markets, significantly increased during 2020. Total External debt stabilised at around 50% of GDP before the Covid-19 crisis hit and edged up to around 55% of GDP towards the end of 2020.
The Bucharest equity market has performed well since 2015, outperforming all Romania’s regional peers except Hungary. In 2019, the domestic capital market recovered from the shock of Emergency Ordinance 114/2018, which targeted banking, energy and telecommunications. The Bucharest Stock Exchange fell by around 16% in March 2020, amid the financial shock in world markets caused by the Covid-19 pandemic. Nevertheless, following the upgrade to emerging market status in September 2020 and extra liquidity in the financial sector, the market index is expected to recover to above the level recorded before the Covid-19 crisis.
Romania’s country risk, reflected partly by government bond yields, has been higher than its regional peers since 2017 mainly because of the weaker underlying fiscal position. Following the March 2020 shock, which increased government bond yields, the global monetary expansion led to a significant decline in yields for the rest of 2020, edging closer to the interest paid by the Polish and Hungarian governments (see below).
The RON has been steadily weakening against the euro over the past 4 years given the twin pressures of the fiscal deficit and higher inflation. Nevertheless, the central bank has had a firm control on stabilising the exchange rate when needed, leading to a more gradual depreciation, when compared to, for instance, the volatility of the Hungarian forint.
The banking sector remained well capitalised throughout 2020, with a capital adequacy ratio of 22.8% as at September 2020, partly because of the decision to relax prudential regulation at EU level. Since 2008, banks have progressively increased their funding from local deposits, and reduced their reliance on external debt. The loan to deposit ratio declined from above 120% in 2012 to below 70% in the second half of 2020, on the back of slower credit growth. Asset quality also improved, as the Non-Performing-Loan (NPL) ratio was pushed below 4% in December 2020. However, with the loan payment moratorium ending, the risk of an uptick in the NPL ratio remains relatively high.
After considerable fiscal expansion, which began in earnest in 2016, when the government adopted a series of tax cuts, social contribution reductions, public sector wage increases, and pension increases, the fiscal deficit reached 4.6% of GDP in 2019. In 2020, on the back of unprecedented fiscal support to firms and employment and declining economic activity, the fiscal deficit rose to 9.8% of GDP (see box below). Worryingly, the structural deficit remains high. That explains why Romania was the only EU country under the Excessive Deficit Procedure in 2020.
Despite the difficult fiscal situation, market access to funding on favourable terms remains strong given the central bank’s accommodating policy. Public debt has remained moderate by regional standards, in spite of massive government borrowing in 2020, reaching 47.7% of GDP at the end of 2020. Foreign-denominated public debt increased in 2020 on the back of multiple Eurobond issuances that financed the deficit. Short-term debt with maturity of up to one year declined to about 12% of total public debt at the end of 2020, as the government relied mostly on medium-term bond issuances.
In 2020 the National Bank of Romania (NBR) reacted promptly to the Covid-19 shock and lowered its policy rate in three steps to a historic low of 1.50%. This was driven by inflation reaching its lowest point in more than three years in December 2020. The NBR also provided liquidity to credit institutions via repo transactions, and purchased government bonds worth EUR 570 million from secondary markets until December 2020, as liquidity in the financial sector improved in the last two quarters. The policy rate cuts were followed by a significant fall of 3m in the ROBOR, which averaged 2.04% in December 2020.
The government has introduced a support package similar to those in other peer countries, focused on safeguarding business liquidity and employment, although somewhat smaller as a share of GDP (approx. 4.5%). Key measures directly affecting the state budget have included: (1) Relief and deferral of fiscal obligations; (2) Faster VAT reimbursement; (3) Employment support schemes, including a short-time work (Kurzarbeit) scheme, which will be operational in 2021 as well (representing 0.75% of GDP). Other measures include state credit guarantees to SMEs and large firms of around 1.2% of GDP, grant schemes to SMEs financed by EU funds and a loan payment moratorium for both firms and citizens of up to nine months (operational until mid-2021).
The FIC expects GDP growth to resume in 2021 after the significant contraction in 2020. In our latest forecast, we estimate GDP to rebound by 5.1% in 2021. The recovery is contingent on a gradual normalisation of economic activity and the public health situation in both Romania and its main economic partners, and, in the medium term, a resumption of structural reforms amid the absorption of EU recovery funds. The National Recovery and Resilience Plan will be a key instrument in guiding structural reforms and investment in the medium term to make Romania a greener, more competitive and more inclusive society. Another key instrument is the European Green Deal, a new growth strategy which aims to transform the EU into a fairer and more prosperous society, with a modern, resource-efficient and competitive economy where there are no net emissions of greenhouse gases in 2050 and where economic growth is decoupled from resource use. Medium term fiscal consolidation should be also be a key priority for governments amid the EU’s Excessive Deficit Procedure.
According to the European Commission’s most recent Cooperation and Verification Mechanism (CVM) report published in October 2019, the reforms needed to reverse the backtracking of previous years had yet to be adopted, but the commitment of the new government to implementing the CVM report’s recommendations is a positive first sign. Key priorities remain ensuring judicial independence, correcting the criminal codes, and tackling corruption. Moreover, the effectiveness of policy-making and predictability of the legislative progress should be improved, alongside the digitalisation of public services and institutions, which will help tackle the informal economy and improve the business climate.
Besides the above-mentioned priorities, the key issues which need to be addressed to support the growth of the private sector are: