Romania’s Euro Adoption Target More Ambitious As Reforms Stagnate- Moody’s

Moody’s analysts say Romania currently meets the debt and deficit convergence criteria though an economic slowdown could temporarily threaten the deficit criterion.

The most problematic is the inflation criterion, which is seen at 6.9% at yearend, up 0.3% compared with December 2007, and 4.4% at the end of next year.

Romania’s central bank has set an inflation target of 2.8%-4.8% for 2008, and 2.5-4.5% in 2009.

The 2008 fiscal deficit is seen by the rating agency higher than the government forecast unless some restraint is exercised.

"The government will again under-spend on investment but, since this is an election year, current spending will be much higher. The government’s forecast calls for a significant increase in revenues, which appears unlikely given our expectations of stable economic growth,” the report reads.

Moody’s estimates a budget deficit of 2.9% of GDP in 2008 and 3.7% of GDP in 2009. In 2007, the budget deficit was at 2.5% of GDP.

The large current account deficit and rise in short-term external debt indicate that Romania’s external vulnerability has increased to medium over the past year.

Although external vulnerability has increased, Moody’s expects the economy to remain resilient in the face of greater risks, as the macro economy is much more stable and economic growth is more robust than during the 1990s.

Still, analysts forecast a current account deficit widening at 16.1% of GDP in 2008 and at 16.2% in 2009. Last year, Romania’s current account deficit was at 13.9% of GDP.

Romania’s Prognosis Commission CNP forecasts a current account deficit of 13.6% of GDP in 2008 and 12.5% in 2009.

"The large external imbalance poses some risks to macroeconomic stability. The current global financial turmoil could cause some international banks and investors to reduce fund flows to Romania as they become more risk averse and/or liquidity constrained. This would eventually cause a reduction in financing available for investor and consumer credit and a concomitant decline in the current account deficit," the report reads.

As for the banking sector, stress-testing indicates that the system should be able to absorb moderate exchange rate and/or interest rate shocks without a serious problem.

Moody said Romania’s 2008 economic growth is expected to be at 6.2% and 5.1% in 2009, while CNP forecasts an economic growth of 6.5% in 2008 and 6.1% in 2009.

Moody’s analysts also emphasize that the disorderly political environment led to a slowdown in the structural reform.

Moody’s Investors Service rated Romania at Baa 3, outlook stable.

“Nevertheless, Romania’s ratings are still low compared to other new EU members (except Bulgaria), due to a number of factors, including inconsistent fiscal policy, the still large structural reform agenda and the risks associated with the country’s steep and rapid transition, such as the large current account deficit and rapid credit growth,” Moody’s analysts said.

Nevertheless, Moody’s considers that the government and banking system could withstand a moderate economic shock at the current rating level.