Guest post: How can Romania solve its public debt issue?
Guest writer Andrei Buruiana analyzes the potential negative effects of Romania's rising public debt and suggests several solutions that the Government should implement quickly to stop this trend.
Romania is once again under investors’ scrutiny after its public debt has been above 50% of GDP for the second month in a row, according to data released by the Finance Ministry last week.
This is the highest public debt to GDP ratio Romania has seen since 1990. For comparison, this indicator stood at around 35% between 2017 and 2019, before the COVID-19 pandemic forced the Government to ramp up public spending to support the economy.
In absolute terms, Romania's debt has reached about RON 600 billion or EUR 120 billion.
Also at the end of last week, Fitch, one of the three major international rating agencies, maintained its negative outlook on Romania's BBB- rating, a rating that it also reaffirmed.
Romania's diagnosis is the same as it was in the previous memorandum: rising debt, twin deficits (budget deficit and current account deficit), all in a climate of elevated prices and war just over the country's northern border.
In the Fitch memo, analysts reiterate both the factors underpinning the reaffirmed rating and the risk factors that could hinder it:
“Credit Fundamentals: Romania's 'BBB-' rating is underpinned by EU membership and EU capital flows that supports investment and macro-stability, and GDP per capita, governance and human development indicators that are above 'BBB' category peers. These are balanced against larger twin budget and current-account deficits than peers, a weak record of fiscal consolidation and high budget rigidities, and a fairly high net external debtor position.
Negative Outlook: The Negative Outlook reflects continued uncertainty regarding the implementation of policies to address structural fiscal imbalances over the medium term and the impact of the Ukraine war and energy crisis on Romania's economic, fiscal and external performance.”
Another important aspect is the estimated economic growth target, revised downward by most analysts, to 2% for this year, a significant slowdown from 2021.
How do these indicators affect Romania and its investors, overall?
First, a country with a high debt that is not sustainable in terms of what the economy can generate, will borrow from financial markets at higher costs than peer countries, thus paying a higher risk premium.
From an investor perspective, Romania needs to offer a fairly high yield on government securities.
This has become obvious, especially for short maturities, i.e. 6-12 months, where yields have been hovering around 5%, according to the NBR's fixing last week.
Increasing yields are primarily a problem for the outstanding sovereign debt because the spiral effect occurs: as the yield (interest) increases, the overall cost of debt increases, the outstanding debt increases, hence the debt ratio increases, and back again, the expected yield has to increase, to meet investors’ requirements.
On the other hand, in the case of bonds, high yields also mean depreciation of their absolute value, hence pressure on the portfolios containing them. I mainly refer to private pension fund portfolios which are affected, in terms of asset value, at these elevated bond yields.
Another influence factor of high yields on RON denominated government securities, associated with devaluation in absolute terms, is the pressure on the local currency. As long as yields on government securities are below the inflation rate, basically negative in real terms, there will be a tendency for the RON to depreciate, i.e. pressure on the exchange rate.
The average inflation rate for 2022 is estimated at around 10% (according to Fitch), whilst Romanian government bond yields are currently between 5% and 7%.
Of course, the National Bank of Romania (NBR) intervenes and alleviates the situation, either through purchases of government securities or purchases of RON, thus supporting the stability of the local currency.
The good news for investors interested in government bonds is that, at some point, once they have depreciated enough, they become interesting to buy, because they can be bought cheaply. Needless to say, at that point the pressure on the RON, coming from this angle, would subside.
Another effect of high debt, over the long term, is the reluctance upon new investments. A debt-ridden country cannot put off fiscal consolidation indefinitely, that is tax increases, and this risk is not quite music to investors’ ears.
What solutions could there be to reduce Romania's public debt?
In terms of measures aimed at addressing this growing debt, the main textbook solution would be fiscal consolidation, exactly as the Fiscal Council has called for in the past and that Fitch is now suggesting.
But as Romania's macro-economic context is a difficult one, due to an elevated price environment (induced by fuel price rises) and as monetary policy measures are exerting pressure already (loan rates have risen and will rise further), the task would be almost impossible.
Basically, should Romania decide to raise its taxes right now, it would be similar to building a cart in the summer or a sleigh in the winter. This would oppose the Romanian saying of “building the cart in the winter and the sleigh in summer”. It would be too late.
Of course, a few tax hikes could address some very specific areas, such as increasing excise duties on luxury goods or on vices, taxing a larger than average number of properties, ideas that have recently come into the public space, from the Ministry of Finance.
On the other hand, an extremely effective button to push on the tax consolidation dashboard would be to improve the collection rate. Romania needs to increase its tax collection, as it is one of the lowest in Europe.
By way of example, considering Romania's tax-to-GDP ratio at just under 30%, with the EU average being slightly above 40%, convergence to the European average would mean an additional 10% of GDP in the public budget.
Basically, in 5 years, as total debt is around 50% of GDP, Romania could significantly reduce its public debt just by bringing its collection close to the EU average.
The ratio of taxes to GDP for EU countries. Source: Eurostat
On the other hand, as a short-term solution, one item that should be a priority now is the NRRP (National Recovery and Resilience Program), a program that Romania cannot afford to miss. It is essential for Romania to absorb all the money and, more important, to put it to work in the real economy (not in the NBR current accounts). This way, real investments will be made, that, in turn, would generate second-round effects.
Needless to say, interest rates on NPRR money are zero for grants and between 0-1% for loans, whilst Romania’s borrowing cost in the financial markets, RON denominated, ranges between 5-7%, depending on maturity.
Also in the short-term solution basket, and due to the disruption of the international food commodity markets, Romania should be able to rise up to the opportunity of being a relevant food exporter.
It is clear that the food market will continue to be complicated in the future (Ukraine affected by war fallout and Russia most likely by embargoes); so this can be a turning point for Romania, a window of opportunity.
Romanian agriculture needs to embrace technology, hence modernize, while expanding its irrigation system, which currently covers only about 10% of the cultivated areas.
A few other solutions, in the medium to long term, point to the way the government relates to companies, both public and private.
When it comes to public companies, the government should restructure and improve those that swallow a lot of subsidies, for example, CFR Calatori, CFR Marfa or Complexul Energetic Oltenia.
It would also be advisable to list as many of them as possible on the stock exchange, to allow them to fight for capital infusions on their own; and all future subsidies should be made available pending reforms and investment plans.
When it comes to private companies, since Romania also faces a trade deficit, the government should encourage local companies to scale up and export as much as possible. Tax facilities should be directed mainly toward companies that export and that are listed on the stock exchange.
The war in Ukraine will end at some point and Ukraine will go through a period of reconstruction, most likely in conjunction with its joining the EU. Romania must be actively involved in the reconstruction of its neighbor country, meaning that the political establishment should earn Romania a relevant seat at the reconstruction table.
More specific, Romanian companies involved in infrastructure and civil construction, those producing or distributing construction materials, all such companies should be able to carry out projects in Ukraine in the coming years.
I have left at the end a solution that should be started immediately and which, over the medium and long term, can help Romania a lot, in terms of budget revenues. This solution is the exploitation of gas from the Black Sea.
The passing of the offshore law becomes essential, both in order to eliminate Romania's dependence on gas imports and also to turn it into a regional player within the gas market. An additional outcome for Romania, should it eventually start exploiting gas in the Black Sea, comes from the royalties collected from the companies involved in drilling and distributing the gas.
The state royalty, as defined in the draft of the law, ranges between 15-70% of the selling price minus a fixed benchmark, and multiplied by the volume exploited. At current prices, Black Sea gas is valued at approximately EUR 150 bln, according to media sources. Since current prices are quite high, energy experts estimate royalties at about 50-60%.
So, assuming that the Romanian state will collect 50% in royalties plus second-round effects from downstream (e.g. VAT applied to gas consumption on the domestic market), this would mean about EUR 75 bln, deferred over the entire operating lifetime. This could be one way for the Romanian government to generate additional money for its budget.
In conclusion, Romania can solve its public debt problem through a mix of measures, such as improving tax collection, making public companies more efficient and listing them on the stock exchange, and exploiting gas from the Black Sea.
by Andrei Buruiana, contributor
Andrei Buruiană is a seasoned professional in financial services, with 15 years of experience, having covered:
- Investment & Pension Fund Management;
- Retail Banking: Wealth Management & Private Banking, Product Management and Business Planning;
- Project Finance: EU Funds;
- Training & Consulting (currently), covering: Personal Finance, Sales and Ledership.
Andrei is also a content creator and contributor on several Romanian business & economics platforms. He has a Bachelor’s degree in International Business & Economics, from the Bucharest University of Economic Studies.
(Opening photo source: Dreamstime.com)