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The new year started well enough and though the Romanian economy was slowing down, with some macroeconomic indicators blinking red, it was still looking like a soft landing was the most likely scenario. Then the coronavirus happened and while this was a blip on our radar back in February, when we published our annual report, it was still a material risk factor we pointed out. To say that we, as many other forecasters, were negatively surprised by what followed would be an understatement.
The scale of the downturn (now a certainty) is becoming clearer, though the longer lasting effects and pace of recovery remain big question marks both for Romania and its major economic partners, making any forecasts much less reliable than usual. The general consensus is that advanced economies will see their worst performance since World War 2 (with significant double-dip decline rates in the second quarter of the year), while emerging economies will also see the steepest drops in many decades. It is also worth pointing out that many uncertainties still cloud the horizon – from medical ones, regarding the coronavirus, to geopolitical issues to potential problems in the financial markets.
Thankfully, Romania seems in a bit better shape than it did a decade and a half ago (though it still looks worse than most of its CEE peers) and most forecasts show the GDP decline to be smaller than in 2009, while the subsequent recovery is seen somewhere between a V- and a mild L-shaped pattern. This means that activity should gradually become decent through the next year, with the recovery set to be completed sometime in 2022 (i.e. GDP to return, in real terms, to pre-COVID levels). Overall, a double-dip decrease in GDP in quarter-on-quarter terms looks highly likely for Q2, though the full-year GDP figure is likely to be down by something in the -4% to -6% range.
Confidence indicators picking up much quicker than in the previos crisis, in spite of unprecedented drop
Source: Eurostat
Consumers not as spooked by crisis as in 2008, retail sales almost flat YEAR-ON-YEAR IN MAY
Souce: Eurostat, Google
As Romania’s major trading partners recover, so should the country. And thankfully, sentiment indicators offer some tentative green shoots: Germany’s top leading indicator, the Ifo business climate index, is more or less in line with a fairly swift recovery, while hiring intentions over the short term in Romania, as measured by European Commission surveys, have recovered much faster in the last few months than compared to the 2009-2010 recession.
Then there are other less traditional indicators which suggest that an overly pessimistic mood is not dominating consumers; for instance, in many parts, people are returning to shopping centers almost like nothing happened (though their spending remains quite a bit off compared to last year), while the frequency with which Romanians searched the word “crisis” on Google has dipped to normal levels by June after not reaching 2009 levels to begin with.
This suggests that as long as the damage to the labour market is not too widespread, things should play out decently over the coming quarters in terms of consumption (provided the coronavirus remains within reasonable limits so as to not lead to major restrictions, of course). For now, job losses as reflected by the total number of employees in the economy seem manageable (figures from the National Statistical Institute), though these figures may be lagging the true events going on in the economy. And indeed, based on figures from the Ministry of Labour, the number of people made redundant during this period would suggest that the doubling of the unemployment rate by year-end should be expected (from c.4% at the start of the year towards 8%). Wage growth has dipped in low single digits as of May 2020, with the private sector average wage barely expanding year-on-year; we would expect a modest pull-back in subsequent months though as with the previous recession of 2009-2010, we think most of the negative impact for the total disposable income should be generated by job losses rather wage cuts.
Hiring intentions returning much faster to normal levels than after previous recession
Employment expectations over the next 3 months index, deviation from historic average
Source: Eurostat
A special risk that is endemic to Romania and not most other EU states is the fact that the country has not managed to contain coronavirus cases as it ended the lockdown in June; a perfect storm of political instability (with shaky support for the PM in the Parliament) and upcoming elections create a backdrop for issues to not be tackled optimally. Consequently, new cases shot up and Romania is now one of the worst performers among the high-income countries. This leads to many short-term uncertainties that could further derail the recovery.
There are some structural negative aspects worth underscoring, like the sticky twin deficits Romania faces, with both its fiscal deficit and current account gap quite high to begin with. Also, general elections were set to take place late 2020 and we hoped that after the elections, an overdue process of major reforms could begin to tackle these issues, though there is no certainty now that the vote could take place this year. With the fiscal gap forecast in high single digits, it is also worrying that Romania may eventually face a downgrade to junk status from Standard & Poor’s and Moody’s by year-end; still, financial markets were already trading longer dated Romanian Eurobonds at similar yields to countries like Serbia (well in junk territory on the rating agencies scale) rather than Poland, so this may not create major ripples in markets. Between December 2019 and July 2020, the spread between Romania and Germany’s 10Y Eurobond widened by a full percentage point. On the other hand, this situation should continue to pressure the EUR/RON to move even higher over the medium term until reforms tackle Romania’s imbalances, and hence, a break above an exchange rate of 5 should not be excluded in the next year or so.
While sovereign risk has been leading longer-dated bond yields higher, short-term rates are better behaved as inflation cooled down and is currently comfortably in line with the central bank’s target interval of 1.5-3.5%. Forecasts also show it remaining in this area (particularly as consumption will not be as buoyant as during 2019), so this means short term rates could maybe even track lower, as the central bank suggested further easing may be in store. This would support lending, particularly as surveys hint that local banks have not tightened their standards as badly as during 2009-2010.
Sovereign bond spread versus Germany shows Romania diverging from CEE post-2016
10Y T-bond yield (local currency) spread over German 10Y Bunds
Source: Eurostat
Where does this leave us? We cannot emphasize enough how uncertain the times are, hence most forecasts and expectations need to be taken with more than a pinch of salt. Risks remain tilted rather to the downside (i.e. instead of a faster V-shaped recovery we would think any deviation from our base scenario would rather be that of a slower L-shaped one); plus we have no clarity on potential domino effects that could cascade into a series of negative effects later on (like a surge in bankruptcies leading to higher unemployment leading to much slower consumption).
That said, we remain confident that Romania, which has been arguably one of the best performing economies in the world in the last couple of decades, should remain in a strong position over the longer run. We view several arguments in favour of this: 1) relative advantages remain (labour costs in manufacturing are comparable to China’s, for example, while being several times below those in Western Europe; it includes large pools of untapped labour resources); 2) good geographic position; 3) EU aid after coronavirus to the tune of EUR 80bn (almost 38% of the country’s GDP, though these will come over a 7 year period) which could significantly improve the quality of infrastructure or education. Summing up: more short-term pain, but those who keep the eye on the long-term perspectives, which Romania offers, stand to win.