Inflationary pressures weigh on growth

The war in Ukraine and the related EU sanctions against Russia and Belarus, agreed upon by the Romanian authorities, will affect the economy in 2022. The direct effects of the war are limited as the country is a cereal exporter (such as corn, wheat, and barley) and relatively independent of its energy supply (around 70% of energy demand is covered by domestic production). The already limited energy imports from Russia (especially crude oil) were drastically reduced thanks to imports from other countries such as Kazakhstan, Iraq, Azerbaijan, and the UAE. Moreover, following the easing of regulatory requirements to offshore tax laws, Black Sea Oil & Gas (an independent energy company) began to extract gas in June 2021 from Romania’s offshore reserves. Gas from the Black Sea’s Neptune Deep offshore field, which will come on stream in 2026, will potentially make Romania a regional natural gas exporter. However, there are indirect effects via the surge in global commodities prices. Consumer price inflation reached 15.5% in June 2022, its highest level since 2003, when Romania faced its last high inflation episode. The price tensions should remain from imported inflation in the second half of the year. It has eroded households’ and firms’ purchasing power as confidence indicators have shown less optimism among families and businesses.

The labor market is gradually recovering, but the unemployment rate is still above the pre-pandemic level. Skill shortages and brain drain remain a challenge, which could lead employees to continue asking for higher wages, while the minimum wage could rise further. This can generate further inflationary pressures. To contain them, the central bank of Romania (NBR) has increased its key interest rates in six steps between October 2021 and June 2022. Further hikes are expected this year, depending on the further development of inflation, which could reach up to 11% on average in 2022 (above the 2.5% +/-1pp target window of the NBR). In addition to inflation, this will weigh on private consumption (62% of GDP) and investment, including construction, as the financing costs rise noticeably. The support from the government remains robust, with measures implemented to soften the impact of higher prices. Net exports should again contribute negatively to growth in 2022, as the economic slowdown in Europe (over 73% of trade is intra-EU), mainly Germany (21% of Romanian exports), will hurt exports. Contrasting with speedy services and cereals exports, exports of electrical components, telephones, machinery, and motor vehicles and parts (35% of exports) will struggle, mainly due to supply-chain disruptions and rising uncertainty. Furthermore, relatively resilient domestic demand and rising energy prices will increase the import bill.

Twin deficits partly financed by European aid

In 2022, the fiscal deficit will slightly widen due to additional defense spending and temporary measures to cushion the fallout of the Russia-Ukraine war, which the public revenues (expected to reach 33% of GDP) will not suffice to compensate because of the economic slowdown. A cap on electricity and gas prices was extended from the end of April 2022 to the end of March 2023. Support measures, amounting to around 1.5% of GDP, include food vouchers for low-income households and grants for the most affected business sectors. Meanwhile, the public finances will benefit from loans and grants under the EU’s Multiannual Financial Framework and Next Generation Recovery Plan over 2022-2027. Still, delays are expected due to administrative shortcomings. The implementation of the NextGenerationEU Plan is also expected to be delayed, with only around 20% of the total allocation absorbed by 2023 because of the low absorption rate. These European funds will also not offset the extra public spending in 2022. Public debt (56% external) will continue to increase but should remain moderate. Political divisions could undermine future fiscal consolidation.

The trade-in goods deficit could widen in 2022 as imports rise faster than exports (deteriorating terms of trade). The current account deficit should only slightly widen, as this should be partly offset by a higher surplus on the services account (4% of GDP in 2021). Moreover, EU agricultural subsidies and expatriates’ remittances (gradually recovering, mainly from Spain and Italy) will not fully compensate for the repatriation of income by foreign investors. European funds in the form of grants or loans, gradually recovering FDIs, and portfolio investments (in sovereign bonds) will finance the current account deficit.

The ongoing alliance between rival parties against a backdrop of heightened regional security problems

In November 2021, the center-right National Liberal Party (PNL) formed a coalition government with the center-left Social Democratic Party (PSD), historically its biggest rival, and the Democratic Alliance of Hungarians in Romania (UDMR), ending almost two months of stalemate. The three parties have a large majority in both houses of parliament. Appointed by President Klaus Iohannis, Nicolae Ciuca (PNL) will serve as Prime Minister for 18 months and then be replaced by a PSD candidate for the final 18 months. This prime ministership rotation can harm the political reform continuity as both parties have particular goals. According to the latest polls, PSD has gained support since the end of 2021 and is currently polling at 35%, followed by PNL at 21%. Regarding international relations, Romania should be admitted into the Schengen area, which would happen in 2023 at the earliest. In the context of the war, among the NATO members, Romania shares the longest border with Ukraine, which has pushed NATO to bolster its military presence in the Black Sea region and deploy a multinational battlegroup to Romania. Furthermore, increased tensions in late April between neighboring Moldova and Moldova’s pro-Russian breakaway region of Transnistria brought Romania (which has close relations with Moldova) even closer to the war. Overall, with its prime ministership rotation, the current coalition government is expected to maintain political stability until the next parliamentary elections, to be held in late 2024.