OREANDA-NEWS. August 24, 2015. Fitch Ratings has affirmed Romania's Long-term foreign and local currency Issuer Default Ratings (IDR) at 'BBB-' and 'BBB', respectively. The Outlook is Stable. The issue ratings on Romania's senior unsecured foreign and local currency bonds have also been affirmed at 'BBB-' and 'BBB', respectively. The Country Ceiling has been affirmed at 'BBB+' and the Short-term foreign currency IDR at 'F3'.

KEY RATING DRIVERS
The affirmation and Stable Outlook reflect the following factors:

Romania's public finances currently compare favourably with 'BBB' range peers. Fitch projects Romania's 2015 general government deficit at 1.8% of GDP, below the 'BBB' median of 2.5%, and its gross general government debt/GDP ratio at 40.5% of GDP, below the 'BBB' range median of 43.1%.

However, the Fiscal Code proposed by the government represents a material pro-cyclical loosening of fiscal policy and increases uncertainty around the public finances. The fiscal code includes significant tax cuts over 2016-17, including lowering the standard rate of VAT to 19% from 24%, reducing various excise duties and changes to tax on dividends, which could lower government revenues by around 2.4% of GDP by 2017. This follows the cut in VAT on food products to 9% in June 2015, which will add around 0.3% of GDP to the 2015 deficit. Broad political backing in parliament for the Fiscal Code means Fitch attaches a high probability to it being incorporated in the 2016 budget, and we have reflected it in our baseline.

Our latest forecasts are for the budget deficit to increase to 3.3% and 3.0% of GDP for 2016 and 2017, respectively. This would represent a partial reversal of the track record of fiscal consolidation under its prior IMF programme and under the European Commission's Excessive Deficit Procedure (EDP) in 2009-13, in which the budget deficit was cut from 8.9% of GDP in 2009. Although Fitch would regard the implementation of the Fiscal Code as a negative credit development due to its impact on public finances, it is not necessarily incompatible with an investment grade rating. Under Fitch's baseline gross general government debt should remain under 45% of GDP over the medium to long term.

However, risks lie predominately on the downside. The Fiscal Code coincides with Romania's electoral calendar, ahead of parliamentary elections expected in late 2016. Some upward pressure on public expenditures also appears probable. This could come in the form of sharp increases in public wages (as some politicians have recently suggested) and defence spending.

Recent criminal charges against Prime Minister (PM) Victor Ponta led to his resignation as leader of the Social Democrat party in July 2015 and increase political uncertainty. He has rejected calls by President Klaus Iohannis for him to resign as PM. With charges yet to be resolved by Romania's National Anti-Corruption Directorate, there is a risk of increased political tension between the ruling coalition parties leading up to parliamentary elections in late 2016. However, early elections are not our base case.

Notwithstanding the developments in fiscal policy, Romania's ratings are supported by a healthy economic outlook. For 2015-2017, Fitch forecasts real GDP growth to average 3.6%, compared with our previous forecast of 2.8%. Growth will be driven by domestic demand, boosted by fiscal stimulus on household consumption and a recovery in private sector investment; while the recovery in the eurozone will limit the deterioration in net trade.

Inflation is low and monetary policy remains accommodative. Since January 2015, the National Bank of Romania (BNR) has cut its main policy rate 75bps, from 2.5% to 1.75%. At the same time, inflation has been falling, affected by supply-side factors (reduced VAT on food and beverage items and lower fuel prices). Prices in July 2015 fell by 1.7% year-on-year. Latest outturns have led us to expect negative inflation for the remainder of 2015 (average -0.2%), before a gradual pick-up in 2016 (average +0.7%) and 2017 (average 2.0%), when inflation will be closer to the BNR's target rate of 2.5%.

We forecast the current account deficit (CAD) will remain moderate at 1.2% of GDP in 2015 and 1.6% in 2016, below the 'BBB' median of 2.5%, and financed by net FDI inflows of 1.5% of GDP. There is a comfortable level of foreign reserves, equivalent to 26% of GDP, covering 5.5 months of imports, which provide an adequate buffer supporting Romania's managed floating exchange rate. However, Romania has a higher net external debtor position than rating peers of 25.1% of GDP compared with the 'BBB' median of 4.6% of GDP at end-2014.

Romania's banking sector has remained stable, despite volatility in the external environment. Banks are well capitalised (sector CET1 ratio of 16.1%), and since the BNR encouraged the write off and sale of bad loans last year, asset quality across the sector has also improved. The risks from the stock of Swiss franc-denominated loans in the sector have lessened. However, the presence of four Greek subsidiaries in the sector (together accounting for 11.5% of total banking sector assets) represent a tail-risk in the event of a Greek exit from the eurozone precipitating a loss of confidence.

Romania's ratings are constrained by a number of structural weaknesses, including the dominance of industry by inefficient state-owned entities and weak public infrastructure. Structural bottlenecks constrain Romania's growth rate and convergence progress towards western European standards of living. GDP per capita at market exchange rates is below the 'BBB' median and 55% of the EU average.

RATING SENSITIVITIES
The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are currently balanced. The main risk factors that, individually or collectively, could trigger negative rating action are:
- A marked fiscal loosening that jeopardises the stability of public finances or wider macroeconomic stability.
- External macroeconomic or geopolitical shocks that significantly erode Romania's fiscal and external buffers.

The main factors that could, individually or collectively, trigger a positive rating action include:

- Sustained low fiscal deficits leading to a reduction in the government debt/GDP ratio.
- Higher trend economic growth and progressive convergence towards income levels of higher rated peers.
- A faster and sustained reduction in external debt ratios.

KEY ASSUMPTIONS
Fitch assumes that under severe financial stress, support for Romanian subsidiary banks would come first and foremost from their foreign parent banks.

Fitch assumes Romania's main economic partners in the eurozone will benefit from a gradual economic recovery with eurozone real GDP growing 1.6% by 2017, up from 0.8% in 2014. In the event of a Greek exit from the eurozone, Fitch assumes this would be unlikely to trigger a systemic crisis like that seen in 2012, or another country's rapid exit. However, it would increase financial market volatility and dent economic confidence.