Weakening growth but economic revival in sight

• Fiscal policy would require skilful steering to achieve stated objectives without harming growth.
• Investment and consumption expected to power the economy forward over the next two years.
• Falling inflation and strong advances in nominal wages set to restore consumers’ purchasing power.

Following a strong 5% growth in the first three quarters of 2022, the Romanian economy decelerated sharply, advancing by a meagre 1.4% during the same period in 2023. High inflation has been eroding households’ purchasing power, eventually slowing down private consumption, which has been the main engine of growth in recent years. However, consumption is still expected to remain an important contributor to economic growth going forward, picking up gradually in 2024 and 2025, driven by double-digit increases in wages and pensions. 

Investment growth has been strong in 2023 and is expected to remain so over the next couple of years. Romania stands to benefit from a vast amount of financing via the EU’s Recovery and Resilience Facility (RRF), amounting to a cumulative 12% of GDP by 2026. Over the coming years, EU-funded investment projects are expected to lead to an increase in the public sector investment’s share in GDP. 

Foreign direct investment (FDI) into Romania reached a record EUR 10.7 billion in 2022. It rose by over 12% year-on-year, bucking the international trend, which saw a contraction. Industry, trade and financial intermediation sectors were the main recipients of FDI. However, FDI is expected to drop by a third in 2023 overall, as the slowdown in domestic economic activity dampens private sector’s  investment appetite. Inflation continued to fall in 2023, albeit from a relatively elevated level. At 8.3%, Romania registered the third-highest annual inflation rate in the EU in October 2023. The National Bank of Romania (NBR) kept its benchmark interest rate at 7% throughout 2023, following an aggressive monetary policy cycle that has been in place since the end of 2021. Inflation is expected to fall further in 2024, led by lower power, gas and food prices as well as subdued demand. Given this anticipated fall, real interest rates could turn positive towards the end of the first semester next year which, in turn, could fuel expectations of a potential interest rate cut, especially if the economy performs below expectations.

Notwithstanding the deceleration in the rate of economic growth, the labor market is expected to remain tight. Unemployment is forecast to fall only marginally to 5.4% in 2024 from 5.5% in 2023. As a consequence, upward wage pressures will continue, supported partially by planned increases to the minimum wage. Historically, net wages advanced strongly, showing double digit growth, at a rate above average inflation. The gap between nominal net wage and inflation growth shrank – and even reversed – following the Covid pandemic. More recently, however, average net wage growth picked up again, reaching 14.7% in August. Real wage growth has turned positive and is projected to be high throughout 2024 and 2025.

Looking ahead, the economic outlook is clouded by the uncertainty surrounding the correction paths for both the budget and current account deficits. While the latter has been falling to an estimated -7.1% of GDP in 2023 and is projected to remain around this level for the next couple of years, the budget deficit situation is more worrisome. As it stands, the budget deficit is forecast to reach -6.3% of GDP in 2023, far above the target of -4.7%. To correct this, the authorities approved a fiscal consolidation package, amounting to 1.2% of GDP, which would come into force at the beginning of 2024. Three quarters of this adjustment rely on tax increases, including for corporate taxes, the elimination of preferential wage-related tax regimes in agriculture and construction, as well as the removal of reduced VAT tax rates for some goods and services.

However, the fiscal consolidation efforts are seriously undermined by the planned increase in pensions. These are expected to go up twice in 2024, by 13.8% from January, following the yearly indexation with a coefficient which accounts for inflation and productivity, and by an average of 40% from September, following the approval of the overdue pension reform law. The additional cost of these increases to the 2024 budget alone is estimated at RON 30.2 billion, around 1.9% of nominal GDP, surpassing any gains achieved through the fiscal consolidation package.

So far it is unclear where the required monies will come from. Romania has been under EU’s Excessive Deficit Procedure (EDP) since 2019, with a reduction to thegovernment’s budget deficit a priority. Failure to do so could lead to a suspension of EU funds, on which the economy relies for growth. Finding a solution to this in the forthcoming multiannual government budget projections is paramount for future growth.