Romanian economy: Looking for better days ahead

With wage growth accelerating throughout 2023 and inflation decreasing steadily, purchasing power has again started increasing in real terms as of the first half of last year. With wage growth accelerating at 15% in November 2023 (latest available numbers) and inflation decreasing below 7%, the result is a hefty real wage increase of over 8% as of late last year. While this is not setting any records, it is by no means soft from a historical perspective.

It is also worth pointing out how robust spending on gross fixed capital formation was during the last few years and in 2023 in particular, which reached all-time highs (though in real terms it is still a bit below 2007-2008 highs, it is still comfortably higher than the historic average or even the past cycle); this indicator tracks overall investments in the economy, from spending on new machinery to construction works on buildings to infrastructure and so on. This is particularly positive as periods where large capital spending accumulates tend to precede periods of significant economic growth. Just to highlight the scale of this dynamic even more, according to Eurostat numbers, nominal figures show that investments in Romania were some 26% smaller than Poland’s in Q1-Q3 2023, despite having a GDP that is 58% smaller than the CEE neighbour; furthermore, as a share of GDP, Romania’s investments were the highest in the EU.

The previous paragraph alone warrants unmitigated longer term confidence regarding Romania, but not all was worth celebrating. For instance, Romania’s twin deficits remain problematic; while the current account deficit narrowed last year, it remains high at around 7% of GDP (versus 9% the previous year). This vulnerability alone could raise serios issues akin to the 2008-2010 deep recession in case a global financial meltdown were to occur again. Secondly, the fiscal situation remains complicated with Romania being at this time the only EU member state placed by the European Commission under the excessive deficit procedure (the budget deficit ended the year at 5.7% of GDP versus an initial target of 4.4%). This has led to some tax hikes at the start of 2024 and more may be on the way.

On the monetary front, the central bank stayed flat with interest rates for most of last year (barring the hike in January 2023 to 7%), with inflation dipping below the key rate by the end of the year, ending 2023 at 6.6%. Meanwhile, the EUR/RON exchange rate was even less eventful last year, trading in a modest range and averaging at 4.94 versus 4.93 in 2022.

2024:​ Mind the electoral year, but also the opportunities on the horizon

As with previous years, we feel that we need to be mindful of the highly uncertain global backdrop. For a small and open economy like Romania, any material shift would undoubtedly have consequences in Romania (good or bad). We are particularly concerned about any negative scenarios unfolding, given Romania’s internal imbalances which expose the country. For instance, in case a financial crisis was to arise, Romania’s fiscal position means that the country has little wiggle room to adopt stimulus, while its gaping current account balance could create significant strain on the FX market if inflows of hard currency are significantly impacted. And there are, unfortunately, significant elements of uncertainty globally, mostly linked to the resettlement of geopolitical relations between the major blocks globally, as well as the specter of fresh armed conflicts in different areas of the world.

Another major topic that could influence how things look globally is the path of interest rates at the world’s major central banks’, notably the Federal Reserve and European Central Bank; these are expected to cut rates by up to 1 percentage point in 2024 starting in the second quarter, something which should alleviate a bit the strain on the cost of risk and help emerging economies like Romania. That said, lower rates will be dependant on CPI convincingly moving lower, so this is one aspect to keep in mind..

The latter aspect is one of the factors that make us believe that GDP growth is set to accelerate a bit this year, printing over 3% versus c.2% in 2023. Other positive aspects for the Romanian economy include: the improving consumer picture amid a tight labour market, hefty wage hikes and inflation reduction, the favourable trend for investments continuing into 2024 (both state/EU funds and private capital amid re-shoring) and the expected recovery in external demand as Romania’s major export partners are stabilizing.

The labour market trends deserve some acknowledgement. While job creation has been slowing down noticeably over the last two years, it is important to note that the overall number of employees in Romania is at its highest since the 1990s. So, naturally, it is getting more and more difficult to fill empty positions or, in other words, the labour market is quite tight. Meanwhile, the number of people paid at the minimum wage dipped by over 20% at the start of 2024 relative to the previous year, meaning that companies are content tto offer higher wages to poach/keep employees. While keeping in mind what we said earlier about investments and how they precede periods of job creation, this means that we could expect robust wage growth for quite some time in the future. Consequently, we would expect purchasing power to again improve quite substantially in 2024, supporting consumption and major purchase intentions (including residential).

Otherwise, despite an expected uptick in inflation at the start of the year on account of tax decisions, we would expect the decrease in CPI to continue over the next years, allowing the central bank to gradually ease the pressure. The first interest rate cuts from the National Bank of Romania are expected in the second quarter, with the key rate set to drop by at least 1 percentage point in 2024. This will further improve consumption and support growth.

Otherwise, 2024 is also special due to it being a super-electoral year. All possible types of elections (except a referendum) will take place this year, with the most important ones (the presidential and general elections in particular) towards the end of 2024. Polls currently suggest that the ongoing socialist-liberal coalition could continue after 2024 provided that the two major parties entertain this idea, as they would gather comfortably more than half of the votes. That said, there is always room for surprises.

On the other hand, given the heavy election calendar, we would not expect any more material decisions on taxation in 2024 unless the economy disappoints significantly, as no party would want to be linked with major tax hikes in such a year. That said, we still think that there is room for some more adjustments starting in 2025.

A special note when looking at the longer-term outlook should be given to the fast-paced infrastructure developments, which should improve the country’s potential outlook tremendously. At the start of 2024, some 800 kilometers of high-speed roads were being worked on versus an existing network of around 1,100 kilometers; works will break ground for fresh highways during the coming years, so it is safe to assume that if current trends hold, Romania will have a highway network double in size by the end of the decade. This will greatly improve the appeal of industrial investments in certain parts of the country and also help lead to a better distribution of economic growth by pumping up regions of the country that have been lagging up until now (like parts of the historic region of Moldavia).

Summing up, we think that opportunities continue to outweigh the risks, particularly when judging things with a longer-term view. While internal risks and external uncertainties abound, we want to point out that this has also been the case throughout most of the recent history and yet, Romania managed to outpace most countries in the world and as per IMF forecasts, its GDP/capita is again set to offer one of the biggest increases in the world in the 2023-2028 period.