Romania saw strong economic growth in 2016, while the fiscal and the current account deficits were kept at bay. The 4.8% real GDP growth rate was not only markedly above the European average, but also the highest level in the six consecutive years of economic growth in the post-crisis period. The main driver of the advance in GDP was private consumption, fuelled not only by tax cuts — the standard VAT rate decreased from 24% to 20% and the VAT rate for food items and non-alcoholic beverages dropped from 24% to 9% — but also by a sizeable increase in the minimum wage and hefty rises in public sector wages. Such measures resulted in a widening of the fiscal deficit, without breaching the 3% of GDP reference value laid down in the Stability and Growth Pact. As regards the external balance, after a period of sustained adjustment of the current account deficit, to levels close to 1%, the closing of the negative output gap entailed a trend reversal. However, at 2.3% of GDP in 2016, this deficit remains significantly below the levels recorded before 2008, underpinned not only by robust growth in exports of manufactured goods, but also by an increasing surplus in the services account. Moreover, despite its widening, the current account deficit remains fully financed by non-debt creating inflows such as FDI and EU capital transfers.
The National Bank of Romania has reached all three stabilities that matter for a central bank. First and foremost, price stability has been achieved. The policy interest rate is at an historically low level (1.75%), while the country faces low inflation. In 2016, there were actually negative inflation rates, yet we did not call it deflation, because domestic consumption grew very strongly. The inflation story in Romania has changed significantly in later years, as we went from relatively high annual levels (close to 6% in early 2013, above the 3.5% upper bound of the ± 1 percentage point variation band of the target) to below-target readings ever since, and even negative values between June 2015 and December 2016. These developments were largely prompted by sizeable successive indirect tax cuts (in VAT and excise duties), adding to the “perfect storm” of deflationary supply shocks in recent years (especially regarding energy and food prices). Currently the annual inflation rate stands at 0.2%. Excluding the first-round effect of the aforementioned tax cuts, headline inflation would have hovered around +1.2% in early 2017. The still below target figure against the background of buoyant economic activity, employment and wages is a possible indication of a flattening of the Phillips curve, a widespread tendency reflecting increased relevance of global inflation dynamics to the detriment of domestic conditions in explaining local inflation developments.
Return to profit
I would also like to point to some dimensions of financial stability. We managed to break the back of non-performing loans (NPLs), reducing the NPLs’ ratio from 22% in early 2014 to 9.6% in early 2017. This fast progress was due to implementing a fit-for-purpose action plan, while the coverage of NPLs by provisions continued to be the highest in Europe. Moreover, the sector is well capitalised, with a total capital ratio that is more than double the required minimum level. Liquidity has remained comfortable, on the back of the stronger domestic deposit base (offsetting the downward, yet orderly, trend in funding from parent banks), implying a lower contagion risk. Profitability and asset quality indicators have also improved. Thus, after recording a negative financial result in 2014 — amid massive provisioning in a bid to clean up the balance sheets — the banking sector returned to profit in 2015 and consolidated its positive financial result in 2016. The banking sector has also overcome the risks induced by two legislative initiatives (one regarding the mortgage debt discharge and another one on the conversion of Swiss franc loans at historical exchange rate) after the Constitutional Court declared them partially or totally unconstitutional. In the challenging context generated by the outbreak of the global crisis, appropriate capital adequacy was maintained without any resort to public funds.
Finally, Romania has enjoyed a lower volatility of the exchange rate than its peers. Net international reserves have further increased, despite reducing the minimum reserve requirements for commercial banks, and the international liquidity ratio has continued to improve.
To sum up, Romania’s macroeconomic position is currently favourable, but it will take a careful policy design in order to properly manage the risks and to ensure the preservation of gains achieved with considerable efforts.
Liviu Voinea is Deputy Governor, National Bank of Romania