Investors Service says that the positive outlook on the nation's Ba1 rating is based on the benefits of EU accession, stronger economic and political institutions, and improved external liquidity, balanced against
the risk of overheating.
"The rapid growth of credit to the private sector (particularly in foreign currency), the related sharp increases in asset prices, and the large widening of the current account deficit all give us cause for some concern," cautions the report's author, Senior Vice President Nina Ramondelli.
The analyst explains that "the situation is further complicated by the government's decision to shift the monetary framework from relying on the exchange rate as an implicit anchor to inflation targeting later in 2005;
this change occurs at the same time that the capital account is to be liberalized in order to allow nonresident investment in local currency instruments."
Membership in NATO in 2004 and the expected 2007 entry into the EU provide Romania with frameworks and incentives for further reforms, but there are nevertheless other credit challenges that Romania must face. Ms. Ramondelli points to the stop-and-go nature of economic and structural-reform policies, which calls out for more consistency, and also to the presence of a still large and unrestructured state-enterprise sector.
Membership Invites Clear Benefits
Moody's is optimistic, however, that EU membership will furnish support for sustaining the growth momentum now underway and for further improving the nation's debt and debt-service burden. "Deepening trade, financial and institutional integration with Europe should bolster Romania's ability to withstand potentially destabilizing capital flows," Ms. Ramondelli states.
"Progress on the EU front is clearly a testimony to the nation's achievements in building and strengthening economic and political institutions," Ms. Ramondelli says. Moody's March 2nd ratings upgrade also was recognition of the improvements that have been made in Romania's external liquidity, and in its government finances and debt.
She notes, however, that the EU reserves the right to exercise safeguard clauses for Romania (and Bulgaria), which could delay entry by one year -- a practice the EU did not adopt for first-wave accession countries.
"This is a reminder of how much more remains to be done," the analyst concludes.
Setting off a Virtuous Cycle
The prospects for EU integration have already set Romania on a virtuous circle. According to the analyst, real GDP rose by 8.3% in 2004 (about 6% if the exceptional gains of the volatile agricultural sector are
netted out), up from an average of 5% per year in 2001-2003 even as inflation fell from 14.1% in 2003 to 9.3%. "Imports have been a vent for excess demand," she says, "such that the current account deficit has
risen sharply over the past two years -- to some 8% GDP by end-2004." But capital inflows were more than sufficient to cover the country's foreign exchange requirements, contributing to a massive buildup of official
foreign exchange reserves to $14.7 billion at end-2004, up from $8 billion in the previous year.
Robust activity and tighter spending controls led to a near halving of the public sector's borrowing requirement (including quasi-fiscal operations) while the role of government in the economy continued to shrink with the landmark privatization of the oil-giant, Petrom and further divestiture of electricity and gas distribution companies. "These were welcome developments in view of the financial losses of the energy sector and the inefficiencies of industrial production," Ms. Ramondelli says.