Romania: suboptimal

government policies
Disruption risks

Ciprian Dascalu, Chief Economist, Romania January 2018

https://think.ing.com/
GDP potential 3.5-4.0%, limited upside: scarce labour
resources, more expensive capital, tighter policies
Consumption to slowdown on: trimmed Services growth spurt suggest the maturity
expectations, wealth effect, higher rates. phase of the current economic cycle.
10.5
12
8.8
9.0
8.8
9
7.5
4.8
6.0 5.7 6.1 6.0 6.1
6 5.3 5.7
4.4 6.0 5.3
4.2 4.3 4.0 4.3 4.3 4.8
3.4 3.5 3.8 4.4
4.3 4.3
2.9
4.5
4.2
3.8 4.0 4.3
3 2.2 1.9 3.5
1.6 3.4
2.9
3.0 2.2
0 1.9
1.6
1.5

-3
0.0

-6 -1.5

Private consumption Public consumption

Agriculture Industry
Fixed investment Others Constructions All services
Net exports GDP (%YoY) Others GDP (%YoY)

2
Industry at post-GFC high; consumer confidence
sharpest fall in 4Q17 since the GFC
Economic sentiment index Consumer confidence Retail sentiment
125 15.0 0 30

115
10.0 -10 20
5.0 -20
10
105
0.0 -30
0
95 -5.0 -40
-10
-10.0 -50
85 -20
-15.0 -60
75 -30
-20.0 -70
Jan-00 Jan-07 Jan-14 2Q07 4Q08 2Q10 4Q11 2Q13 4Q14 2Q16 4Q17
Jan-00 Jan-07 Jan-14

ESI Long-term average Confidence (QoQ, lhs) Confidence (rhs) Retail Long-term average

Construction sentiment Industry sentiment Services sentiment

10 15 60

0 10
45
5
-10 30
0
-20 -5 15
-30 -10
0
-15
-40 -15
-20
-50 -25 -30
Jan-00 Jan-07 Jan-14 Jan-00 Jan-07 Jan-14 Jun-02 Jun-06 Jun-10 Jun-14
Construction Long-term average Industry Long-term average Services Long-term average

3
Consumption frenzy coming back with a
vengeance after late-2016 general elections
Mid-to-late cycle? On ING survey: what would you Maybe people are still
steroids on wage policy do with extra 200€/month? shaken after 2008 crisis.
7.5 % of consumers
1400
RO 12 (RONbn)
who would
PL 16 spend most of 1200
5.0 the extra money
CZ 19 1000
UK 22
2.5 800
Europe 23
FR 23 600
0.0
DE 26
400
AT 27
-2.5
ES 28 200

-5.0 NL 29 0
BE 33

2006
2002
2003
2004
2005

2007
2008
2009
2010
2011
2012
2013
2014
2015
1Q09 3Q10 1Q12 3Q13 1Q15 3Q16
IT 38
Retail sales (QoQ%)
Household spending (QoQ%) 0 10 20 30 40 Net financial assets Property assets

Consumption... Wary consumers Wealth effect...

driven by the wage One in eight Romanians ... however, property
policy, though some would spend the assets are one third
signs suggest a bit of helicopter money, the below their 2007 high,
caution ahead. lowest share among probably still weighing
countries surveyed. on overall sentiment.
4
Still, solid wages to keep things moving along
Wages being pushed higher Confidence jumped to a Consumers, ready to dig
by state wage policy record high in 1Q17 deeper in their wallets
35 10 -30
(12 months ahead outlook) (major purchase intentions over 12 months)
30 (nominal wage growth, %YoY)
0 -40
25 -50
-10
20
-20 -60
15
-30 -70
10
-40 Savings -80
5
Unemployment -90
0 -50
Economy
-5 -60 Financial -100
(long term average)
Jan-12Jan-13Jan-14Jan-15Jan-16Jan-17 Consumer confidence index 1Q02 3Q05 1Q09 3Q12 1Q16
-70
Buy a car Purchase/build home
Manufacturing Public sector
Private sector Home improvements

2-digit wage growth... Collapsing in 4Q17... Bigger ticked items…

Due to minimum pay ... on higher interest ... just took a turn south in
hikes, increases for state rates, weaker RON, 4Q17 as the monetary
employees. Concerns uncertain outlook for policy transmission likely
about manufacturing taxes, despite good job improved and could be
competitiveness. prospects. underestimated
5
The idea in the government program:
Income redistribution from capital to labour.

The side effects:

Unpredictable economic policies lead to
weaker GDP growth.
Romania: labour vs capital. Capital drives GDP
growth and takes a bigger share of the income
% income at current market prices, 2016 (% Taxing capital is likely to affect economic
share of GDP) growth in an young capitalist system
100% 100% 10
8.0 7.7 8.1
90% 80% 8
6.6
80% 60% 6
4.7
4.1 3.9
70% 4140 333937 4235
3.5
424642 4139 37 38 38 40% 3.0 4
4650 364841 4146 43 51 32
61 56
60% 52
20% 1.1 0.6 2
50%
0% -0.8 0
40%
-20% -2
30%
525149 52 50 494750
4750 47 47 454643474342484844 -40% -4
20% 4140 40 39
3133 34
-60% -7.3 -6
10%

0% -80% -8
EU

Greece
Belgium

Estonia

Austria

Romania
Spain

Finland
Sweden
Ireland

Latvia

Luxembourg

Slovenia
Bulgaria

France

Italy
Cyprus

Lithuania

Netherlands

Portugal

UK
Malta
Czech Rep

Germany
Denmark

Croatia

Hungary

Slovakia

-100% -10

Taxes on production and imports less subsidies Labor Quantity Labor Quality

Operating surplus and mixed income, gross Capital Total Factor Productivity
Compensation of employees GDP

7
Is the 3.0% of GDP budget deficit target for 2018
within reach? It might be with some, yet to be
announced, measures
The government backs down from promises The pension system’s deficit, already a major
and/or come up with offsetting measures. issue, is about to widen further in 2018.
Government plans for 2018 (under 1
debate within the ruling coalition) % of GDP Date
31% increase in minimum wage 0.3 Jan-18 0
23.1% increase in minimum pension -0.1 Jan-18
25% increase in public sector wage -1
envelope -2.0 Jan-18
Transfer of social contribution from the -2
employer to the employee 2.0 Jan-18
-3
2.25% `solidarity' tax on employers’ total
wage bill 0.6 Jan-18 -4
Income tax cut from 16% to 10% -1.3 Jan-18
-5
Taxation change for SMEs and liberal
professions 0.1 Jan-18 -6
Optional contribution to pillar II private (% of GDP)
pension system * + decrease of -7
contribution to 3.7% of gross wage 0.6 Jan-18
-8
25% wage hike in public health system

2007
2004
2005
2006

2008
2009
2010
2011
2012
2013
2014
2015
2016
8M17
and 20% for public education -0.4 Apr-18
No one-off special dividends -0.2
Total 2018 -0.4 State social insurance, balance
Source: PSD, MinFin, ING,; * could be up to Consolidated budget execution
0.9% of GDP

8
Consumers
on steroids
Inflation - the fruit of
the suboptimal policy mix
The era of very low inflation is over, but will it
spike? Romania CPI is a special case…
Regulated prices and base effect –partial ... with CORE3 inflation steadily moving
explanations, CPI profile differs from peers... higher; NBR significantly revised it lower
5 5
(CPI, %YoY) (CORE 3, %YoY)
4
4
3

3 2

1
2
0

1 -1

-2
0
-3

-1 -4

-5

4Q19
1Q16
2Q16
3Q16
4Q16
1Q17
2Q17
3Q17
4Q17
1Q18
2Q18
3Q18
4Q18
1Q19
2Q19
3Q19
ING Romania NBR target
Romania - NBR f'cast ING Hungary ING f'cast NBR target
ING Poland NBR f'cast Previous f'cast

10
The labour market is tightening, despite
untapped resources, policies needed to address
State policies and increased workforce Low labour participation; job creation
shortages are pressuring wage growth. looking toppish on fast wage growth.
0.4 25 70
150
20

0.3 68 50
15

10 -50
0.2
66
5 -150

0 -250
0.1
64
-5
-350
0.0 -10
62 -450
1Q10

1Q14
1Q05
1Q06
1Q07
1Q08
1Q09

1Q11
1Q12
1Q13

1Q15
1Q16
1Q17

4Q02

4Q13
4Q99
4Q00
4Q01

4Q03
4Q04
4Q05
4Q06
4Q07
4Q08
4Q09
4Q10
4Q11
4Q12

4Q14
4Q15
4Q16
Labour market tightness (Unemployment rate
/ Vacancy rate) Job creation (12M-rolling, 000s, rhs)
Real wage growth (%YoY, rhs) Labour force participation (4Q avg, %)

11
CE4: Hiding behind flat Phillips curves
Phillips curve broken across CEE; the Significant untapped labour supply in
strongest FX pass-through in Romania Romania, but structural policies missing
14
The significance of 18.0
12 variables (t-Statistics) Underemployed part-time
explaining core HICP in CEE economies workers
10 15.0
Seeking work but not
immediately available
8
12.0 Available to work but not
seeking
6
Unemployment
4 9.0

2
6.0
0

-2 3.0

-4
Eurozone ULC Brent FX 0.0
Core Euro area Czech Hungary Poland Romania
Republic
Poland Hungary Romania Czech Rep.

12
Massive unintended tightening - assessment
needed as transmission mechanism improved.
NBR buying time via liquidity management.
Stress scenario: change in Consumers taking more risk, NBR needs to deliver to
debt-to-income ratio though still far from 2008 regain credibility
14 36 4.0 Real rates vs end-2018
0.5
12 3.5 c.banks CPI forecast
32 3.0 0.0
10
2.5 -0.5
8
28 2.0
6 -1.0
1.5
4
24 1.0 -1.5 Real 3M X-
2 0.5 -2.0 bor (%)
0 20 0.0 Real key
consumer real-estate real-estate real-estate -2.5
loans loans loans loans not
1Q08 1Q10 1Q12 1Q14 1Q16 rate (%)
under under Debt-to-income ratio (%, lhs)
-3.0
Prima Casa Prima Casa
program program New HH loans (RONbn, CPI adj., rhs)
Romania Poland Hungary

The state guarantee... Higher wages... Following NBP...

has allowed low earners encouraged more debt ...as words seemed
to buy a house. NBR and fuelled inexpensive, but acted
considers regulatory consumption, net like NBH: credibility costs
measures to address wealth to income ratio and likely higher
vulnerable borrowers. virtually flat. terminal rate.
13
Credibility cost: major adjustment via liquidity
position. Repeating same mistake in 2018?
Liquidity squeeze: public debt pre-financing,
FX interventions, state dividends
3.50
17 3.00
Front-loading hikes, blurred transmission
due to surplus liquidity won’t work
7 ING
estimates, %
6

2.50 5
12
2.00
4
7 1.50
3
1.00
2
0.50 2

-3 0.00 1
Jan-14 Jan-15 Jan-16 Jan-17
Banks' position vs NBR (RON/bn/day, monthly 0
Jan-14

Jan-15

Jan-16

Jan-17

Jan-18

Jan-19
Jul-14

Jul-15

Jul-16

Jul-17

Jul-18

Jul-19
average, lhs)
3M ROBOR (%, average, rhs)

Key rate (%, rhs) Key policy rate 3M ROBOR

Credit facility rate Deposit facility rate

14
RON: weakened by
its master
NBR talks down the RON to keep
broad real monetary conditions
accommodative
Deteriorating external picture
Trade gap widening driven by consumer Services surplus might not be enough to
goods and one-off auto imports. cover the trade gap for goods.
35 0 10
30 (12M rolling average) (EURbn, 12M rolling sum)

25 5
-400
20
15 0
10 -800
5 -5
0 -1200
-5 -10
-10 -1600
-15 -15
-20
-2000 -20
-25
-30
-25
-35 -2400

Trade gap (EURm, RHS) Exports (%YoY, LHS) Goods Services Primary Income
Imports (%YoY, LHS) Secondary Income CA CA+KA+FDI

16
Global central bank balance sheets still supportive

Balance Sheets of Major Central Banks (12m change, USD trillion)

ING forecasts
US Japan
3.5 Euro Area UK
Switzerland China +ve = net expansion
3.0
Other * Total CB Liquidity of CB liquidity
2.5
Central banks still
2.0 adding to global
liquidity in 2018
1.5

1.0

0.5

0.0

-0.5

-1.0 -ve = net contraction

of CB liquidity
-1.5
2011 2012 2013 2014 2015 2016 2017 2018 2019

17
RON: expensive or cheap?
Real effective exchange rate, REER deflated with Real effective exchange rate,
ULC deflated (2005 = 100) manufacturing wage costs export prices deflated
160 170 BGN 160 BGN CZK
BGN CZK CZK
150 150 HUF PLN
HUF PLN HUF
150 RON
RON PLN
140 140
RON
130 130 130

120 120

110 110 110

100 100
90
90 90

80 70 80

No misvaluation... Competitive wages... Export issues…

with RON looking just
modestly more
expensive than some
peers unit labour costs
deflated.
18
in the manufacturing RON a bit expensive
sector lead to this REER relative to peers, but
looking better than most export integrated in
peers. global value chains is
mitigating risks.
Except for labour intensive consumer goods
sector, REER suggest RON undervaluation
Exports gaining market share within the Consumer goods - uncompetitive, using
single European market and even globally. unskilled labour force, outdated technologies
1.00 0.0 108
0.90 REER,
-1.0 2011=100
0.80
104
0.70
-2.0
0.60
0.50 -3.0
100
0.40
-4.0
0.30
0.20 96
-5.0
0.10
0.00 -6.0
2010 2011 2012 2013 2014 2015 2016 92
C/A (% of GDP, lha) 1Q11 1Q12 1Q13 1Q14 1Q15 1Q16
Market share (goods) in EU Manufacturing Capital goods
Global market share (goods& services) Intermediary goods Consumer goods

19
EUR/RON: free float or an upward adjustment in
comfort zone from 4.50-4.60 to 4.60-4.70?
Isarescu: a shift to a more ‘flexible’ FX regime. Two days later he saw RON rate at equilibrium.
Weaker RON: to offset higher rates impact on broad conditions, support investments
4.70
7 Oct-17 & 8 Jan-18:
7 Jan-15: NBR governor Isarescu 7 Jan-16: „stability zone” Isarescu signals more
4.65 hints at „stability zone” reaffirmed by c.bank governor RON flexibility

4.60

4.55

4.50

4.45 9 Feb-17: Isarescu sees

limited room, if any, for
RON strengthening due
4.40
to competitiveness
erosion
4.35

EUR/RON NBR "lines in the sand"

20
Forecasts and conclusions
Main ING forecasts
1Q17 2Q17 3Q17 4Q17E 2017 1Q18F 2Q18F 3Q18F 4Q18F 2018 1Q19F 2Q19F 3Q19F 4Q19F 2019

GDP (%YoY) 5.7 6.1 8.8 7.7 7.2 6.6 5.1 3.8 4.1 4.7 4.3 3.7 4.0 3.9 4.0

CPI (%YoY) 0.2 0.9 1.8 3.3 1.3 4.5 4.1 4.0 3.1 3.9 3.4 4.0 3.7 3.3 3.6

Key rate (%) 1.75 1.75 1.8 1.75 2.25 2.50 2.50 2.75 3.00 3.25 3.50 3.50

3M rate (%) 0.86 0.86 1.6 2.05 2.35 2.55 2.65 3.00 3.25 3.50 3.65 3.75

10Y yield (%) 3.86 3.89 4.1 4.40 4.20 4.30 4.40 4.45 4.50 4.60 4.70 4.80

EUR/RON 4.55 4.55 4.6 4.65 4.68 4.70 4.70 4.68 4.67 4.65 4.62 4.60

EUR/USD 1.07 1.14 1.18 1.18 1.20 1.25 1.27 1.30 1.31 1.32 1.33 1.35

USD/RON 4.25 3.99 3.90 3.94 3.90 3.76 3.70 3.60 3.56 3.52 3.47 3.41

Oil (US$/bbl) 53 48 58 67 55 51 52 61 60 55 52 52

22
Summing up
• Domestic growth capped by structural issues
↓
• Suboptimal policy mix - no material fiscal adjustment
↓
• Inflationary cost – eroding income
↓
• Higher RON rates – discouraging consumption
↓
• Weaker RON – part of the adjustment
• Higher FX volatility? Not really...

• Forecast uncertainty is high:

• Changing government plans & political noise
• European election calendar (Italy) & ECB stance
• Geopolitical tensions & resurgence of nationalism
23
 Thank you

https://think.ing.com/
 ING EM Economics Team
Country Name Title Telephone Email
UK Dorothée Gasser-Châteauvieux Chief Economist EMEA, South Africa, Israel 44 20 7767 6023 dorothee.gasser@uk.ing.com
US Gustavo Rangel Chief Economist, LATAM 1 646 424 6464 gustavo.rangel@americas.ing.com
Czech R. Jakub Seidler Senior Economist, Czech Republic 420 257 474 432 jakub.seidler@ing.cz
Hungary Peter Virovacz Senior Economist, Hungary 36 1 235 8757 peter.virovacz@ingbank.com
Philippines Joey Cuyegkeng Economist, Philippines 632 479 8855 joey.cuyegkeng@asia.ing.com
Poland Rafal Benecki Chief Economist, Poland 48 22 820 4696 rafal.benecki@ingbank.pl

Piotr Poplawski Senior Economist, Poland 48 22 820 4078 piotr.poplawski@ingbank.pl

Jakub Rybacki Economist, Poland 48 22 820 4608 jakub.rybacki2@ingbank.pl

Romania Ciprian Dascalu Chief Economist, Romania 40 31 406 8990 ciprian.dascalu@ing.ro
Russia Dmitry Polevoy Chief Economist, Russia & CIS 7 495 771 7994 dmitry.polevoy@ingbank.com

Egor Fedorov Senior Credit Analyst, Russia & CIS 7 495 755 5480 egor.fedorov@ingbank.com
Singapore Tim Condon Chief Economist, Asia 65 6232 6020 tim.condon@asia.ing.com

Prakash Sakpal Economist, Asia 65 6232 6181 prakash.sakpal@asia.ing.com

Turkey Muhammet Mercan Chief Economist, Turkey 90 212 329 0751 muhammet.mercan@ingbank.com.tr

25
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27