20 reasons for better rating, 2 for maintain, 1 for a declining rating. Why  GEO 114 in Romania? 

Sovereign rating is a key economic indicator. Romania pays a too drastic interest for the financing of its budget deficit. Rating is the cost of financing all investments in the economy. Democracy builds on credit, prosperity with investment.

Citeşte AICI varianta în limba ROMÂNĂ

A lower rating than a stable or an improved one

A high cost of loan leads to a corresponding higher cost of total funding capital (which also includes equity investment capital return). Directly and immediately, a declining rating implies a higher financing cost for the overall economy.

It leads to additional budget expenditure, interest payments to finance the deficit, reduces the public, the private, and the stock market investment. A negative change of rating perspective will postpone access to the emerging market status and the OECD membership of Romania.

A higher cost for the risk-free Treasuries, is directly translated into higher financing costs for all economic agents, leads to a parallel shift of rising interest rates, both on the risk and the maturity. In the real economy, a higher perceived risk, makes all loans more expensive.

The longer the maturity of an investment project, the riskier is the project and thus it is financed more costly. All financial risks and interest level increases with the basic interest rate reference of the Treasuries. Treasury rate is direct expression of the sovereign rating. Rating is a systemic indicator with a pandemic influence on the overall economy.

A higher Robor (the local banking offer rate) is a direct result of the declining outlook for the sovereign rating.  And for a higher expected government interest expenses and private borrowing costs.

The Treasury, companies and people are borrowing at more expensive interest charge. What the economy has gained in recent years by rebalancing the local credit to Lei from Euro can be lost at higher interest rate for the local currency Leu.

The behavior of an economic agent is anticipatory. Higher current prices indicate increased inflation expectations. Higher interest rates extend pressure on the Ron exchange. Increased interest rate lead to higher inflation expectations. Although international commodity prices are relatively stable lately.

Again, the source of higher interest cost expectations comes from risk-free interest increase (1-year T-bills, now at 3.5%). This vicious cycle leads to increased inflation expectation.

Obviously, it is the easiest thing to blame recent imbalances on recent salaries and income increase. The second culprit – the imbalance between higher aggregate local demand and its lower supply of internally produced goods. Importers are looking for the euro against lei, that is exerting additional pressure on local Leu, interest and exchange rate.

But with a limited depreciation of the currency, the pressure is on the only variables left to weaken – higher interest and current account deficit. As such, the current account deficit is a leading indicator that can be interpreted as cause for concern.

All other indicators are in good standing, even if they are causes and not effects of increased inflation and higher financing costs. The confusion between causality and correlation can lead to erroneous interpretations.

A significant source of economic vulnerability with a predominant influence in a developing economy is the cost of financing. This interest expense is actually the sovereign rating expressed as a percentage.

If the national rating is weaker than the fundamentals or the economic evolution estimates, then the economic agents (including Ministry of Finance and National Bank) pay this additional cost. For each marginal interest rate increase, the full weighted cost of capital of a project also increases. A higher cost excludes, at each marginal rate increase, an increasing number of fundable projects.

Therefore, the higher the interest and the respective cost of capital, the fewer projects look bankable. National, regional, corporate or individual funding gets more expensive and more difficult to source.

The high cost of funding has been, is and will be the most respectable (more out of fear) economic indicator with pandemic negative effect across the economy. The rating agency becomes a de facto a kind of an economic monitor; a navigator of the economic development of a corporation or a nation.

In recent history, the failure of the rating organizations to correctly and timely discern the risk accumulation in the mortgage and banking market ended up with a high social and economic cost. As a result, the ultra-conservative behavior of rating agencies, changed alternatively – slow to change outlook to positive, quick to alter the rating to negative outlook.

The asymmetric consequence of these changes in rating outlook are more of a kind of a mystery to the public. But, the consequences, when the outlook or rating is changed to negative, the downside economic impact is significant.

Sovereign rating is thus a key independent indicator of influence for many dependent economic variables. Romania is now at the bottom notch of the Investment-grade rating. Rating firms tend to be critical on negative or outlook downgrade.

They would rather try to avoid an eventual perception of their inability to predict future events of default in due time, so being negative is good business.

Therefore, when in doubt, rating agencies are probably more tempted to issue a lower rating than a stable or an improved one.

A downgrade (a negative rating change) leads a debtor to a more expensive deficit financing position. Sovereign and all other interest rates can subsequently increase a few percent higher.

Even a slight decline in the rating may lead to a tangible deterioration in the international position of a debtor. If the agencies would raise sovereign rating, as we argue that we deserve, the scenario would significantly relieve some pressure of government funding costs and increase its budgetary flexibility.

Practically, rating firms make their lives easy, they do not take risk of not being critical. They will always prefer the error of being too drastic.

The comparative study of ratings for similar countries (Eastern Europe), the indicators of the rating methodology – which matter both in size and in priority, show that Romania is 2 steps below the economic merit rating, at least in the context of the evolution of the last 2 years.

Some rating concerns are valid about the future: the mantra of sustainability, the need to decouple the (pro-cyclical) fiscal and monetary (too relaxed) policies, caution in estimation of revenue growth, matching certain expenditures with sustainable incomes.

However, it looks that the critical position that really matters is the current account and balance of payments position. These indicators remain a basic criterion for a stable rating or for a positive rating.

Rating agencies have biases about what public finances stability and security means to investors. Within their rating reports (that look very much the same) agencies give the impression that they do not always issue an impartial analysis, although arguments based on their superior global, historical and perspective views are valid and pertinent.

For example, it is already folklore in the economic analyst word that a wage-led growth policy (WLD) is contrary to the ratings of credit rating agencies. It seems that the agencies give a more favorable rating to countries applying austerity measures and not WLG.

Their economic policy proposals support fiscal consolidation, debt reduction efforts and declining public spending. Thus, economic recommendations become more of a political economy suggested course of action.

Agencies issuing sovereign debt rating very often mention the need for austerity and tax consolidation measures. Measures that are obligatory and not negotiable. However, the soberness of the message will not mention anything about economic growth, improve in living standards or real convergence acceleration. A recent example, when Portugal was downgraded, the rating report immediately recommended a dramatic cut spending.

Even positive outlooks and ratings that remain stable in the longer run are always accompanied by a recommendation to maintain low debt rates and keep costs as low as possible. A sanction that, from the point of view of health and sustainability of public finances, is always the first and last recommendation.

The reputation of credit rating agencies depends on their professional ability to predict the evolution and risk of default of borrowers’ instruments by assigning them pro-actively lower rating levels.

The higher the ability of a rating agency to accurately predict the future non-payment event, the more solid its professional reputation will be.

Some critical public perception has not gone away because the agencies have failed to correctly and timely anticipate the biggest failure of the sub-prime credit market more than decade ago.

Following inability to predict the volatility and correction of the financial markets in the late 1990s, the three major rating agencies were the target of a well-grounded criticism.

The most cited examples are the failures of sovereign issuers (the Asian countries in 1997, the Russian Federation in 1998 and Argentina in 2001), and the top-ranked top-rated mortgage bonds before the 2007 sub-prime crisis.

20 reasons for a better rating

Reason # 1: Romania’s economic performance trend is sustainably positive

Budget execution for the last two years is in sustainable parameters. Revenues have grown steadily over the past 6 years, but growth in the past two years is much higher than the one accumulated over the previous four years.

Most recent 2018 increases: VAT revenue from VAT (11%), excise (7%), property tax (2%), non-tax income / dividends (24%), insurance receipts (31% contributions). A decision that turns out to be, although strongly disputed at time of implementation, appropriate and correct.

Romania’s economic accession is sustainable and top performing.

Budget deficit <3%, sustainable by market financing without incurring any additional debt, the public debt <35%, medium term inflation <3%, structural deficit <3.5% – although out of the prescriptions, but in favorable evolution.

The current account deficit is <4.5%, although under the pressure of a marginal economic growth (only slightly above potential) but also with a rate Leu devaluation of <1% per year over the last 5 years, would have warranted a higher current account deficit.

Romania’s economic emancipation constantly puts pressure on unsatisfied higher domestic demand for imports.

Although the excess of aggregate demand is constantly looking for products and services outside the country, the current account deficit is not significant above what is considered sustainable in the case of an open economy as that of Romania.

The National Bank of Romania estimates that public debt should remain below 45% rather than 60%, but the current account should not exceed 4%.

The current account deficit of € 9.4m is financed in an acceptable proportion of 80% of FDI (€ 5 billion) and € 2.4 billion in European fund transfers. A positive remark can be made about subsidies received and paid in full for the 1 million farmers.

With solid, sustainable economic growth, an average of 2 times that of the EU and 1.5 than the world average, Romania grows constantly and converging in real terms: economic growth sustainability: 3.8% in 2015; 4.8 in 2016; 7.1% in 2017; 4.1 in 2018.

Reason # 2: The central bank operates with independent monetary and financial policy. Romania has monetary stability, financial stability

Between 2013 and 2018, the Ron exchange rate depreciated nominally by 5.6%, less than 1% per year.

Monetary and financial stability is a national asset. Even though Central Bank merit has sometimes been overshadowed by too much caution or by exaggerated conservatism, monetary policy has been able to translate correctly into the economy, albeit often late.

The volatility of the exchange rate, interest rates and economic indicators does not help the real economy, and the nominal economy – of the banks. Banks managed to stay profitable in economic decline, even in recession.

The government and the central bank will be there for help to the government, following the European and American model. The modern central bank is no longer fully independent, but it is the key co-pilot, a navigator of national economic policies in the troubled waters of today’s market.

The new central bank model must also assume new objectives of growth and employment, currency and interest rate; together, these are, if not impossible at least in contradiction with the classic inflation aversion.

Sustainable economic growth, low and non-inflationary full unemployment and unconditional support for the euro (ECB model) or interest rate (US Federal Reserve model) should be complemented by support for the lowest possible funding cost for government, corporations or individuals.

The National Bank has proved to be a too precocious with the interest rate increase (contracting monetary condition too early) and late with rates decrease (accommodate monetary response to economic decline.

A bank that seems to take side more with banks (the banking system) as well as with bank clients. In a historical perspective sometimes, it would have been better for the Central bank to be less lenient with the banks and more understanding with banks clients.

By always extremely prudent positioning, the central bank seems to be rather a monetary council that takes care of both the interest and the exchange rate.

Sustainable economic growth but also optimum unemployment are the new obligations that can be added to the job description of the new modern banker model. In perspective, the Bank looked relaxed in fear of recession / economic downturn (keep rates high too long) but hurried when it is concerned about economic growth beyond potential (raise rate too early), with increased aversion to inflation.

But there is an old saying – Central banks are always wrong: they are quick to monetary policy tightening, but late to relaxation of policy when notice the first signs of slowdown or inflation.

As a consequence, fiscal policy leads, in a way, the conduct of monetary conduct, which is why, Central Bank appears to be primarily fixed on fiscal policy. And if the logic of the arguments is correct, then one can imagine that if Romania had a Monetary Council, we would have been roughly better, in Bulgaria’s economic, better position?

If this is logic, with the benefit of hindsight is correct, although debatable, then then, why the struggle of the Central bank to keep inflation in balance and exchange rate in check during all these years?

Reason # 3: Institutional Progress of Romania

And the simple fact that we are functional members but also excel at the EU presidency, with all our internal political fluidity, shows that Romania is a country with European vocation, institutional capability and social balance.

The political alternation, the promotion of people from all echelons of power, the free access of women and young people to the political, economic and social responsibilities is an undeniable portfolio of the social excellence of the European Union. Romania’s institutional capacity is functional.

This has improved significantly as a result of the sustained effort required by economic, political and social adaptation to the EU, NATO, Presidency of the EU Council.

Reason # 4: The banking system. Good performance in nominal economy. Progress is required for more support for the real economy

Romania has a functional, efficient, competitive banking system, well represented in financing the deficit. But less interested in financing the real economy, resulting in a small degree of financial intermediation, below 50% (34 banks with assets of 450 billion lei and a profit of 7).

If banks were to have more real private credit, so economic growth, perhaps the financial part of GEO 114 would not have been necessary. Liquidity and solvency are well above legal requirements, even local ones, which are more stringent than European ones. Credits grew by 6.6% in 2018, as evidence that some of the economic kinetics also depended on lending activity, with the trend towards the cheaper (in interest) euro.

The commercial behavior of banks is adjusted to the new requirements of the Romanian economy, operating also for the benefit of the entire society not only of the organization and its shareholders.

Excess profitability but also solvent capital for lending does not justify the unjustified ratio between the local and European interest margin (credit minus deposit), even after adjusting to the country and currency risk.

The penalty administered by banks is not only on the active interest rate on loans (too high) but also on passive deposits (too low). A negative rating outlook will still be a sufficient reason for increasing this gap that is so critical for the economy. Economic logic: rating, interest / robe, loan margin, credit, investment, growth, prosperity.

Democracy is built on credit, but prosperity with investment.

Reason # 5: Wage led economic growth work – WLD policies, primarily based on wage increases, incomes and pensions, have been shown to have no significant impact on inflation, course depreciation, or the economic advance kinetics.

Export competitiveness has not decreased but even increased. Only in 2018 wages increased on average by 13%.

The salary and income growth argument are listed as the first vulnerability insertion of these WLD policies that are centered on social advancement and a more inclusive economic growth.

With and objective view of the past data, these courageous economic policy decisions prove to have been successful.

Romania’s budget wage is only 10.8% of GDP compared to 10% in the EU.

Reason # 6: Accelerated convergence

Although the initial parity of purchasing power parity was high, Romania recovered remarkably within a nominal and real convergence. Gross domestic product is at € 9,600 per capita.

The potential for economic growth is also supported by a natural continuation of integration into the EU value chain.

The economic strength of the country lies also in the size and diversification of the economic sectors.

It is thus predictable that there will be a downward trend in hiring, but rising salaries.

Reason # 7: The picture of macroeconomic imbalances, as it is prescribed by the EU, shows all indicators.

Are balanced. If the net investment position is indeed critical, the same can be assessed for all our regional competitors.

A sign or that the indicator does not adequately reflect the new economic reality – pandemic investment apathy, or that all European countries are in the same investment retraction, in line with the final part of the longest expansionist economic cycle.

It is natural for the economic pendulum to slow down, as some countries, industries or companies, reposition or reallocate resources, shrink economic activity, lower turnover or temporary stock growth.

An economic deceleration is also an indicator of current growth conditions for the world economy, but also a pro-cyclical cyclic volatility stabilizer.

Reason # 8: Nouveau smart economic policy: allocating pro-investment capital and social profitability to all stakeholders, not just shareholders.

The 2019 budget of Romania with all its uncertainties, is a business plan of inclusive economic performance, social peace (Pax Economica) and macroeconomic balance and intergenerational prosperity.

With public investment allocations increasing to € 10 billion, we must at least make them intelligent, with objective of a well-designed economic and social return; if institutional money is so expensive, primarily because of a sovereign rating that is too small, we are forced to be careful and rigorous about the management of the funds.

Reason # 9; Benign inflation. Higher than the EU average but in line with economic growth

Average inflation in 2019 was 3.2% compared to the European average of 1.5%.

But revenue growth across the spectrum, wages, pensions was, in real terms, after inflation, double digit (over 10%).

In Europe, this growth indicator is three times lower. Only lately, Germany has dared to increase the salaries of physicians and technologists, it is true with much higher percentages than we did.

An argument that we have done well so far, taking care of the two categories. Economic incentives and temporary facilities are functional and profitable.

Reason # 10: National security and respect for international commitments are financial priorities.

Romania budgetary allocation for our military, defense and security priorities has always been done fully, in time.

We are an example for all of our partners. Romania, makes substantial efforts to allocate, in all its forms, funds for the defense industry. Romania is an impeccable partner at the political and military level.

We spend almost 1.5% on interest, but we make the effort to honor our financial obligations to our political, social and military partners, both internal and external.

Reason # 11: The strategic development sectors are also recognized through budget allocations

Strategic sectors with competitive advantages are well-funded, well supported by economic policies.

The IT sector, health care and education are well supported economically, as far as we can do now. The budget allocation substantially increases for health by 7.3 billion lei, in education by 10 billion lei.

The wages for those who care for our health is already remunerated, adjusted with purchasing power parity, at Western European standards. The average salary for the 200,000 hard and software professionals is over 6,500 lei net.

Certainly, they deserve even more, just for the sector export performance of € 4.5 billion (20% of the total exports).

Reason # 12: Economic, financial, social and cultural emancipation

Entrepreneurial, corporate and technology-driven culture, automation, entrepreneurship and social, financial and economic empowerment are on the rise.

Only in 2018, Romanian entrepreneurs who have made an exit or have sold some of their companies have earned more than 1 billion euros. Another pro-cyclical, favorable economic indicator.

Reason # 13: Mergers, acquisitions, restructurings, business restructuring, activities denote economic activity

An effervescence of the economic market of mergers and acquisitions proves a long-term sustainable commercial interest for the Romanian market.

Spectacular transactions were made in all areas of great interest and economic potential, from IT to real estate, from agriculture to FMCG, from Farma to DIY sector.

Closed deals, are a financing confirmation of commercial success received by Romanian companies (unicorn type) located on the frontier of technological advance. Similarly, mergers and acquisitions in the financial-banking sector show preoccupation and expectation of future interest and profitability.

Reason # 14: No major financial crisis, state aid, innovative monetary policies. Romania worked hard

Romania avoided a systemic economic and financial crisis. At institutional and legislative level, Romania has structures, practices and results, many of them well above the European outcomes.

Legislation is appropriate, aligned with European directives. Functionality of regulatory institutions of key systemic importance – guarantee schemes and funds that are critical in all systemic sectors (insurance, pensions, investments, deposits, loans for SMEs, rural credits, etc.) are again an example of success.

Reason # 15: Romania finances innovation. Education has better quality standards, more adequate to today’s labor market

The education system in Romania is free. As a young person, you can make a top school that gives you the chance to pursue a career in any company, with only your intellectual effort.

Master programs at the Western level, finance by state with full scholarships. You can pursue a doctorate and receive a research grant from the Romanian state; even if you are a professional who earns a good salary.

The Romanian state proves an extraordinary generosity from this point of view, at least in comparison with other states in Europe or America where you can pay for your university loan in your 50’.

The education system is good, fair and offers opportunities for personal and professional development. Romanian pupils and students are ambitious and hardworking, skilled and disciplined, modern and interested.

Their instructors are able. They have to be professionally and continuously trained.

They are obliged to provide informative and instructive content of interest to their students.

Romania finances and provides economic support for personal and entrepreneurial development schemes, Start-up Nation, First Home, gRowth, Green House, Invest in you, Youth Entrepreneurship Financing Program, SMEs Finance, etc.

Reason # 16: Small Public Debt. Sustainable, even after the toughest criteria

The public debt of 70 billion euros is below 35% of GDP.

From this point of view, the health of public finances is solid. Romania’s economic fundamentals are sustainable and intact, although evidently subject to local and international economic uncertainties.

Expenditures on government debt interest are only 4.5% of GDP (the average of these expenditures for countries with the same rating is twice as high).

Public debt is one third less than the average of countries with the same rating in Central and Eastern Europe. What reasons are, in fact, for a weaker, negative rating outlook?

Reason # 17: Tax policy has priority – Deficit Management is the public finance mantra.

Only secondary, economic sustainable, non-inflationary economic growth. The budget deficit, calculated according to both standards, cash and European is in acceptable below 3%, with sustainable financing for long term. The fiscal position of the budget is sound, with a low debt ratio and implicitly a leverage capacity for capital investment.

Reason # 18. Real estate market is developed, not posing a significant systemic risk

Romania has a more evolved, more solid real estate market now, that is less exposed to major correction risks. There is obviously the risk of market and sector correction, but the real estate sector is more developed, both commercial and residential, that are less correlated.

Residential, private real estates are different from corporate ones, as well as those in large urban agglomerations compared to those in economically and socially declining areas.

The new urban reality, the real estate in big cities is dependent on the economic advancement of a new generation of middle class who wants a better, sustainable living standard.

Who is not willing anymore to waste time on the commuting? The real estate market depends on the economic success of the less risky middle class that wants a better standard of living.

Reason # 19: The regional and international political and economic context is an opportunity for Romania Although provocative, this context is also promising.

The US and China will eventually reach an agreement. Thus, is more probable that the dollar appreciates, dollar interest will not increase.

Probably the same for the euro, and similarly, interest on Lei is expected to stay low. In terms of financing costs, if interest rates are not rising, why would a sovereign rating decline?

Brexit can be an economic opportunity, but hopefully this fundamental political error, the biggest after World War II, will be reversed. Especially with the support of new generations, those that have the most to lose from Brexit.

Reason # 20: Sovereign financial liquidity and solvency is sound, sustainable and long-term funding is functional

Romania financial liabilities are covered by growth in economic activity and by significant financial guarantees.

The risk default or non-payment is completely non-existent. If the reserve administered by the NBR (€ 33.6 billion, in gold and currencies) and the Ministry of Treasury buffer (probably equivalent to around € 6 billion) is combined and simply compare to the total public debt of € 70 billion, there is a coverage ratio of 60%.

Obviously, the NBR reserve, the MF buffer cannot and will not be fully spent and only part of the debt needs to be refinanced each year. The solvency of Romania’s public and monetary finances is solid, sustainable, bankable.

2 reasons to keep the rating

Reason # 1: Financial rating can become a self-fulfilling prophecy.

On the basis of the complementary causality methodologies used on an exhaustive database of Moody’s, S & P and Fitch’s ratings on long-term corporate bonds issued between 1990 and 2011, studies show that a downgrade from investment grade to the speculative rating leads to an increase of at least 3% in the probability of default.

The additional risk effect induced by the rise in the default probability indicator is more pronounced for both lower ratings and a more drastic decrease in the rating. The effect is also stronger for companies that already have a low initial rating.

In conclusion, this pro-cyclical prediction quality of a rating can evidently become a self-confirmation of the negative scenario that becomes the most likely.

A rating evaluation self-fulfills the vision initiated with the negative outlook: a circle that can be vicious or virtuous.

Decreasing a rating leads to higher costs, slower economic growth, higher interest rates, i.e. worsening budget execution. Conversely, improving the rating will help meet a more balanced budget.

Reason # 2: The insurmountable labor market deficit and shortage will keep unemployment around current 4%.

Negative demographics, but also the inexorable exodus of talents are our great vulnerabilities for which we have no short-term solutions.

One reason for eventually changing the rating outlook:

The political and implicitly social stress associated with a counterproductive series of legislative, economic and political decisions seems the only plausible reason (although only qualitatively estimated) of a negative rating outlook.

But this stress is the price imposed on any modern, functional economic democracy.

And certainly not a sufficient reason for a weaker rating outlook. Especially since obvious, agencies tend to equalize their ratings for the same borrower.

Herd instinct is prevalent also in rating industry.

What to do now

In the coming period, the possible outlook rating change seems to have more qualitative related motivation for the translation of scenarios on the implementation of GEO 114, than on objective, quantitative economic fundamentals.

Any outlook downgrade rating will induce a more austerity policy change: rating agencies are thus becoming direct contributors that incite decision-making towards economic austerity.

Are rating agencies in fact the economic policy makers?

Changing the perspective from stable to negative is the first step towards a downgrade that can follow in 6 months, which seems quite inevitable and maybe already in the books.

What should be done in the 6 months until a new rating is made in order for a downgrade not to occur?

Given that the negative change in the rating outlook will inevitably make it more difficult for the government to balance the budget, what should happen in six months to avoid a downgrade?

Approval of the budget is of outmost importance, immediately (clear and present danger).

Then we can deal with GEO 114. Ratings reflect past accumulated changes, not the impact of current actions. It’s like black and white balls have accumulated in the economy over the last 6 months, but the balance tends to incline to blacks.

GEO 114 is just the last ball, which may be black or white or gray, but it’s not the only reason for any change in perspective. Budget approval could be a white ball in the Government yard, stronger than the gray ball of the highly probable GEO amendments.

As long as the approval is done anyway, postponing the approval merely tilts the public economic balance on the negative side. Our ratings and our economic performance deserve much lower European interest rates and margins.

In the fall of 2018, Moody’s rating agency reconfirmed Romania’s good financial rating, with the assessment of maintain the rating at stable.

The Romanian economy’s perspective was positive, of the Investment grade type.

The report mentioned the positive opinion on the sustainable, stable evolutionary outlook, favorable rating analytical factors regarding the economic evolution of Romania in the future, especially considering the significant efforts made by the Romanian government in the last four years for investment in human resources.

In conclusion, the only notable event to change this merit list for the most recent rating in August remains the argument of GEO 114.

Maximizing the compromise, amending the requirements, any gesture of elegant concession would be well received by the market and give an ascendant to the Government for any other future measures that would ensure viable and cheap financing of the Romanian economy.

Sovereign rating is now a matter of national financial security and should be our zero priority.