OTP Bank: "Tax measures and high oil prices will temporarily stop disinflation in Romania"

Romania's economy is showing weaker growth than previously anticipated, say OTP Bank analysts, who attribute the slowdown to challenges in the services and industry sectors, fiscal consolidation and weakening activity in the eurozone. In their opinion, the forecast for the second half of the year is thus influenced by recent international economic developments, trends in the Eurozone, new local tax increases and the evolution of local macroeconomic indicators.

Even though annual GDP was forecast earlier in the year to reach nearly 3% growth in 2023, growth has been slower, weighed down by weaker consumption and exports, amid inflation-eroded real incomes and the deterioration of the international situation in the production area, and reached only 1.7% in the middle of the year. Therefore, the economic growth outlook for the full year is 1.9%. At the same time, inflation continues to decrease and is on track to reach approximately 7.5% at the end of December, while there will be no new developments in the reference interest rate, with the BNR expected to maintain the current rate, according to a statement of the bank, GDP performance in the first half was fueled by the IT, construction and services sectors, while industry, which contributes more than 20% to GDP formation, had a negative contribution.

At the beginning of 2024, the GDP growth trend will improve to an estimated annual value of +2.7%, determined by household spending (supported by the increase in real wages), by the increase in public consumption and a return to the dynamics of exports, according to the bank.

"Given developments over the past month, indicators in the third quarter suggest that the slowdown in growth will now last longer than expected. The subdued growth we have seen so far is driven by household demand, a good recovery in the construction sector and a huge increase in investment spending, much of which is financed by external non-reimbursable funds.Expectations should be reserved for the end of this year as spending will be constrained by the fact that credit growth has also continued to weaken, even though credit generation has returned to previous trends for the corporate segment and consumer loans." noted OTP Bank analysts.

Inflation has been steadily declining since February 2023 and reached 8.8% in September. This decline is expected to continue until the end of the year, mainly under the influence of base effects and, in particular, the correction of food prices, taking into account the input of the 2023 agricultural harvest and the capping of trade allowances for basic food products, according to the bank.

"Currently, inflation is still falling, but we must be aware that January will bring a temporary reversal of the disinflationary trend, due to the fiscal measures implemented for fiscal consolidation. The effect of higher oil prices will also contribute to stop disinflation in the first quarter of next year. Our forecast shows that service and goods price inflation will remain relatively inflexible, while food price inflation will continue to decline," analysts say.

Given the expectations of local disinflation for the beginning of 2024, it is unlikely that the National Bank will start reducing the reference rate, according to OTP Bank. Regarding the budget deficit, the bank's analysts are of the opinion that the consolidation measures recently taken by the Government are not sufficient to bring the deficit to the level of 3% next year.

Mihaly Kovacs, Economic Advisor, OTP Bank's Research Centre, said in a video conference: "The deficit initially estimated for this year was 4.4% of GDP, but it seems that it will move towards 6%. Meanwhile, through an agreement with the European Commission, the Government increased the deficit target to 5.5% and there will be decreases in expenses and investments, but which will not produce significant influences on the deficit in 2023".

The analyst added: "For next year the scenario differs a little. As you probably know, the Government has adopted measures on taxation that represent about 1% of GDP or something more, related to indirect taxation, VAT, excise duty, turnover tax or minimum profit, the removal of some tax breaks for industry IT and in the construction sector and new taxes applied to micro-enterprises. All this is meant to reduce the deficit from 6% to 5%. However, we believe that these measures are not enough to bring the deficit to the 3% target in 2024. There will be a 2% gap and we do not expect any further consolidation measures due to the four election rounds. Although next year the European fiscal framework will be important, we understand that countries could be allowed to bring the deficit to 3% by 2025. Therefore, we do not expect that there will be a significant negative effect or that other measures will be imposed from on the part of the European Commission".

On the labor market, analysts note that while economic growth has slowed, it has remained robust to date with slow but steady employment growth. Labor market tightening indicators show no signs of easing. During this time, real wages have managed to grow strongly as inflation has fallen, and will be further boosted by the minimum wage increase in 2024.