In a world full of turbulence and uncertainty, Romanian companies have gradually learned to adapt to the ebb and flow of unpredictable tides, forging new paths or rethinking existing ones, according to a BRD report for investors.

Labor market: in its depth lies a hidden labyrinth of structural weaknesses (e.g., high levels of inactivity, significant regional differences, growing demographic constraints)

According to statistics, the labor market remained stable with low unemployment and growth in both employment and average nominal wages. However, in its depth lies a hidden labyrinth of structural flaws (e.g high level of inactivity, significant regional differences, growing demographic constraints), which leads to an increasingly acute problem – the lack of qualified labor.

To close the gap and strengthen the labor market base, it is time to improve the quality and relevance of the education system and accelerate the implementation of dual educationto strengthen links between academia and business, encourage reskilling and upskilling of the workforce and embrace diversity.

Increasingly attracting foreign workers may reduce the pressure in the short term, but not as a long-term solution. We expect the labor market to cool slightly in 2023 amid slowing economic activity, weakening corporate finances and continued uncertainty, leading to a more cautious approach to hiring. On the other hand, we do not expect the unemployment rate to rise significantly (BRD forecast: 5.6% in 2023 and 5.8% in 2024), as companies still need to work hard to attract and retain talent.

Overall, as the report shows, the Romanian economy is becoming more and more resilient, consistently outperforming other EU member states in recent quarters and continuing its nominal convergence, according to the “Romanian Economic Prospects”, GDP per capita increased to 77% of the EU27 average (such the same level as Portugal or Hungary).

“However, overall progress has been a symphony of heterogeneity, with each economic sector moving at its own pace,” the report’s authors note. The bank revised upward its GDP growth estimates to 2.6% in 2023 and 3.4% in 2024 (from 2.1% and 3.0% previously). Fast and timely implementation of EU-funded projects will be essential to keep the economy afloat.

Inflation: Inflation will be moderate, declining fairly steadily in the second half of the year

Domestic inflation will moderate, declining fairly steadily in the second half of the year and returning to single digits (BRD estimates 8.2% by end-2023 and 4.8% by end-2024).

The following quarters will have slightly different dynamics of core inflation and prices for exogenous components of the consumer basket. While the latter will decelerate rapidly amid strong base effects in the energy subcomponents, core inflation is expected to decline much more slowly.

Fiscal policy and public debt: on paper, medium-term fiscal policy sets ambitious targets

Fiscal policy must be both nimble and flexible to meet future challenges. Therefore, fiscal consolidation should become a priority, which will contribute to the achievement of several goals/objectives: Accountability (compliance with EU fiscal rules), Sustainability and stability (ensuring the acceptability of public debt, reducing external vulnerability), Confidence (maintaining the credit rating) and growth potential (opening up space for investments needed to increase production capacity).

On paper, the medium-term fiscal policy sets ambitious goals of reducing both the general and structural budget deficit to below 3% of GDP by 2024. However, this is more difficult given the widening gap between needs (pension, health care, energy, security, green transition) and resources (economic activity is slowing down and the “magic wand” of inflation is less powerful).

Recognizing Romania’s poor track record in implementing structural reforms and the potential for additional spending ahead of the 2024 election supercycle, there is significant potential for slippage.

Budget execution in the first quarter of 2023 supports the above assumption as we see higher than initially expected budget spending pressures and tax collection lagging behind

Money market and monetary policy: The macroeconomic environment is leaning towards maintaining high interest rates for a longer period of time

It is premature to talk about interest rate cuts, at least until core inflation clearly declines to the central bank’s inflation target, fiscal consolidation progresses and pressures on the labor market ease

Under the baseline scenario, we expect the NBR to keep the key rate unchanged at 7.0% until the end of the year, while interbank rates will hover around the current level. Provided that the 3 conditions mentioned above are fulfilled, the NBR may start gradually reducing the cost of borrowing next year (probably in the second half of 2024) to 50-75 basis points.

Currency Market: We expect RON to continue mastering the art of balance

The trajectory of the EUR/RON exchange rate will be mainly determined by: i) the interest rate differential vis-à-vis the Eurozone (albeit narrowing), ii) the twin deficit, which is being revised downwards but still significant, iii) FDI inflows and absorption of EU funds, iv) NBR’s availability to prevent excessive exchange rate fluctuations, supported by a solid level of foreign exchange reserves.

Accordingly, we forecast the EURRON to average 4.95 in 2023 (4.96 at the end of the period) and 4.98 in 2024 (4.99 at the end of the period).