The government should prepare for an economic contraction as high as 8-9%

15 iun. 2020 English Section

The Fiscal Council predicts a contraction of the GDP between 4% and 6% in 2020  

Aurelian Dochia: "The most concerning figures are those concerning the German industry, where the contraction is particularly strong"

Ionuţ Dumitru: "We estimate a contraction of the GDP of 7% and a financing need of approximately 130 billion lei"

Fiscal Council: A quick turnaround of the economy in the 3rd and 4th quarters is very unlikely, and that could impact the economy over a longer time

Tax experts warn the government that it should be prepared for an economic downturn of 8-9%. The Executive needs to be cautious and take into account a minimum level of contraction of the real GDP in 2020 of at least 3.5%, according to the 2020 Annual Report of the Fiscal Council. The Council points out that it is necessary to consider two more macroeconomic scenarios for the current year: one based on a more realistic contraction of real GDP in the range of 4-6%, and a negative scenario that predicts a more severe contraction of GDP (8-9%).

This year's first budget rectification, which adjusted Romania's economic growth forecast with the magnitude of the shock caused by the Covid-19 pandemic, is built on an optimistic decline in the real GDP of only 1.9% for this year. The Fiscal Council notes, however, that the government should take into account the negative scenario of an 8-9% contraction, in order to prepare for the situation of a stronger impact of the pandemic on economic activity, given that "the two scenarios would lead to budget deficits for 2020 of 8.1% - 8.9% and 9.9% - 10.4% of the GDP, respectively, well above the Government 's current estimate of 6.7% of GDP. The need for funding for this year would therefore rise to massive levels between 11% and 14.3% of the GDP, according to Council estimates.

"The balance of risks related to these estimates, leans to the negative side, i.e., the occurrence of a higher budget deficit", says the Fiscal Council. "The FC again warns that sticking to the current schedule for implementing the new pension law, in the absence of offsetting measures, would make it almost impossible to cut the budget deficit in 2021, down from the current level, even as it is already dangerously high.

The return to fiscal-budgetary sustainability is essential for going through this very difficult period and calls for a reconsideration of the pension law enforcement calendar, as well as the timely, public communication of fiscal-budgetary policy plans."

Ionut Dumitru, chief economist of Raiffeisen Bank and former chairman of the Fiscal Council, told us that Raiffeisen forecasts a 7% contraction in GDP this year and a financing need of 130 billion lei, about 13% of GDP.

He said: "At the bank, we have a projected 7% GDP this year. First of all, when we talk about forecasts, no one is right because no one reads the stars. But a forecast can be more realistic or less realistic, or have a lower or higher probability of materializing. At the moment, with the information we have now, a forecast of an economic contraction of just -1.9%, like the one made by the Government, is unrealistic. That is, it is not impossible, but it has a very low probability of materializing. Most market analysts now anticipate a contraction somewhere between -5 and -9%, something like that, so we have an economic growth projection -7%, and we have a -8.5% budget deficit forecast. For a budget deficit of that size, our projected need to borrow, is 85 billion, and on top of that there is also a debt of 44-45 billion debt reaching maturity in 2020 - only principal payments, because the interest payments are already included in the budget deficit - so in total we are talking about 130 billion lei. That is, somewhere around 13% of GDP, that is our estimate for funding needs."

Ionuţ Dumitru: "All the NBR can do is provide a respite to allow the allow the fiscal-budgetary policy to adjust"

The economist thinks that the Government will find it harder to finance itself this year, but fortunately, so far, things have evolved favorably. He told us that the NBR will have to "buy significant amounts" of government bonds from the secondary market to help the Government cover that need for financing. "Favorably, meaning that they have been successful in selling the foreign bonds issue, have succeeded in selling bonds domestically again, because at one time, after the sparking of the Covid crisis, there was a deadlock, and the Finance Ministry was unable to raise financing. But over the last few weeks, the Finance Ministry has been pretty successful in borrowing. (...) I expect the NBR to acquire significant volumes (of government bonds from the secondary market). There is a need for the NBR to somehow significantly help cover this very high need for financing. But what the NBR can do is only provide time for adjusting the budgetary-fiscal policy, because we cannot maintain deficits like that over a longer period of time. Let's hope that while this year we will have a large deficit, we will start significantly cutting it next year, because we cannot finance such large deficits in the medium term.

He also said that 2022 is a very optimistic deadline for bringing the budget deficit down to the 3% limit required by the European treaties. "I don't think that we will end up so quickly below 3%, we will probably need at least 3-4 years", Dumitru concluded.

Dochia: "The recovery measures that we are taking or trying to take are also measures which will cause negative consequences in the long run"

Economist Aurelian Dochia told us that the Government's forecast is overly optimistic, and every forecast, including those of the international financial institutions such as the World Bank, the International Monetary Fund or the European Union have made harsher contraction predictions for Romania than those of the Government.

"4-6% is a realistic range, even though the probability is still low because a lot can happen in the coming months: we don't even know how this pandemic is going, whether there will a second wave or not, how consumers will behave... There is very high uncertainty. Undoubtedly, a greater contraction of the GDP also means the deficit will be greater, and again, about every analysts' and international institutions forecasts are going with a deficit that could end up as high as 10%. (...) The government will not end up having trouble borrowing. It is clear that on the domestic market financing in lei can be secured with the help of the NBR, and on the international markets there is liquidity and interest from investors to find investments, given that many securities and assets are at zero or negative return. So there are investors that are desperately seeking securities with a positive return of 3-4%, like Romania has. I don't think there are any borrowing problems, it is a good thing our rating has remained steady, and again, given how things are going elsewhere, in major economies that represent benchmarks in the world, I would say that there is nothing exceptional, we are a smaller economy and we have other vulnerabilities in other regards, but we do not stand out in any way". Aurelian Dochia further emphasized that the route followed will probably be short-term consumption and structural changes in the economies do not happen over night.

If the European economy does not function properly, and it probably won't, we will suffer the consequences. The most worrying thing for me was when I saw the figures on the German industry, the contraction there is particularly strong and we cannot escape (without consequences) if Germany is facing such a contraction. (...) Imbalances and deficits are vulnerabilities that will cost us in the long run. But probably no one cares what will happen in the long run, everyone wants to do something to get out of this pit we are in now and the idea is that "in the long run, we will see what happens." But, often, the remedial measures we implement or try are also measures that will have long-term negative consequences, Dochia said.

The minimum contraction level, in the opinion of the Fiscal Council, is -3.5%

Its calculations, which are based on the first figures published by the National Institute of Statistics (INS) regarding the evolution of the economy in March and April (the dynamic of April was extrapolated for the first half of May - taking as implicit the hypothesis that after the loosening of social distancing economic activity returns to pre-pandemic parameters) and on the estimates of the National Strategy and Forecast Commission (CNSP) for the manufacturing, construction, retail and services sectors (which had a share in GDP of 65% in 2019) are leading "to a median drop (on annual economic growth) of about 2.6-2.7 percentage points (pp) for each month considered (about 2.5 percentage points in March and 2.9 percentage points in April 2020)".

The CF report mentions: "Thus, for the interval assumed/available as information, the total impact is -7 pp; starting from an increase of 4.1% of the GDP for 2020 (the one that preceded the current rectification - the projection of the CNSP for the winter 2020 variant ) we reach an estimate of the annual GDP dynamic for 2020, corrected with the directly predictable impact of the pandemic, according to that INS poll, of approximately -3%. Given the previous predictions of the Fiscal Council when it comes to overestimating the dynamic of the economy for 2020 by at least 0.5 percentage points, this leads to a corrected estimation, concerning the dynamic of the real GDP, of -3.5% in 2020, also given the INS data. This is considered by the Fiscal Council as a minimum level of contraction for the real GDP this year, based on the assessment of some official data from the National Statistics Institute".

"Another element for the corroboration of a macroeconomic scenario consists of comparing the current situation to the major economic crisis of 2008, with the mention that the magnitude of the current shock could be even greater. Also, the dynamic of the real GDP of 2009 and 2010 (of -5.6% and -3.9%, respectively) also represents a base benchmark for this year's evolution. Furthermore, the previous crisis - having its roots in the financial sector - and thus being more homogeneous in terms of its causes and mechanisms of transmission, seems to have been easier to fight through economic policies. The current crisis, with its multiple facets, involves more extensive measures both in terms of the instruments and the amounts of money spent.

Given the estimates above, the historical benchmarks, as well as the described risk factors, some of them very likely to come true, the Fiscal Council has deemed necessary making a scenario that considers involving a real GDP contraction of 4-6% as well, in the first budget rectification of 2020. Such a scenario can also be corroborated with the predictions of some international institutions. The predictions of other analysts share the same range. The data used for the domestic economy - from the INS - can be corroborated with other data which appears in studies and polls collected by various organizations".

The Fiscal Council predicts the drop is more likely to reach -5% this year, and a drop of 8-9% is more likely if several of the aforementioned risks materialize.

A summary of arguments that could lead to a higher contraction of the GDP relative to the minimum threshold 

According to the Fiscal Council, there are numerous arguments whose validation, individually or as a whole, can lead to a higher contraction of GDP in relation to the minimum level determined above:

- (i) the economy returning to the pace it had prior to the abnormal period in the second half of May is very unlikely;

- (ii) a quick recovery of the economy in the 3rd and 4th quarters is also very unlikely, and that could affect it over a longer period;

- (iii) the other sectors of the economy (which account for 35% of the GDP) will also suffer because of the pandemic;

- (iv) the impact (assessed by the INS) of the contraction of the international trade (with the answers focusing on a drop of "up to 25%" and "25-50%") could amplify the effects being considered could make the resumption of economic activity more difficult, especially since Romania is integrated and dependent on the international added value chains, the restart of the economy to a different degree than that of our trade partners is essentially impossible;

- (v) the study of the NSI, which underlies the estimates for the CF, is made between March 17th, March 19th, with the subsequent developments not likely to bring improvements, quite the opposite;

- (vi) agriculture, which usually has a notable contribution to the GDP in the first second and fourth quarter, could have a weaker dynamic;

- (vii) the drop in turnover could lead to an increase in costs pertaining to intermediate consumption caused by the current exceptional situation;

- (viii) the evaluation of the effects of the contraction of the economic sectors is done in isolation, without taking into account their functional interdependencies (which are usually analyzed with input-output matrices);

- (ix) the implications of the financing channel are not taken into account, as it could be a major source of risk to GDP dynamics - as capital outflows from emerging economies reached about $ 100 billion in Q1 2020, almost double compared to the peak of the previous crisis in 2008-2009, and most of the capital outflows took place in other emerging economies than China. Moreover, global economic circumstances could lead to new waves of capital withdrawals from emerging economies, which would complicate, to the point of making it impossible for those countries to finance their current account deficits.

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