Consequences of Credit Rating Downgrades for Romania
Analysis by Divo Pulitika, Fund Manager, InterCapital Asset Management
The recent downgrades of Romania’s credit rating outlook from Stable to Negative by Fitch on December 24th, 2024, and S&P on January 24th, 2025, underscore growing concerns over the country’s fiscal and economic stability. While these downgrades do not yet equate to a reduction in the actual rating, they serve as a clear warning and a precursor to potential downgrades into sub-investment grade (junk) territory, should fiscal and macroeconomic trends fail to align with expectations. The implications of such moves extend across Romania’s bond and equity markets, government finances, and broader investor sentiment.
The bond market is likely to bear the brunt of any potential downgrade, as it reflects both fundamental and technical adjustments. Institutional investors such as pension funds and insurance companies, which are often restricted from holding junk-rated bonds, would be compelled to offload Romanian bonds if two or more agencies reduce the rating to sub-investment grade. Even the shift in outlook has triggered some early repositioning, as investors anticipate further downgrades. Romanian 10-year euro-denominated bonds currently trade at a yield of 5.96%, representing a 351-basis point (bps) spread over German Bunds, which equals to 3.51% over Germany. This spread, already elevated compared to regional peers like Hungary (184 bps; 1.84%) or Greece (89 bps; 0.89%), indicates that markets have begun to price in higher risk. Historically, spreads for Romanian bonds peaked at nearly 600 bps in 2022 during the energy crisis and the war in Ukraine. If the spread returns to such levels, yields could reach 8.4%, leading to an estimated 16% decline in bond prices. Should the psychological barrier of a 10% yield be breached, bond prices could drop by as much as 26%. Such declines would directly increase Romania’s borrowing costs, as higher yields on existing bonds translate to higher rates for newly issued debt. The first major test will come on February 21st, 2025, when Fitch has scheduled an update on Romania’s rating.
While credit rating downgrades are less directly tied to equity markets, the broader impact on investor sentiment can weigh heavily on stock prices. Negative sentiment toward Romania could lead to capital outflows and lower valuations across the Bucharest Stock Exchange (BVB). From a fundamental perspective, Romanian banks, which hold significant amounts of sovereign bonds, could see their balance sheets negatively impacted. A drop in bond prices would erode the value of their holdings, creating potential losses in their profit and loss statements. Banks like Banca Transilvania and BRD, which are key components of the BET index, may face notable headwinds – currently difficult to estimate since the information about the Romanian bond holidings and their currencies and maturity, is not public.
Additionally, governments often resort to higher taxes during fiscal crises, targeting high-earning sectors such as energy and banking. Romania has a history of imposing such measures, as seen in December 2018 when the “tax on greed” caused Banca Transilvania to lose almost 20% of its market value in a single day. Potential tax increases on corporate profits, dividends, or specific industries would disproportionately affect BET components, given its heavy weighting toward banks (making up almost 30% of the bET index) and energy companies (almost 50% of the index). For example, raising the dividend tax from 8% to 10% reduces the effective gross yield on the BET index by 0.11 percentage points. Similarly, an increase in corporate tax rates from 16% to 20% could make Romanian equities 5% more expensive based on current P/E ratios, reducing their attractiveness to investors.
A credit rating downgrade would force the Romanian government to pay significantly more to finance its debt, potentially leading to stricter budgetary measures. The government has already projected a 7% budget deficit for 2025, which aligns with market expectations, but sustained fiscal discipline will be crucial to prevent further downgrades. Higher debt servicing costs may prompt the government to accelerate tax collection efforts or introduce new taxes, including those targeting consumption or property. While such measures could stabilize fiscal accounts in the medium term, they risk dampening domestic economic activity in the short term, particularly as Romania faces slower GDP growth projected at 2.5% for 2025.
Despite the immediate risks, it is important to note that a credit downgrade does not equate to economic collapse. If the government manages to implement necessary fiscal reforms without resorting to excessive or counterproductive taxation, the equity market could recover from any short-term sell-offs. Romania’s long-term economic trajectory, supported by EU funding and structural reforms, remains more critical than temporary sentiment-driven volatility. For patient investors, any significant declines in equity prices due to a downgrade could present attractive buying opportunities, particularly in sectors with strong long-term growth prospects. However, the path forward will depend heavily on the government’s ability to demonstrate fiscal discipline and regain investor confidence.
Romania’s proposed budget appears to align with the base-case models presented by Fitch and S&P, projecting GDP growth of 2.5%, a budget deficit of 7%, and inflation at 4.4%. These targets are broadly in line with consensus estimates of Bloomberg analysts that project Romania’s GDP will increase 2.6% in 2025, and suggest that a downgrade can still be avoided if fiscal reforms proceed as planned. However, the government’s ability to maintain discipline amid political pressures, especially in the run-up to presidential elections, remains a critical question. The coming months will be decisive for Romania’s financial stability – the focus will be not only on increasing taxes, but also significant attention should be put on improving the collection, with Romania having the worst rate of VAT collection out of the whole EU as per the latest European Commission data, with the gap amounting to 30.6%, 8.5 billion euros in 2022, while the EU VAT compliance being of approximately 7%. While the current downgrades are warnings rather than full-fledged crises, their consequences underscore the importance of credible fiscal policy and structural reform in navigating a challenging economic landscape.
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About Đivo Pulitika
Đivo Pulitika is a portfolio manager at InterCapital Asset Management, Croatia’s leading asset management company. Pulitika began his career in the financial industry while studying at the Faculty of Economics and Business in Zagreb, initially joining Intercapital’s analysis department. Over time, he became the head of this department, where he focused on promoting investments in regional capital markets, conducting stock valuations, and organizing roadshows and conferences for clients. In 2019, he transitioned to InterCapital Asset Management, where he led the equity analysis department. Pulitika is also responsible for preparing and implementing policies on responsible and sustainable investing. His expertise and leadership have significantly contributed to the firm’s success in managing investment funds and individual portfolios for a wide range of clients.
About InterCapital Asset Management
With nearly 20 years of experience and a portfolio that includes 19 classic funds and 5 ETFs, InterCapital is the largest independent asset management company in Croatia, managing EUR 500 million. Over the years, InterCapital has demonstrated expertise and innovation in investment fund management with multiple products and services launched. Namely, InterCapital is 1st SEE asset manager that has pivoted from classic UCITS funds into ETFs and digital robo-advisory space with its APP Genius. InterCapital has a clear path to offer cost-effective and attractive products across the SEE region, following its mission to develop regional capital markets by implementing the best global standards and practices.