Romania’s new pension law could result in a less favourable sovereign debt trajectory and weaken fiscal credibility over the medium term if implemented as planned and without offsetting measures, Fitch Ratings says. The eventual impact will depend on the broader direction of fiscal policy, including efforts to exit the ongoing Excessive Deficit Procedure.

The new law, which received parliamentary approval on 20 November, is intended to remove inconsistencies in how state pensions are calculated as part of efforts to improve public pensions sustainability under the Romania’s National Recovery and Resilience Plan. The retirement age for women will rise to 65 by 2035, and indexation will be based on average inflation rates from next year. However, an unexpected element of the reform is the planned recalculation, which will see around 3 million pensions rise by an average of 22% in September next year, according to the government. This could undermine the medium-term sustainability of the pension system.

Near-term fiscal implications appear limited as the recalculation impact would only materialise late in 2024. However, from 2025 the fiscal impact would be large and persistent. The finance ministry has estimated that the cost could be close to 1.8% of GDP in 2025, implying a fiscal gap of 6.1% of GDP in the absence of offsetting measures.

The passage of the new law therefore increases the risk of further fiscal slippage, as the government has not spelled out in detail how the higher payments to retirees would be funded. It is unclear whether the law might be redesigned to reduce its potential fiscal impact, and/or additional fiscal policy measures introduced to increase revenues or reduce spending elsewhere.

Fiscal policy is subject to political uncertainty, with presidential elections due in November 2024 followed by parliamentary elections no later than March 2025. The passage of the law also revealed some tensions between the governing Social Democratic and National Liberal parties, but we think the coalition will hold together until the elections.

Lower-than-expected revenue growth has already driven fiscal slippage relative to the government’s original 2023 deficit target of 4.4% of GDP. In its recent autumn forecast, the European Commission projected a deficit of 6.3% of GDP this year, unchanged from 2022. The government’s consolidation package, announced in September, should then help bring it down to 5.3% next year and 5.1% in 2025. The Commission’s forecasts do not include its own estimate of the costs of the new pensions law.

Persistent fiscal slippage would represent a risk to our baseline general government debt/GDP forecast for the sovereign, which is rated ‘BBB-’/Stable. We currently see the debt ratio remaining broadly stable over our forecast horizon, at slightly below 50%, which is about 5pp below the ‘BBB’ category median. It would also undermine the credibility of Romania’s fiscal strategy, in particular the commitment to bring the budget deficit below 3% of GDP to exit the ongoing Excessive Deficit Procedure, which pre-dates the pandemic.

Romania is the only EU member state currently subject to the Excessive Deficit Procedure, and its commitment to exiting the process has been a key fiscal anchor, along with conditionality for disbursements of grants from the Recovery and Resilience Facility, which are an important source of non-debt financing. The fiscal impact of the pension law will therefore also depend on whether the EU authorities deem it consistent with improving the sustainability of both the pension system and the public finances.

Large budget deficits that lead to a rising public debt/GDP trajectory over the medium term are a negative rating sensitivity for Romania, as we noted when we affirmed its rating in September. Notwithstanding the recent fiscal weakness, Romania’s rating is supported by a debt level lower than ‘BBB’ peers. Furthermore, the Romanian economy has been more resilient than the EU with a GDP growth rate of 2.1% in 3Q23, compared to no growth in the EU overall.

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