OREANDA-NEWS. Fitch Ratings has downgraded Romania's Long-Term Local Currency (LTLC) IDR to 'BBB-' from 'BBB' and affirmed the Long-term Foreign Currency (LTFC) IDR at 'BBB-'. The Outlooks are Stable. The issue ratings on Romania's senior unsecured foreign currency bonds have been affirmed at 'BBB-'. Romania's senior local currency bonds have been downgraded to 'BBB-' from 'BBB'. The Country Ceiling has been affirmed at 'BBB+' and Short-term Foreign Currency (STFC) IDR at 'F3'. Fitch has assigned a new Short-term Local Currency (STLC) IDR rating of 'F3'.

Downgrade of LTLC IDR

The downgrade of Romania's LTLC IDR to 'BBB-'from 'BBB' reflects the following key rating drivers:

In line with the updated guidance contained in Fitch's revised Sovereign Rating Criteria dated 18 July 2016, and as part of a broader portfolio review, Fitch concluded that Romania's credit profile no longer supports a notching up of the LTLC IDR above the LTFC IDR. This reflects Fitch's view that neither of the two key factors cited in the criteria that support upward notching of the LTLC IDR are present for Romania. Those two key factors are: (i) strong public finance fundamentals relative to external finance fundamentals; and (ii) previous preferential treatment of LC creditors relative to FC creditors.

Assignment of STLC IDR

The assignment of a STLC IDR of 'F3' to Romania is consistent with Fitch's approach to assigning ST ratings by using its LT/ST Rating Correspondence table to map the STLC IDR from the LTLC rating scale. According to Fitch's Rating Definitions, the Fitch Rating Correspondence Table is "a guide only and variations from this correspondence will occur". However, variations to this approach are rare in the case of sovereign ratings.

Romania's STLC is derived from the mapping to its revised LTLC IDR of 'BBB-' and was assigned as part of the portfolio review referenced above.

KEY RATING DRIVERS

Romania's 'BBB-' LTFC IDR balances a favourable economic growth outlook, against fiscal risks from increased pro-cyclical fiscal policy and upcoming elections in November this year. In addition, a larger net external debtor position than the 'BBB' median and structural weaknesses in the economy remain constraints on the rating.

Fitch's 2016 and 2017 fiscal deficit forecasts, at 3.0% and 2.9% of GDP, respectively, remain unchanged from six months ago. However, Fitch continues to highlight the negative pressures on medium-term fiscal sustainability as a result of sizeable tax cuts under the Fiscal Code. The vulnerability of public finances is also heightened in light of the current electoral cycle, which in 1H16 saw the approval of several populist measures, including a new public wage bill due to come into effect August 2016 increasing government spending, as well as a legislative initiative promoted by parliament for further social security contribution cuts.

Romania's widening fiscal deficit also puts upward pressure on general government debt, which in recent years has gradually deteriorated towards the median debt ratio of the 'BBB' range. Fitch's latest medium to long-term baseline projects government debt to reach 39.6% of GDP in 2016 from 38.4% in 2015, remaining on an upward trend, but staying below 45% over 10 years, a level which is not necessarily incompatible with an investment grade rating. Refinancing and interest rate risks are low, with around 85% of total debt stock in medium to long-term maturities, with fixed rates.

The first round effects of the Fiscal Code have helped fuel strong consumption growth, which will remain a key driver of GDP in 2016-2017. Positive momentum in domestic demand will help stimulate private sector investment, which in turn will offset a decline in public investment and EU fund related spending. However, with robust growth in domestic demand, net exports will provide a negative contribution to GDP as import demand outpaces export growth. Fitch's latest projection is for an average real GDP growth rate of 4% for 2016-2017, above Romania's 3.0%-3.5% economic growth potential and above the median of 'BBB' peers.

Romanian banks are well capitalised (sector capital adequacy ratio 19.5%, 1Q16) and profitable (RoE 12.8% in 2015).The banks are sufficiently funded by local deposits and their balance sheets are gradually improving as the share of non-performing loans continues to decline. However, the Debt Discharge Law approved in May, which allows individuals with a mortgaged-backed loan the ability to return real estate collateral to the banks in exchange for writing off their loan, has created an uncertain outlook for the sector. Romanian banks have already tightened lending standards, increasing minimum mortgage down-payments, which risks weighing on credit demand.

Romania's rating remains constrained by its higher net external debtor position than 'BBB' peers, estimated by Fitch at 20.3% of GDP for 2016, compared with the 'BBB' median estimate of 6.0%. The majority of external debt is attributed to the private sector. However, its sustainability is supported by ongoing trends of deleveraging and a relatively large share of intercompany lending. Since peaking at 39.2% of GDP back in 2012, Fitch forecasts net external debt to continue gradually declining in 2016-2017.

Progress in converging Romania's GDP per capita levels towards that of higher rated peers has been slow. Meanwhile, higher potential growth is constrained by structural weaknesses in the labour market, such as high long-term unemployment (44% of total unemployment, 2015), skills mismatches, and low productivity growth, as well as the dominance of inefficient state-owned enterprises in key economic sectors. Recent increases in public and private sector wages risk medium-term price competiveness.

SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)

Fitch's proprietary SRM assigns Romania a score equivalent to a rating of 'BBB' on the Long-Term FC IDR scale.

Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows:

- External Finances: -1 notch, to reflect Romania's significantly higher net external debtor position than the 'BBB' median, and lower international liquidity ratio than the 'BBB' median.

Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.

RATING SENSITIVITIES

The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are currently balanced. The main risk factors that, individually or collectively, could trigger negative rating action are:

- Significantly higher fiscal deficits and worsening of government debt dynamics.

- A deterioration in external debt dynamics.

The main factors that could, individually or collectively, trigger positive rating action include:

- Credible fiscal consolidation, which improves the long-term trajectory of public debt dynamics.

- Sustained improvement in external finances.

- Sustainable economic growth which will support progressive convergence towards average EU income levels.

KEY ASSUMPTIONS

Fitch assumes that under severe financial stress, support for Romanian subsidiary banks would come first and foremost from their foreign parent banks.

Fitch assumes Romania's main economic partners in the EU will benefit from a gradual economic recovery.