Real household spending growth in Romania will decelerate in 2023 as still high inflation hurts purchasing power and a sluggish economy leads to rising unemployment and minimal real wage gains, a study published by FitchSolutions says.

Consumer spending outlook for 2023

Retail sales growth has slowed above H222 and we believe this trend will remain in place at least beyond H123 as high prices discourage consumers from making discretionary purchases.

In a regional comparison, Romanian consumers are negatively affected by the current high food and energy prices, with food and utility bills claiming a large part of their budgets. Therefore, tighter-than-expected inflation is a key risk to our near-term consumer spending forecasts.

Consumer spending in Romania will grow relatively slowly in 2023, with real household spending (at 2010 prices) growing by 2.9% compared to last year. That's a slowdown from figures of 8.7% and 6.4% annually in 2021 and 2022, respectively, when growth was boosted by subdued base effects from the 3.5% annual contraction in 2020.

The level of growth in 2023 will reflect a slow economic expansion and still strong inflationary pressures. We estimate that total real household spending will increase to 597.8 billion lei in 2023, from 580.9 billion lei recorded in 2022.

Romania's retail sales posted impressive double-digit growth rates in 2021, helped by low base effects created by the slowdowns in 2020. While retail sales growth continued in 2022, the pace of growth slowed over the course of the year.

In March 2023 (latest data available), retail sales increased by 6.7% from last year. Growth was on a lower trajectory over H222, with the six-month July-December 2022 rolling average at 3.6%, compared with an average of 6.7% over H122 and an average of 7.1% over the whole year 2019, before the Covid-19 pandemic.

This indicates that retail sales growth is currently below trend levels. We believe this is likely to remain so at least into early 2023 as consumer confidence remains depressed by difficult macroeconomic conditions.

The end of the year is expected

The growth trajectory should begin to accelerate towards the end of 2023 as inflation declines, economic growth improves and consumer spending power increases.

Our forecast of decelerating real consumer spending growth in Romania in 2023 is consistent with our Country Risk team's forecast that the economy will grow at a real rate of just 2.4% in 2023, down from forecast growth of 4.8% in 2022.

This will be due to a combination of headwinds, including energy prices that are still well above pre-2022 levels, tighter financial conditions and a slowdown in the eurozone that is affecting external demand for Romanian exports. On the domestic demand side, our Country Risk team estimates that the contribution to real GDP growth from private consumption will decline from 3.8 percentage points (pp) in 2022 to 2.5 percentage points in 2023.

Consumption will lose momentum due to price pressures and tighter financial conditions. If inflation in Romania and the rest of Europe exceeds our expectations, domestic and foreign demand would be compromised and economic growth in Romania would be lower than we currently estimate.

The unemployment rate will rise

Given the expected slowdown in the economy in 2023, Romania's unemployment rate (as a % of the labor force) will increase slightly to a forecast 5.9% from an estimated 5.6% in 2022, which will put pressure on decrease in the disposable income of households.

On a positive note, the country's tourism industry will continue to recover in 2023, in line with a global increase in travel. We estimate that total arrivals will increase by 4.1% in 2023, reaching 13.2 million. Tourist arrivals are expected to exceed levels from 2019 to 2023, marking a full recovery.

In many markets, inflationary pressures remain high and, while the pace of price changes is slowing, they remain higher than central bank targets and higher than what consumers have become accustomed to, particularly over the past decade.

The impact will not be spread evenly across different segments of consumer spending, with the prices of some components such as rent; services and some food products (e.g. meat and poultry), remaining stickier and higher in 2023.

If nominal wages cannot keep up with these high rates of inflation, consumers will continue to see erosions in their purchasing power. The uneven nature of price increases will mean that consumers will have to allocate more and more of their disposable income to meeting basic needs.

In Romania, consumer price inflation remains at double digits, reaching 11.2% annually in April 2023 (latest data available). Food inflation remains high at 19.8% y/y in April 2023 (latest data available), however both food and headline inflation are showing signs of easing after a high start over T123.

Inflation below 10.5%

Fitch forecasts that consumer price inflation in Romania will average 10.5% in 2023, down from an estimated average of 13.8% in 2022. Price growth should begin to slow in 2023 as disruptions it fades and the base effects become more favorable.

However, inflation will remain well above the 3.5% average seen in 2017-2019, before the Covid-19 pandemic. This means there will be continued pressure on consumer purchasing power as food and energy claim larger shares of household income.

Many markets boasted strong post-Covid labor markets driven by rapid economic recoveries locally and globally. In addition, governments have been very supportive of local labor markets, leading to tight markets that have pushed nominal wages up.

While inflation erodes real income gains, the strong labor market was a major driver of strong real growth in consumer spending in 2022. However, with many global economies set to slow or even enter recession in 2023, we begin to highlight rising unemployment as a risk to our near-term consumption outlook.

In Romania, the unemployment rate (as a % of the labor force) has recovered from a peak of 6.0% in 2020 during the height of Covid-19, falling to an average of 5.6% of the labor force in 2021 and 2022. , our Country Risk team expects this rate to accelerate marginally in 2023, averaging 5.8% over the year.

This will remain above the pre-Covid average of 4.0% seen in 2018 and 2019. If economic conditions worsen in the market, there is a risk of increased unemployment, which will quickly fuel a weaker consumer outlook.

Interest rate risk

Interest rate risk arises for owners of debt or bonds from fluctuating interest rates. How much interest rate risk a bond has depends on how sensitive its price is to changes in market interest rates.

Over the past two years, interest rates have risen from historic lows, where households and consumers took on significant amounts of debt, to higher levels than before Covid.

Different depending on the type of debt, many financial institutions have significant interest rate risk on these types of products. This has the potential to spread across sectors. Households and consumers are servicing this debt at significantly higher rates, with the risk of straining already strained disposable incomes.

These elements can mean a negative wealth effect for households, which can quickly cause consumers to reduce their discretionary spending.

We caution that inflation is still significantly higher than the central bank's target range of 1.5%-3.5%, suggesting the bank will be under pressure to continue its tight monetary policy in the coming months. Consumer spending will be weighed down by higher interest rates, which will force households to devote more of their disposable income to debt repayment.

The National Bank of Romania (BNR) took the decision to maintain its benchmark policy rate at 7.00% on May 10, 2023. The policy rate was maintained after 11 consecutive increases that raised it by 575 basis points above the 1.25% level it was at. before the current cycle starts in October 2021. We expect the NBR's rate hike cycle to end as cost of living concerns continue to rise, although we expect it to remain cautious on price pressures.

We currently project a year-end policy rate of 7.00% in 2023; as a result, we anticipate that the BNR will maintain its rate throughout the year, in response to the relaxation of inflationary dynamics and a tempering of the downward pressure on the Romanian leu, especially as the effects of previous rate increases are beginning to trickle down into the economy.

In September 2022, the Romanian government decided to extend a support scheme to protect households and small businesses from rising energy bills until the end of August 2023. The country capped gas and electricity bills for households, small businesses, hospitals and institutions public up to certain monthly consumption levels and compensating suppliers for the difference from November 2021. The first scheme operated until March.

The second was originally scheduled to run until the end of March 2023, but has now been extended. Besides extending the deadline for the scheme by five months, the government has also reduced the level of monthly consumption that will benefit from the price cap. These measures should support consumer spending in 2023, protecting households from rising energy prices.

Furthermore, to support vulnerable households facing the high rate of inflation, the government announced in November 2022 that pension recipients of less than 3,000 lei per month will receive semi-annual payments of 600 lei-1,000 lei in 2023, depending on individual pensions.

Beneficiaries of pensions of less than 1,700 lei per month will continue to receive "social vouchers" of 250 lei, bimonthly, in 2023. In addition, energy vouchers worth 1,400 lei will be paid in two equal installments to beneficiaries in aged 60 or over who receive pensions of less than 2000 lei per month. Walks to the minimum wage and child benefit from January 2023 should also support consumer purchasing power among low-income households.

The broader economic challenges facing households and consumers stem from the reopening of post-Covid economies. Inflationary pressures are driven by demand- and cost-pull inflation. In an attempt to tame inflation, central banks have raised their policy rates to some of the fastest rates ever, making debt issued during the historically low interest rate period less valuable.

Combined with the tightening of quantitative easing, financial institutions face liquidity problems and severe interest rate risks. While this is a relatively new issue, ongoing factors such as labor market dynamics and the Russia-Ukraine conflict continue to put downward pressure on our consumption outlook.

The economic trajectory of the post-Covid recovery of many markets highlights the risk of rising unemployment and its impact on our outlook for consumption on the short term.