Romania's Q2 GDP Shrinks Less Than Feared, But Risks Mount

Romania's economy contracted by 0.4% in the second quarter compared to the same period last year, a much milder decline than the 1.5% drop analysts had predicted. The flash estimate from the National Statistics Board also showed that GDP was flat on a quarterly basis. A detailed breakdown of the figures is expected in September.

The better-than-expected performance offers some relief, but the broader picture remains fragile. Domestic demand has been weak since the government raised taxes and cut spending last year to tackle the EU's largest budget deficit and protect its investment-grade credit rating. This has made Romania an outlier in central and eastern Europe, where household consumption is driving growth in countries like Slovakia, which expanded 0.7% annually in the same period.

Looking ahead, several factors threaten to weigh on output in the second half of the year. A severe drought has pushed the Danube River to record lows, forcing the complete shutdown of Romania's sole nuclear power plant on Thursday. This will likely hit energy supplies and industrial activity. Additionally, fuel prices have risen due to conflict in the Middle East.

Political instability adds another layer of risk. A pro-European coalition government collapsed in May and has not been replaced, stalling policymaking and threatening investment. While Romania narrowly avoided a credit rating downgrade to junk by Fitch in late July, Moody's has indicated that the country's ability to pass a 2027 budget with further deficit cuts will be crucial for maintaining its rating.

Erste Bank projects a mild recession of 0.3% for the year, anticipating strong investment activity and substantial EU fund inflows. However, the bank cautions that the ongoing political situation poses significant downside risks to state investment and, consequently, to GDP growth.