European Frontier Markets: Romania – frontier sweet spot, with a political twist

Following the shock in December 2018, when the government surprised the market by introducing taxes across some sectors of the economy, the Romanian market has been one of the best performing in the EM universe, with the BET index (including dividends) returning 36% ytd. The political environment is improving, following the weak results of PSD and ALDE in the European Parliament elections in May, and ALDE subsequently breaking the coalition with PSD in August, with the capacity to implement changes affecting the business sector being significantly reduced, in our view. The macro context is also supportive, having outperformed our expectations so far this year, and showing signs of limited external contagion from the weakness in the German economy, while we expect GDP growth at 4.2% over the next couple of years. The stock market’s size and liquidity remain an issue in terms of MSCI promotion to EM, but the market infrastructure is there, while Romania should benefit from Kuwait’s upgrade in 2020E. With a 1YF dividend yield of 8%, Romania is the highest yield market in the EM/FM universe, while the MSCI Romania index is trading at a 1YF P/E of 8.4x, 13% below its long-term average, and at discounts of 35% and 21% to the MSCI EM and FM, respectively, which support a continuing case for having a positive view on the market, when combined with the favourable macro and political context. The budget deficit remains an issue, particularly as we are in a full election cycle, and an adjustment will temper growth; however, with the debt to GDP below 40%, and the adjustment split over a couple of years by the EU, we do not see this as a structural threat.