Romania's deficit reduction efforts depend on political stability, Fitch says

BUCHAREST (Reuters) - The implementation of tax hikes and other measures to lower Romania's deficit, the EU's largest, depends on the stability of its new broad coalition government and will inform its ratings, Fitch Ratings said on Tuesday.

The EU and NATO member has been rocked by political instability in the wake of a presidential election, which was cancelled in December and re-run in May, with market turmoil boosting borrowing costs and crashing the leu currency.

The extended election cycle inflated Romania's budget deficit above 9% of output last year and the risk of a downgrade to below investment grade appeared imminent. But financial assets stabilised by end-June when a new broad coalition government announced a series of tax hikes.

However, the four parties that form the government of Liberal Prime Minister Ilie Bolojan were reluctant to enforce the unpopular tax hikes and planned cuts to state spending, which have been criticised by unionists and employers and triggered protests by public sector workers.

The parties have also agreed to rotate prime ministers from Bolojan to the centre-left Social Democrats before 2028 parliamentary elections, running the risk of policy disruptions. The two parties already disagree on income tax.

"Significant fiscal consolidation will weigh on economic growth, and implementation risks cannot be discounted," Fitch said in a statement.

"Coalition dynamics and the implications for fiscal settings beyond next year could shift as its two largest parties ... have agreed that Bolojan will make way for a new prime minister from the Social Democrats in 2027."

The government will raise value-added tax, excise duties, levies on dividends and banks' turnover, and a series of other measures, some from August and others from January, with a budget impact of 1.1% of output this year and 3.5% in 2026.

Fitch, which like rival agencies S&P Global and Moody's rates central Europe's second-largest economy on the lowest rung of investment grade with a negative outlook, holds its next review on August 15.

(Reporting by Luiza Ilie; Editing by Joe Bavier)