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Thursday, August 9, 2007

Romanian Inflation

From Bloomberg today:

Romanian Central Banker Says Inflation Risk `Serious'

By Adam Brown

Aug. 8 (Bloomberg) -- The National Bank of Romania Governor Mugur Isarescu said risks of missing his inflation forecast are ``more serious'' as wages rise and the government spends more.

Average annual wage increases of more than 20 percent and plans to widen the government budget deficit to account for more-generous social programs and building projects may force the central bank to miss its year-end annual inflation forecast of 3.9 percent, Isarescu said in an interview in Bucharest today.

``We are not introducing uncertainties into our projection,'' Isarescu said. ``I have to stress that our list of uncertainties, risks associated with the projection, were more powerful. This time some risks are pretty serious.''

Isarescu, who has headed the bank since 1990, with a one- year break to serve as prime minister, faces pressure from the European Union to slow inflation and take other measures to ensure the country can adopt the euro After it joined the 27- member bloc in January.

The central bank's inflation projection of 3.9 percent at the end of this year is down from 4.9 percent at the end of last year and 8.6 percent a year before that.

The annual inflation rate in July, to be released by the statistics office on Aug. 10, was between 3.8 percent and 4 percent, Isarescu said. That's lower than the 4.4 percent median estimate of five analysts.

Wage Growth

He said wage growth, which accelerated to an annual 23 percent in June, was also the main factor in the central bank's decision on July 31 to leave its key interest rate, the monetary policy rate, at 7 percent after cutting it four times earlier in the year. At the start of 2007, the rate was 8.75 percent.

``On the macro policies, we have to compensate this rapid increase in wages by something,'' Isarescu said. ``This is why we stopped decreasing the interest rate.''

Wage gains, which include the government's 20 percent pay increase to state employees this year, have ``eroded all the stock of productivity gains which have been added since 2005. Along with the appreciation of the currency, it's also contributing to the erosion of future productivity gains. There is a risk of a correction in incomes.''

Budget Revenue

Isarescu also warned that the government, which plans to widen its budget deficit to 2.8 percent of gross domestic product and 2.7 percent of GDP next year from 1.7 percent of GDP last year, should not overestimate budget revenue to compensate for underestimating them in the past.

``In the last two years we totally underestimated budget revenue,'' he said. ``I warn that it's not at all the case for the government this time to continue this very positive budgetary projection based on the past. There is no room for such a continuation.''

Another serious risk to inflation, Isarescu says, stems from more-volatile swings in the leu, which has gained 6.6 percent against the euro and 11.6 percent against the dollar so far this year, making it the world's seventh-best performing currency. The leu's strength slowed price gains of imported items and goods and services gauged in foreign currencies, such as telephone bills, rents and gasoline.

``There's at least an equal possibility for the exchange rate to go either way at this time,'' Isarescu said. He said the ``very appreciated'' exchange rate may be vulnerable to strong swings in the opposite direction.

``The risk of overvaluation is to move in the opposite direction much more strongly,'' he said. ``Financial markets, particularly the foreign exchange markets, tend to overshoot. The central bank is very limited to doing something to this natural tendency to overshoot.''

He also predicted the country will meet its goal of joining the European Central Bank's exchange-rate mechanism, a precursor to adopting the euro, in 2012 and adopt the currency in 2014, if not earlier.

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