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Tuesday, December 16, 2008

Romania Accepts Budget Deficit Exceed 3% GDP, Industrial Output Falls Sharply

Romania’s premier-designate Emil Boc admitted today that the 2008 budget gap may exceed the European Union limit of 3 percent of gross domestic product.

“Our budget deficit stands between 3.5 percent and 4 percent of GDP this year, we’re outside the EU treaty,” Boc, who was nominated yesterday to be prime minister, said in Bucharest today.


The outgoing government had previously targeted a shortfall of 2.3 percent of GDP this year and 2 percent next year. The EU stability and growth pact requires governments to keep their budget deficits below 3 percent of GDP, and provides for financial penalties for countries that breach the ceiling. Even if the policy is likely to be flexibilised in 2009 given the severity of the economic slowdown, this stance is hardly applicable to the Romanian case, since the economy was in effect booming during most of 2008, and the bubble only finally burst during the financial crisis of October.

The spending program of the new government, which was published today by Romanian newswire Mediafax, includes plans to reduce spending next year to narrow the budget deficit to 2.5 percent, but we will see if this move is now enough to satisfy officials in Brussels and analysts at the credit ratings agencies. Romanian sovereign debt was effectively lowered to junk bond status by Standard and Poor's last month, and there is of course no possibility of euro membership with such a rating.


The draft also includes a 45 percent pension increase and an increase in the minimum wage to 600 lei ($208) from 540 lei as of Jan. 1, a reduction of the value added tax for staple foods, infrastructure investments and incentives to companies to stimulate growth and create jobs. Contrarian voices were thus not hard to find and Varujan Vosganian, the outgoing Liberal finance minister, told Realitatea TV in an interview today that the measures included in the working draft will push the budget deficit to 6 percent of GDP next year.



The Liberal Democrats and the Social Democrats, who formed a governing coalition with a two-thirds parliament majority on Dec. 14, also agreed to keep a 16 percent flat tax over the next years.

Industrial Output Falls Back Sharply In October


More evidence that a major contraction of economic activity is now underway in Romania came in today with the publication by Eurostat of the harmonised industrial output data for October. Output in Romania fell a seasonally adjusted 3.4% from September, and 3.2% from October 2007. In fact the rate of expansion in Romanian industry has been slowing since the spring, and as you can see in the chart below we are simply moving over to negative readings on a year on year basis. Still this data will now start to give us a nice handle on the actual rate of contraction as it takes place.





The Leu Being Dragged Down By The Zloty


Poland's currency is falling very sharply at the moment, as the slowdown in Western Europe reduces demand for its industrial products and an internal credit crunch slows down domestic demand. The zloty had its biggest intra-day drop in a month today, falling to its lowest level in more than two years, amidgrowing concern the economic slowdown is worsening. The zloty was down as much as 2.5 percent at one point, falling to 4.0812 per euro, its weakest level since July 10 2006, and passing through the psychologically important 4 per euro level. The zloty has been the worst performer over the last month among regional peer currencies when compared with the euro.

The Romanian leu fell today to 3.9462 per euro from 3.9426 late yesterday, while the Hungarian forint dropped 0.2 percent to 268.34.

Saturday, December 6, 2008

Romania's Economy Heads Off Quietly And With No Fanfares Into It's Deepest Crisis in a Decade

Before I go any further, let me first apologise to any regular readers this blog may still have. Daddy has been very much away on business I'm afraid, and for far too long. What with all the things that have been happening out there, I just haven't had the time to put pen (or my thoughts) to paper on Romania. This absence has been doubly regretted by me at least, since while I think the economic outcome of Romania's boom-bust cycle is unfortunately all too predictable, we are still sitting in the waiting room, and the emergency dentist (which in this case will probably be the IMF) will only be able to get to grips with the patient when the root problem afflicting the tooth becomes more apparent (and simply unbearable), and at this point we are still some way little way off from that stage. Meanwhile we simply apply the antibiotics and the anti-inflamatories, in order to calm the troubled nerve as best we are able.


Controversy surrounding the Romanian economy is nothing new, nor, as Manuel points out in his post on the recent election, are Romanian politics strangers to tumult. Nonetheless the intensity of controversy has grown considerably of late, with a wide variety of assessments being offered concerning the likely impact of the intensifying international credit crisis on the short to medium term outlook for the Romanian economy. National Bank of Romania (NBR) governor, Mugur Isarescu, has been consistently arguing that the country should be able to avoid an excessively "hard landing"as the bank attempts to cool its evidently overheated economy and engages of fire-extinguising activities in the banking sector trying to control the impact of set of adverse external circumstances that are largely beyond its control. But most of these comments (or at least the more convincing ones) preceded the meltdown in the international financial markets which followed the Lehman Brothers bankruptcy, the fallout from which has surely had a strong negative impact on Romania's economy and greatly complicated the task of conducting macroeconomic policy which faces the new government to be be formed following last weekends elections.

The other complicating factor has been the "own goal" scored recently by the Romanian political process, with one politician after another proposing fiscal deficit raising policies, at just a time when the international financial markets have become extremely sensitive to just this development in countries which are, due to their large current account deficits, mainly dependent on external borrowing to finance their lending needs. The accommodative fiscal policy being run by the Romanian government has also been extremely ill advised at a time when the central bank was busy trying to cool overheating by applying a restrictive monetary policy. For policy to be coherent, the two main levers need to be operated in tandem, and not at cross purposes.

However, despite all odds, Romania has been hanging on in there, and GDP remained strong in the third quarter, a situation which has lead some commentators to use the term "gravity defiers" to describe those East European economies, like Romania and Bulgaria, that have so far avoided having a sharp adjustment, despite having evidently unsound macroeconomic fundamentals, and in particular unsustainably large external deficits.

Not everyone has been convinced by the positive posture being assumed from within Romania, however, and Fitch Ratings agency had already downgraded Romania's outlook (together with that of the Baltic states and Bulgaria) from stable to negative by August pointing out in the process that the economy was extremely vulnerable to external financial pressure. This association of Romania with the Baltics is not incidental, since the Baltic economies were until only very recently - as Romania is now - the fastest growing in the European Union (with rapid credit expansion and large current-account deficit, sound familiar) but have subsequently experienced a very sharp growth slowdown following a sharp tightening in domestic credit demand and a dropping-off of external demand after high internal inflation fuelled by very large annual wage rises destroyed competitiveness. Indeed both Latvia and Estonia are now in deep recession, and have moved in a matter of months from being the EU's fastest growing to being the EU's most rapidly contracting economies. This is precisely what the expression "boom-bust" really means.

The million dollar question at this point is whether or not the Romanian economy is destined to follow along the same path. In the analysis that follows I will basically be arguing that this is exactly where the Romanian economy is now headed. Some evidence to back the view can be seen in the latest reading on the EU economic confidence indicator (see below) which after months of trending slowly and steadily downwards suddenly lurched sharply south in October and November. Another detail which we would do well to bear in mind is that after many months of consecutive rises, seasonally adjusted retail sales fell in Romania (by 2.1%) in October over September. Indeed a growing quantity of anecdotal evidence now suggests that something important changed in Romania in October, even if we may yet need to wait several months to see the in the cold clear light of day the actual consequences of what happened. Another signal we have is that all is not exactly well, is that the number of newly-established companies increased only 0.7 percent in the year up to mid-November when compared with the same period last year, while bankruptcies soared according to the latest data from the Trade Registry Office (ONRC) - and in fact October was the month with most cases of insolvency, up a whopping 79 percent over October last year. In addition Romania's banks experienced a sharp liquidity crisis in mid October (see more below) and needed to borrow a total 49 billion lei (13 billion euros) in October from the central bank (using its lombard credit facility). This is 28 times the total amount borrowed between January and September 2008, according to NBR data. Banks only borrowed 20 million lei in lombard credits in September, while the total value of the loans issued was 1.75 billion lei between January and September.







Events Take Their Course


A capital-inflow-driven absorption boom has underpinned rapid catch-up growth but also fuelled macroeconomic imbalances. In particular, the external current-account deficit has risen to unsustainable levels. And, since mid-2007, headline CPI inflation has surged well above the central bank’s target, in part reflecting the firstround effects of food and energy price shocks. Rapid credit growth has raised risks to financial stability, although the largely foreign-owned banking system remains wellplaced to absorb shocks. In this setting, fiscal policy has been highly procyclical and lacked medium-term orientation.
IMF Article IV Consultation, July 2008



The IMF quote above basically spells out the general understanding economists have of what has been happening in Romania. Real GDP growth has been robust,but has increasingly been running up against capacity bottlenecks. Largescale emigration, notably to Italy and Spain, and high demand for workers, especially in construction, have resulted in tight labor market conditions. As a result, real wage growth has outpaced productivity growth, with buoyant public-sector wages adding to private-sector wage pressures. With core inflation under pressure, headline inflation has surged, partly owing to the firstround effects of shocks to energy and food prices, and to some extent reflecting the 2007 drought. However the initial shock has evidently moved over into second round effects, and price setters, faced with higher unit labor and other input costs, have been struggling to maintain their markups, as also indicated by surging producer-price inflation.

It is in this context that the fact that fiscal policy stance in 2007 was highly procyclical becomes a problem. The fiscal deficit increased in 2007 to 2.25 percent of GDP, up from 0.5 percent of GDP in 2006. Adjusted for the automatic effects of the booming economy on the fiscal position, the IMF estimated that the 2007 structural deficit rose to almost 4 percent of GDP. As a result, the fiscal stance was highly expansionary, adding an estimated net fiscal stimulus of 2 percent of GDP to an already overheating economy. Thus the Romanian economy was simply booming along just waiting for something unfortunate to happen, and, of course, true to form and as was to be expected, it eventually did.

Octobers "Sudden-Stop" Credit Crunch

Bank lending seems to have ground to a virtual halt in Romania in mid October (and October is the latest month for which we have statistics from the National Bank of Romania). After rising at a monthy rate of 4% (or a 50% annual rate) in September, total lending to households and non financial corporations actually fell in October (when compared with September) by 0.6%. For an economy which has been experiencing a debt driven consumer and construction boom it is hard to overstate the significance of this single fact. We seem to have what is known as a "sudden stop" in aggregate bank lending here, and the Romanian economy may now well fall rapidly into recession, following the tried and tested path so recently pioneered by Latvia and Estonia.

While RON denominated lending continued to advance slightly, the largest hit appears to be being taken - not really surprisingly - by forex loans, which fell in total by 1.5% in total month on month (-1.9% corporates, -1.2% households). Given that the RON strengthened slightly against the euro during the month the decline was probably less than it appears (since the book value in RON of forex loans falls when the Leu strengthens - and vice versa - and this revaluation is of course the great danger represented by a sudden Leu slide, since not only will the monthly payments on the mortgages shoot up, so too will the capital value of the outstanding mortgage, as anyone unfortunate enough to have taken out a loan in Japanese Yen, or CHF, surely already knows to their cost). But basically, since the currency fluctuated wildly but was actually up against the euro by 1.5% in October, we really do need to wait till we get to see what happened in November to have a clearer picture.



However, if we look back over the two months of September and October (where the currency fluctuations to some extent cancel each other out, but that overall the leu weakened 4.5% against the euro) then it is clear there has been a sharp slowdown in forex lending, and the effects of this slowdown will gradually be felt over the next six to nine months. Well, gradually or not so gradually, since new car sales (which obviously normally need finance) fell by nearly 30% year on year in October (to 20,478 from 29,347 a year earlier), according to the latest data from the Romanian Association of Automobile Producers & Importers. Basically if we look at the pattern which we can see in other economies which have been affected by the credit crunch, what started off as a slowdown in demand for cars as oil prices rose "transited" to an inability to finance purchases as oil prices fell back again. Hence the current difficulties of motor industry "majors" like Ford and General Motors.



Fiscal Deficit Issues

Another area of concern has been Romania's budget deficit, which stood at 2.4% in 2007, and is expected to widen in 2008 and 2009 . A number of factors are contributing to this steady deterioration:

1) the rising cost of government borrowing;
2) forecasts of a sharp decline in GDP growth for 2009
3) enactment of spending pledges made by candidates ahead of Nov-08 elections


Romania's loose fiscal policy stance and the growing public spending commitments were among the key reasons cited by credit ratings agencies for the recent downgrades in Romanian debt to what is effectively 'junk' status. Indeed Finance Minister Varujan Vosganian recently estimated that spending increases authorised by parliament before last weeks elections could widen the budget deficit considerably beyond the EU’s 3% of GDP limit, and some estimates suggest that, on a worst case scenario, it could possibly even amount to as much as 7% of GDP in 2009.

Indeed it looks as if the deficit could even pass the 3% level in 2008 (the year of such a rapid expansion, there is surely no excuse for this) since the 11 month budget deficit widened to 2.9% of GDP following a sharp drop in budget revenues over the last two months according to Varujan Vosganian last week. Vosganian told a press conference that budget revenues in October and November were 1.3 billion euros below the projected level.

Perhaps the highest profile decision in the context of the recent Romanian fiscal deficit "cause celebre" was the one taken on 8 October by the Romanian Parliament, when it agreed to a pay rise for teachers which was calculated to be in the region of 50%, and this against the explicit wishes of Calin Popescu Tariceanu, the prime minister, who headed the then minority liberal government. The main worry arising from the teachers’ pay increase, aside from the concerns over how it will be funded, centres on the impact it will have on the pay demands of other public-sector workers and, in turn, of private-sector workers. If such wage pressures are not resisted, then they will obviously only weaken further an already weakened Romanian competitiveness and in all probability would drive inflation back above the 10% mark in 2009. This would be the result in normal circumstances, but the Romanian economy is not in normal circumstances right now, and it is highly unlikely that the present credit crunch and the pressure from the international financial markets will leave time for this inflation spiral to run its course. Much more urgent matters are likely to make their presence felt first.

Varujan Vosganian seems to be tirelessly explaining in the face of deaf ears that the proposed increase could push the budget deficit up in the direction of 7% of GDP in 2009, as no provision had been made to raise taxation, and the outgoing government issued an emergency ordinance on October 28th postponing the increase, following a warning from the IMF about the likely fiscal consequences.

Defenders of the recent decisions, however, are quick to point out that Romania's accumulated public debt, at around 12% of GDP, is still extremely low. But this is to miss the force of the macroeconomic argument against running such annual deficits at time of high GDP growth. Basically, at this point, the Romanian economy has been overheating (and has not been stuck deep in recession), so the principal macro argument would be in favour of fiscal surpluses (and substantial ones, say 3% or 4% of GDP) to try and drain excess demand from the system. This is doubly the case when you look at the underlying difficulties of applying standard monetary policy (the central bank has been raising interest rates since to try and keep inflation better under control) in a context where foreign exchange denominated loans have been freely available at what effectively amount to negative interest rates.


Although the government has made an effort to promote a more prudent fiscal policy, the temptation to win more voters has proved to be stronger. Consequently, the government decided to increase the benchmark index for calculating individual pensions by 20 % to RON 697.5 as of November earlier than originally planned. The benchmark index was already increased in November 2007 by 35 % and by another 7.5 % in January 2008. It will be further raised next January to complete the promised reform of the pension system aimed at bringing the average pension to 45 % of the average gross wage from the level of 35.5 % in November 2007. Doubtless we will soon here complaints about how "internation financial speculators" have brought the Romanian economy to its knees, but such voices would do a lot better looking at the degree of responsibility exercised by Romanian politicians in the face of the world's worst financial crisis in over 75 years, in a climate were concerns about procyclical fiscal deficits are known to be widespread.

Substantial Inflation Pressures Remain

Inflation lies at the heart of the mechanism which has been steadily - via the expansionary fiscal posture - undoing the Romanian economy, and, right on cue, Romanian inflation increased again in October, hitting 7.4 percent, after dropping back to 7.3 percent in September. Consumer prices were up 1.1 percent month on month.



In the Romanian context it is impossible to relate this inflationary pressure exclusively to rising energy and food costs, doubly so since these latter have now been falling steadily since July. The Romanian economy has been running at a much faster pace than it can comfortably sustain, and nowhere has this been clearer than in the strong upward pressure on wages, with net wages growing at an annual 24.6 percent in September while unemployment continued to hover near a 16-year low. In fact annual net wages increases have averaged around 24% over the last 6 months (see chart below), while real wage increases (allowing for inflation) have averaged around 15% throughout 2008.




Monthly unemployment has been running at around 3.9% of the labour force (or 350,000 people) according to data from the Romanian Labour Ministry, or at around 5.9% according to the EU harmonised rate published by Eurostat (the difference between these two numbers is due to the different methodologies and criteria used). In either case these are historically quite low rates for the Romanian economy, and it needs to be borne in mind that there are at least a million Romanians (or another 10% of the labour force) working abroad (largely in Spain and Italy) most of them sending monthly remittances home to their families and relatives, remittances which in their turn fuel domestic demand, demand which the economy lacks sufficient capacity to meet without putting pressure on inflation.

Of course, having made the point so forcefully about how much of a problem inflation has been in the Romanian economy, I think I should point out that this problem may well be set to disappear, or at least become somewhat less important in the general picture, should the Romanian slowdown prove to be as dramtic as I fear it might. We could move very rapidly from a situation of undercapacity and overheating to one of excess capacity, and sharp cooling as domestic demand folds and exports stagnate. Naturally everything depends on what happens to the Leu, since if we see a further substantial weakening in the currency this in itself will tend to add to inflation pressures, depending on how large a fall in the currency we are talking about.


Monetary Policy and the Leu

The Romania central bank which has been using monetary policy as best as it is able to try and fight the inflation threat, kept its key policy rate - which is the second highest in the EU after the 11% rate in Hungary - unchanged at 10.25% in October, although they did lowered reserve requirement on leu deposits (to 18% from 20%, as of November 24) in an attempt to ease the growing pressure on domestic liquidity which has been so evident since the mini financial crisis of mid October.



Further monetary tightening (following the Hungarian example) might have seemed a more prudent strategy, particularly given the current comparatively low level of the real policy rate (only 2.75% above inflation), the continuing inflation pressures, the continuing loose fiscal stance and the recent credit rating downgrade from S&P. There is also the credibility issue to take into account, since Romanian inflation is still running well above the central bank year end target of 3.8%. On the other hand, if we take account of the rapid deterioration in the internal economic climate since October, then exercising caution may have been more sensible than it seems at first sight. The problem is that the Romanian central bank - like its Hungarian counterpart - is now caught between the need to protect the value of the Leu (given the prior level of forex borrowing) and the need to try to offset the rapid and dramatic decline in internal demand.



Just what kind of pressure we could see on the Leu in the coming weeks was illustrated during the days between 10 and 20 October, when the tremendous pressure on the currency (see spike in chart above) forced the Romanian cenbank to intervene directly in the foreign exchange market to defend the currency. Questions remain about the extent to which any local tightening policy can work while private indebtedness continues to be fueled by forex denominated (largely euro) loans and the NBR is sure to face increasingly difficult decisions as growth slows in the coming months

In fact central bank Governor Mugur Isarescu argued that the bank responded to an "attack on the leu'' which had drained lei from the market and driven overnight interbank market rates sharply higher. The Banca Nationala a Romaniei sold 40 million euros on October 10 for lei on the interbank market and the Finance Ministry sold 291 million lei of three-year bonds on October 16. Overnight Interbank Bid Rates (ROBID) soared to 19 percent on October 17 (up from 16.53 percent on October 16) as banks frantically tried to get their hands on lei. Rates have subsequently come back down again, but at the start of December they were still hovering in the 12% to 13% range, well above the 7% to 8% range of January 2008, and also well above the 10.25% targeted central bank policy rate. Basically these rates seem to have gotten completely out of alignment with central bank policy towards the end of August, and there seems to be little evidence (or likelihood) that they will be coming back into line anytime in the near future (see the time series for yourself here - also anyone looking for a quick and handy list of banks with exposure to the Romanian market, the quoting banks for ROBOR are ABN Amro, Bancpost, Banca Transilvania, BRD Groupe Société Générale, BCR, CEC, EximBank, ING, Raiffeisen Bank and UniCredit Tiriac Bank).

Some analysts question whether Romania can fin­ance its 59 billion euros in external debt without International Monetary Fund support of the kind secured by neighbours Hungary and Ukraine if such "attacks" continue to occur. The leu has now slipped 7 per cent against the euro since August, while the Romanian stockmarket is down 71% in the year to date and the leu has weakened by 21% against the US dollar over the same period.

Romania's GDP Continues To Grow Strongly


Romania's economy continues to put in a very strong performance and grew by an annual 9.1 percent in the third quarter, driven forward by the continuing consumption and lending boom, although most observers - including the the government - are agreed that all of this is now about to slow, and sharply. Indeed the government itself has forecast that growth will slow to about 4.5 percent next year, although others consider this to be rather overoptimistic under the circumstances and the big question is, just how "sharply" is sharply? Are we about to see one of those famous "hard landings"? There are reasons for believing that we may well be.

At this point it is very hard to see just how far the economy actually slowed in the third quarter (at an annual rate it fell back from 9.3% to 9.1%, which really doesn't seem like very big beer), in the first place since we still lack detailed data, and in the second because don't publish or supply to Eurostat seasonally adjusted quarter on quarter data, which is really the most informative number we could get are hands on at this point, if it existed. So we are really stuck with "proxies" like short term retail sales data, and confidence indicators (unfortunately Romania doesn't seem to have much in the way of PMI surveys).


Despite all this, you could say, couldn't you, that Romanian GDP growth still does look pretty robust. You could say this, that is, until you look at what actually happened to Latvian GDP growth following the onset of a credit crunch in that country. As we can see in the chart below, the Latvian economy was cruising along at a nifty 11% annual growth rate until the third quarter of 2007, at which point things started to go nastily wrong, and headline GDP growth fell off a cliff, reaching the dizzy low of around minus 5% a mere four quarters later. And of course Latvia is now stuck in a very, very deep slump.


So just what happened? Well basically, the Latvian economy was being driven to grow way too fast by a rapid increase in foreign exchange credit. And Latvia, like Romania, had large numbers of workers outside the country, busily sending home remittances, while wage inflation at home went up and up. As we can see in the chart below, this credit was effectively cut back sharply in the spring of 2007, and down came the Latvian economy on the back of the cut. As we can see in the earlier chart I presented, year on year increases in Romanian forex lending have now been slowing since the mid summer, and I think it is not unreasonable to suggest that there is a strong danger of following the Latvian path, especially after the "short sharp shock" of mid-October.

So just when will Romania enter recession? At this point it is hard to say, but if the Latvian pattern is anything to go by, negative year on year growth could arrive as early as Q3/Q4 2009, and we might even see quarter on quarter contractions starting with Q1 2009 (although we won't necessarily know this, since, as I say, the data we need simply isn't published).

Government Aid Package

In response to this deteriorating outlook the outgoing government did announce a stimulus package, which is scheduled to take effect in January, and involves items like exempting reinvested dividends from a 16 percent tax, giving companies a bonus of 1,000 euros for every person they hire who has been unemployed for more than three months and faciliating 500 million euros worth of investments and other aid for farmers. There is also an allocatation of 3 billion euros for job-creating investments, lower social insurance payments and a 250 million-euro credit line for medium and small businesses via a cash injection into state-owned bank CEC.

The government will grant aid of as much as 50 million euros to companies planning to invest more than 100 million euros and create at least 500 jobs, according to the plan. Investments of less than 100 million euros that generate at least 300 jobs stand to receive aid which could total up to 28 million euros. It will also give companies a 5 percent reduction in their tax bill in exchange for paying taxes on time and exempt new car sales for a year from a "pollution tax'' that ranges from 150 euros to 700 euros per car.

Credit Downgrades


But all of this is likely to be of little avail, since it is mainly small scale counter cyclical stimulus if the international financial standing of Romania continues to deteriorate. In late October the international ratings agency Standard & Poor’s (S&P) cut Romania’s long- and short-term foreign-currency sovereign credit ratings from BBB-/A-3 to BB+/B, and its local-currency long-term rating from BBB to BBB-. S&P pointing out the growing risks posed by high and rising private-sector leverage and dependency on an increasingly uncertain external financing channel. Given the size of Romania’s macroeconomic imbalances, they argued, the economy is highly vulnerable to any sudden tightening in external financial conditions which could cause a sharp downturn in economic growth.

On November 10 Fitch followed suit, and downgraded Romanian debt - together with that of Bulgaria, Hungary and Kazakhstan - two notches to what is effectively 'junk' status (specifically BB+) as a result of their "concerns about the macroeconomic policy framework in Romania" and the country's ability to avoid a severe economic and financial crisis. Noting the widening current account deficit - which is expected to exceed 14% of GDP this year - a deficit which Fitch believes has been fuelled by excessive credit growth, the agency argued that a much stronger policy adjustment, especially in the fiscal policy area, would have been needed to avoid a currency crisis. Fitch specifically drew attention to the private sector foreign currency balance sheet mismatches, and argued that any imminent currency crisis would "require substantial external financial support from the international community to prevent a sovereign credit crisis."

Fitch specifically singled out Emerging Europe as the most vulnerable Emerging Market region to the deterioration in the global financial and economic environment owing to the fact that so many countries have large current account deficits and relatively high levels of short-term external debt, and that these render them particularly susceptible to reduced capital and financial market flows (including from foreign parent banks).


Since the onset of the credit crunch in August 2007, Fitch has now downgraded the foreign currency ratings of nine countries in emerging Europe (by a total of 11 notches), and this contrasts with just three upgrades that have been made over the same period. Eight countries are now on Negative Outlooks - which a record level for the region - while no countries are on Positive Outlooks, signalling that ratings remain under downward pressure.

IMF Aid In The Pipeline?


Obviously with the EU institutionally bogged down in its own issues of core and systemic bank bailouts, it is clear that the community's ability to offer meaningful assistance to Romania is going to be limited. Thus all eyes in Eastern Europe have been looking hopefully over in the direction of Washington, and the International Monetary Fund. The IMF has already offered aid to Hungary, Iceland, Serbia and Ukraine to help them cope with the difficult coktail of a credit drought, falling investment and shrinking government revenue. Romania, has so far not openly sought IMF help, although this does not mean that channels of communication and "dialogue" have not been opened. The sheer size of the current account deficit and the short term increase in the very sensitive area of government spending may make it increasingly difficult to fund the country’s $75 billion in external debt without IMF aid. In a statement to the local media, Juan Jose Fernandez-Ansola, the International Monetary Fund's (IMF) senior representative for Romania and Bulgaria recently observed that "The initiative to increase teachers' wages by 50% may need to be reconsidered. We estimate the impact on the budget would be modest in 2008, but would reach over 0.75% of GDP in 2009. In addition, if the increase were extended to other public sector employees, the impact could reach over 4% of GDP in 2009. This would send a wrong signal to financial markets." So it is not hard to see the kind of tack the IMF will be taking in any negotiations.

However, there are important differences in the monetary systems of Romania on the one hand and the Baltic states and Bulgaria on the other, and these differences may facilitate rather than complicate the issue of IMF aid. The Baltics and Bulgaria all operate some variant of the currency board system, whereby the currencies are pegged to the euro at a fixed exchange rate (or within a narrow band), a feature which effectively prevents these economies from conducting their own independent monetary policy, thus placing the entire burden of macroeconomic adjustment on fiscal policy. The appreciation of the euro against the US dollar damaged the competitiveness of those economies vis-à-vis those economies whose currencies are linked to the dollar. Romania's managed-float on the exchange rate side has, in contrast, provided it with greater flexibility and some ability to utilise monetary policy as part of its macroeconomic stabilisation programme.

Thus Romania has been able to resort to some degree of exchange rate depreciation to preserve external competitiveness over the past 12 months, while the central bank pushed up interest rates to keep real rates at positive levels and contain inflationary pressures. The complicating factor here has been the availability of substantial foreign exchange credit, at rates well below those imposed by the NBR. This has undoubtedly taken much of the cutting edge off central bank monetary policy in the short term, although as we are seeing, this supply of cheap credit has now, suddenly, "run dry".

At the end of the day there is substantial agreement between all the main institutional actors (leaving aside Romania's own political class) - the NBR, the IMF, the EU Commission and the ECB - that Romania's external deficits are unsustainable in the long run; that fiscal policy has been ill-advisedly pro-cyclical; that wage growth has been excessive; that rapid credit-growth has been fuelling an unsustainable growth in consumption; and that a sharp and significant correction is now about to take place.

The Immediate Outlook


This year's extremely good agricultural harvest has undoubtedly offered strong support to headline GDP growth in recent quarters, but this fortuitous virtuous circle may well repeat itself in 2009. On the other hand, the financial position of private households, after becoming ever more strained as domestic interest rates have steadily risen, together with the costs of servicing a growing volume of private debt, may well now deteriorate substantially as the lack of available credit and the rising layoffs in manufacturing industry exert an ever-tighter grip. In general terms, private consumption was already slowing before the onset of the credit crunch in October, and increased by 12.2 % yoy in Q2, following the record high of 14.3 % yoy in Q1.

Investments also continued at a strong pace in Q2, driven mainly by new construction projects (up 34.8 % yoy), while investments in equipment was already slowing (down to 23.8 % yoy in Q2). In the first half of the year the construction sector absorbed 20 % of total investments in the economy, and it is this sector which will now be particularly hard hit.


Slowing construction activity is now expected for the rest of the year, and should become more pronounced as we enter 2009 and new project steadily dry up. Prices of new housing and real estate transactions generally have been losing momentum in recent months, especially in the capital city Bucharest. This slowdown can also be observed in the national construction activity index, which has seen the value of construction works drop to an annual 19.1 percent rise in October (down from 28.3 percent in September, and down even further from the average 33 % yoy increase registered in the first half of 2008) . Month on month, construction growth slowed to 5 percent in October from 8.5 percent in September. More importantly, the number of new building permits issued has now been showing a steady monthly decline. Evidently the volume of construction activity continues to rise (even if at a slower pace) since existing projects need to be completed - credit crunch or no credit crunch, and regardless of whether there will actually be buyers for the completed properties. But at some stage activity may well grind to a near halt, as the appetite for new building projects suddenly evaporates. This is what we have seen in other similarly affected economies, and there is no good reason why Romania should be any different here.

This view is reflected in the recent press statements made by Gabor Futo, executive manager of real estate developer Futureal Group. Futo takes the view that no new real estate projects will be started in the next two years and that 90 percent of the forthcoming ones already announced will be called off for lack of financing. Futo testifies to the way in which banks are now much more cautious in making loans and how developers are experiencing increasing difficulties in obtaining financing. Futureal recently started work on the new commercial center "Gold Plaza" in the northern city of Baia Mare. The center will have 30,000 square meters - all of them available for rent. The project aims to be completed in the first quarter of 2009 and will cost about 97 million euros. The company is a leading developer in Central and Eastern Europe, with projects worth more than 1.6 billion euros, including more than 6,000 residential units and some 500,000 square meters of commercial area.

And, of course, it isn't only the construction sector which is getting hit. Since the problem is the availability of credit rather than interest rates per se, then anything which can't simply be bought on a credit card will be affected, and first in line here is the Romanian auto industry which could register its first bankruptcies towards the end of the first half of 2009 according to Alin Tapalaga, Manager of Porsche Inter Auto, the retail division of the Porsche Romania . Tapalaga feels the most affected companies will be those who have recently built showrooms, and especially in the past year using bank loans as finance,.

The Romanian banks themselves are expecting a massive drop in lending to individuals in the last quarter of the year, especially for mortgage loans, despite forecasts of cheaper land and properties, following a worsening in lending conditions, according to a recent survey carried out by the central bank. Not surprsiningly, credit cards are the only lending product for which banks expect to see a slight increase in use in the last quarter, but even here they expect a much smaller increase than the one registered between July and September 2008.


And all this reticence to spend comes despite (or perhaps because of) the fact that property prices are now falling. Three-room apartments in Bucharest have fallen by around 15 percent since the beginning of the year according to the the ZF real estate index. ZF suggest that prices nationally have dropped by 2 percent to 3 percent over the last six months, following stagnation or even slight increases earlier in the year. ZF compile their index by analysing prices asked by sellers on the anuntul.ro website. The value at which the deal is actually closed may be as much as 20 percent below the asking price they say. Whereas a typical seller was asking an average of 140,000 euros for a 70-square metre three-room apartment in January, the price reached 118,000 euros in November, or over 20,000 euros less. The sharpest monthly decline was registered in November, when the average price per square metre reached 1,686 euros, 5 percent lower than in October, according to the ZF analysis.

Exporting Your Way Out Of Trouble?

With domestic demand now set to fall sharply, as people buy less property and large ticket items, while companies prune back investment in response, the only way forward for Romania to achieve economic growth - and pay off its debts - would appear to be through exports, since the fiscal policy arm has, as we have seen, been basically frittered away during the good times. But here we hit a big snag, since Romania runs a large goods and services trade deficit. In fact, between January and September 2008, Romania's balance-of-payments current account posted a deficit of 12.7 billion euros, up 14.8 percent over January-September 2007. The deterioration was largely a result of the wider trade deficit (13.7 billion euros), which was up 11.7 percent over the same period of last year. On the positive side exports did grow (19.4%) more rapidly than imports, but that will be of little consolation if exports need to drive an economy where domestic demand is either flat (best case) or declining.

And funding this deficit could become increasingly problematic, since foreign direct investment now covers only around one third of the gap in the current account, which means that foreign debt is on a strong upward spiral. Effectively this situation makes Romania susceptible to capital outflows in the medium term, and, were this to happen it would trigger a harsh real adjustment for Romania's economy and its citizens.

Romania needs to attract capital inflows (including FDI) in the region of 15 billion euros per year to cover a current-account deficit which is expected to exceed 13% of GDP. In 2008 alone it is estimated that the net external indebtedness of Romania will rise by some 6 billion euros. Non-publicly guaranteed external debt came in at 31.501 billion euros at the end of September, up 25.9 percent from year-end 2007. The NBR has, of course, built up a strong foreign exchange reserves (27 billion euros at the end of November, or around 8 months imports) and can more than likely ride out the change in market sentiment in the short run. Also foreign direct investment of 7.2 billion euros covered 56.6 percent of the current account deficit over the January-September period, with equity stakes and reinvested earnings making up 52.7 percent of the total, while intra group loans accounted for the other 47.3 percent.

But at the end of the day, having the reserves to ride out the crisis (with or without the aid of the EU and the IMF) isn't really the problem. The problem is how you turn a credit-driven internal-demand-boom economy into one where new-found export competitiveness means external demand drives growth. And how you do this, while protecting all those heavily-forex-leveraged households form the more or less inevitable downward correction in the value of the leu. Obviously the path from one point to the other passes through a hell of a lot of what we economists call "creative destruction", but lets just hope for the sake of all those who have to live through this "correction" inside Romania don't find the whole process a far too painful one.

Wednesday, September 3, 2008

Romania Producer Prices Accelerate Again In July, Wages Continue To Rise

Romanian producer price inflation accelerated to the fastest pace in four years in July as energy and labor costs soared and a weaker leu nudged up import prices. The cost of goods produced in factories and mines rose an annual 20.3 percent the fastest rate since August 2005, compared with 19.4 percent in June, according to data from the Bucharest-based National Statistics Institute. Prices grew 1 percent on the month, following a 2.1 percent rise in June.



Prices of manufactured goods rose an annual 23.2 percent in July, compared with an increase of 22.1 percent in June. Price growth in the mining and drilling industries slowed to 16 percent from 17.8 percent and costs of electricity, natural gas and water rose an annual 5.5 percent after a 0.1 percent increase in June.

Wages Up An Annual 25.8%

Romanian annual wage growth, a key factor behind the central bank's recent interest rate increase drive, accelerated further in July as rising investment continued to boost demand for workers.

Net monthly wages rose an annual 25.8 percent to 1,273 lei ($564), compared with a 24.4 percent increase in June, according to the latest data from the Bucharest-based National Statistics Institute. Wages rose 2.7 percent on the month.





Wage increases have helped boost retail sales and imports, and propelled economic growth up to 9.3 percent in the second quarter. The central bank has also said higher wages drove annual inflation to a three-year high of 9 percent in July and forced it to raise its key interest rate to 10.25 percent, currently the highest in the EU.

Domestic demand has also been fuelled by strong inflows of worker remittances and a lending boom. Total private sector debt (households and companies) was up by an annual 55.8 percent in July. Now the interesting thing is that this rate of increase is now slowing, and if the slowdown in the rate of increase continues then construction will gradually grind to a halt as we have seen in other credit and construction boom driven economies.




The rate of increase has been slowing since it hit a peak in January at 66.8%. But a word of warning needs to be added here, since the stock of loans includes a very large proportion - 54% in July - which are forex denominated (mainly euros), and the leu has been rising against the euro until very recently (driven by the high yields on offer following the interest rate rises at the central bank), which means that the leu value of the stock would decline, so there is a valuation component here. Nonetheless I think it is a pretty safe call to say that the credit boom in Romania is now past its peak, and what awaits us is the inevitable slowdown.

Monday, September 1, 2008

Romania's Economic Growth Accelerates In Q2 2008

Romania's economy grew faster than generally expected in the second quarter, fuelled by a lending boom, increased investment and rising wages. The economic expansion accelerated to an annual 9.3 percent from 8.2 percent in the first quarter, according to preliminary data out today from the Bucharest-based National Statistics Institute.



Net wages were up 24.4 percent in June, while annual private debt was up 65%. As a result domestic investment grew in the second quarter by 30 percent from the same period last year - and reached 6.5 billion lei ($2.7 billion) - led by a 35 percent increase in construction. Central bank Governor Mugur Isarescu forecast 9 percent growth for 2008 last month, and warned the economy is "overheating" with upward pressure on inflation and a deteriorating current-account deficit.

To try to restrain domestic deman the central bank raised its main interest rate to 10.25 percent in July, the highest in the EU, as the inflation rate rose to a three-year high of 9 percent.

Tuesday, August 12, 2008

Romania Inflation Accelerates Again in July

Romania's inflation rate rose to a three-year high in July as increases in government-administered prices added to pressure from a consumption boom which is being fuelled by soaring lending, rapidly rising wages and a strong stream of remittances from Romanians working in Spain and Italy. Inflation accelerated to an annual 9 percent in July from 8.6 percent in June, according to the latest data from the National Statistics Institute earlier this morning. On the month, prices rose 0.7 percent, following 0.3 percent rise in June.




The government increased natural gas prices by 12.5 percent and electricity prices by 5.3 percent effective July 1. It also raised taxes on tobacco to 50 euros ($75) per 1,000 cigarettes from 41.5 euros.


Romania's economic expansion, fuelled by consumer spending, cheap loans and surging wages, was seen by many as a benign process which were simply bring western European living standards to the EUs poorest member state. Now, inflation is soaring, property prices have started falling and the current-account deficit is widening steadily. Romania's increasingly looking like a copy-cat version of what has already taken place in the Baltic nations of Estonia and Latvia.


State-administered price increases added to pressure from rising international food and fuel costs to boost inflation from a 17-year low of 3.7 percent in March 2007. The increase have prompted the central bank to raise its key interest rate seven times since last October to the current level of 10.25%, which is the highest rate in the European Union.


A weaker leu, which has lost more than 11 percent of its value against the euro in the past year, has also pushed up consumer prices. Rising wages and a lending boom are the main drivers behind price increases in recent months. Net paychecks were up an annual 24.4 percent in June as private debt expanded 63.4 percent on year.

Central bank Governor Mugur Isarescu said on Aug. 4 inflation will start to slow this month as an expected bumper farm crop lowers food prices and the increase of state-administered prices slows. He added that the economy, which grew 8.2 percent in the first quarter, would expand as much as 9 percent this year.


Romanian annual wage growth, which prompted the central bank to raise the European Union's highest interest rates last week, accelerated to 24.4 percent in June as investment boosted demand for workers. Net monthly wages rose to 1,273 lei ($564) in June, the Bucharest-based National Statistics Institute said in an e-mail today. Growth accelerated from an annual 23.3 percent in May, while wages rose a monthly 2 percent.



Central bank Governor Mugur Isarescu said last week that wages are rising too fast, helping boost the inflation rate above 9.1 percent in July and outstripping productivity gains, while the economy is ``obviously overheating.''



Romania's entry to the EU last year set off labor migration to Italy, Spain and other bloc members, aggravating a labor shortage and further increasing wages. The remittances they send home on a monthly basis has also boosted demand for workers inside Romania.





Unemployment in June was 3.8 percent, the lowest rate in 16 years, the National Labor Agency said on July 10.




Higher paychecks are also helping spark a lending boom as Romanians exercise their increased borrowing power. At end-June 2008, total non-government credit was up year on year by 63.4 percent, or 50.5 percent in real terms, on the back of the 40.0 percent increase in RON-denominated loans (28.9 percent in real terms) and the 89.3 percent advance in foreign currency-denominated loans expressed in RON (when expressed in EUR, forex loans expanded by 62.7 percent).



Romania's construction industry, including commercial and engineering works, expanded an annual 34 percent in May, the fastest pace in the EU, the institute said on July 4.



The Romanian Association of Construction Companies has said builders, who employ 300,000 workers in the nation of 22 million, need another 300,000 workers just to stay on scheduled with current projects.

Thursday, August 7, 2008

Romania Industrial Output and Retail Sales June 2008

Romania's industrial output increased year-on-year in June, according to the latest data from the National Institute of Statistics. However, on a monthly basis, output fell over May. Industrial output grew at a 4% year on year pace in June, helped by a 5.1% rise in production from the manufacturing sector. However, output of utilities fell 2.3%, and that of mining and quarrying declined by an annual 3.1%.



Month-on-month, industrial output fell 1.5% mainly because of a fall in production from the manufacturing and utilities sectors. However, output from mining increased. Most industries showed evidence of a decline in output. The steepest fall in output of 2.8% was for intermediate goods, followed by a 2.4% fall in the production of capital goods. Production of energy fell 0.7%, while consumer goods output fell 0.5%.



Meanwhile, in another report published this morning, the statistical agency said that the volume of retail sales excluding motor vehicles expanded 19.3% in June. This was helped by double digit growth from both the food and non-food sector. Retail sales of non-food items grew 27.1%, while that food, beverages and tobacco was up 10.9%.

Sales volume for the maintenance and repair of motor vehicles, motorcycles, which includes also retail sales volume of motor fuel, increased 23.5% in the month. The rise was mainly due to a 24.3% increase in the sale of motor fuels. Turnover in business services were up 7.3% in the month. Retail sales, excluding motor vehicle sale, increased 9.7%. Sales volume of motor vehicles and cycles, including repair and maintenance fell 13.7%. On the other hand, retail sales of services grew 23.6%.



Wednesday, August 6, 2008

Where Now for CEE and Baltic Currencies?

By Claus Vistesen: Copenhagen


Ever since the illusive credit turmoil began sentiment in the market place has been fickle and essentially, like the assets of which it consists, volatile. We started off with an adamant focus on downside risks to growth which then turned into a focus and fear of inflation. Now, as the cyclical data has turned for the worse in Europe and many places in Asia the focus seems to be reverting to growth. Now, I won't go into the whole decoupling v recoupling discussion at this point since I think that this dichotomy is a false one. It never was about de-coupling à la traditionelle but moreso about two interrelated points. The first would be the extent to which the world already has decoupled from the US in the sense that a key group of emerging economies are now set to ascend in economic prowess. The second would be the extent to which the de-coupling thesis always built on a fallacy. The main point would be that the main fault line of slowdown was observed across economies with external deficits; something which, I am sure most will agree, is sure to impact surplus economies too.

Now, that does not completely let the ECB off the hook since by maintaining a focus on inflation it also assumed the role, if only temporary, of the new anchor in a re-wamped version of Bretton Woods II as the Euro ascended to new highs. This bet on global re-balancing was always going to end in tears and in this light the Eurozone could not decouple from the US; that much, I think, is true.

The key issue here however, as I have argued time and time again is represented in two crucial interlocked questions which together form a key structural trend in the global economy. One is what happens when the surplus economies slow down and there is not sufficient demand to pull the economy back up? Demographics and a high median age are key variables to watch in this regard. The second question is the extent to which hitherto deficit nations can turn the boat around and increase savings (i.e. rely more on exports) and what it will mean for global capital flows when they begin this process?

In the context of the CEE economies the themes above are also present. In a recent note I detailed the change in sentiment from growth to inflation and what it might mean for Eastern Europe's economies and their respective currencies. The key situation as I sketched it was one of a dilemma.


On the one hand, the rampant inflation levels suggest that the exchange rate be loosened to allow appreciation and thus pour water on the roaring inflation bonfire. On the other hand however the Baltics, as well as many other CEE countries, are saddled with extensive external deficits financed by consumer and business credit denominated in Euros. It is not difficult to see that this represents a regular vice from which it will be very difficult to escape since as long as the peg remains deflation seems the only painful alternative as a mean of correcting.

(...)

Another point which is specifically tied to Eastern Europe is that if domestic nominal interest rate increase to keep up with inflation rates it will have a strong substitution effects towards Euro denominated loans. This can become a dangerous cocktail should the tide turn against the currencies.


Now that the focus seems to be changing back again it appears to be a good time to revisit the situation

Within this global nexus of what exactly to do with inflation relative to growth, many Eastern European economies has so far opted to go for inflation by raising interest rates. At an initial glance this seems quite reasonable and in many ways the CEE central banks merely latched on to market sentiment and expectations that many emerging economies would seek to use nominal appreciation as a tool to flush out inflation.

Consequently we have seen how both Ukraine and Hungary have chosen to loosen the peg to the Euro as well as other floating currencies in Eastern Europe have seen their yield advantage increase in an attempt to flush out inflation. This has not been without problems though or more specifically it is not clear that an appreciation of the currency is all for the good. Two points here would seem particularly important. One is the simple question of whether in fact an appreciation is deflationary in a world where capital flows, and in particular the hot kind, act strongly on yield. However, another point would be specifically tied to the situation in Eastern Europe. As such, nominal appreciation of the currency also increases the purchasing power which is not what many CEE economies need at the present time as they stand before the task of correcting a rather large external balance. Moreover, rising domestic interest rates will increase and exacerbate the credit channel by which loans denominated in Euros and Swiss francs become more attractive. I have shown this to be true, for example, in the context of Lithuania. The important thing to do note here would what would happen to the servicing of these liabilities should the domestic currencies depreciate.

What happens next then? Or more concretely, even though CEE currencies, in general, have enjoyed a rally on the back of market expectations of nominal appreciation fed by hawkish central banks what happens if and when central banks reverese course?

An initial warning shot across the bow was handed to us as the governor of the Czech central bank mused that he might lower rates come next meeting due to the strenght of the Koruna and the subsequent effect on exports. Also Poland recently opted to abandon the hawkish stance as rates were kept steady. In light of this event Macro Man managed, as ever, to hit the proverbial nail on the head.



There is little more bearish for a currency these days than abandoning the inflation fight in a pursuit of growth; this is particularly the case when the market is heavily positioned the other way.


This is exactly the issue which now confronts many Eastern European economies. What to do as growth visibly tanks at one at the same time as inflation stays high. One thing here would be for the central banks to hold their raising cycle which in itself should ease the pace of appreciation but what if they need to lower rates.




Now the numbers above do not, in themselves tell anything remotely interesting. For one, the difference between the economies are quite big. For example the Czech Republic has been able to gain, with a comparatively low interest rate, currency appreciation which has actually helped the external balance in so far as it has made imports cheaper. Obviously, at this point the benign effect on the trade balance is just as much down to decreasing domestic demand as the value shield of a dear currency. On the other hand, if we consider especially Ukraine, Romania, and Hungary the price has been dearer and the subsequent effect on inflation less pronounced. One could always argue that the situation would have been much worse, but one thing is certain; the ensuing loss of competitiveness has not been compensated for with a decrease in inflation. And one has to wonder whether pushing nominal interest rates ever higher would be a sound solution.

The key here is that these high interest rates carry with them a high lock-in premium which makes it difficult to reduce them without causing substantial pain to the currency. Add to this that as long as interest rates stay in this territory the incentive to borrow in foreign currency remains very appealing. In fact, the incentive structure here is quite disruptive as many of these economies have higher rates on domestic currency deposits and lower rates on foreign credit. This incites consumers and companies to place their deposits in local currency while funding themselves in foreign currency. Finally, there is of course the more standard economics 1-0-1 point that whatever nominal rate is ascribed to a currency and an economy the latter needs to be able to provide the structural demand for which to satisfy the yield. Otherwise you just pour more gasoline on an already raging bonfire.

Obviously, as long as the local currency remains strong and on an upwards march or the trading band is kept in place the show goes on. But the longer this structure lingers the more difficult it will be to break free; and break free they must since I am quite sure that Eurozone membership is off, for the immediate future at least.

Another more hard hitting point would simply be that whatever growth momentum these economies had going into 2008 it is now steadily levelling off. Now, these economies need to rebalance their external accounts at the same time as they labour under the yoke of slowing growth, high interest rates which are difficult to reduce and/or a quasi fixed exchange rate to the Euro. Can you feel the chilling cold of deflation blowing across the Urals? I can.

Basically, the past years' rapid process of nominal convergence will now need to be kicked into reverse, since it is quite obvious that many CEE economies have been riding a blade too tough.

Be Careful Indeed

Last time I massaged this specific topic I summarised by ominously stating that the CEE economies and their central banks should be careful what they wished for in terms of using higher interest rates and subsequent nominal appreciation of their currencies to flush out inflation. The key point was that the effect would likely be limited and only further worsen the imbalances in the economies. And thus, here we are.

Another more subtle point in the context of market reactions would be the boomerang effect which comes from the currency appreciation as interest rates are increased (and the peg/band abandoned) to the subsequent plunge when the economic tide turns. In line with the change in global sentiment towards growth and deflation (see e.g. here) and the fact that other hitherto strong yielders (e.g. the Kiwi and Aussie) are beginning to falter we may be at an inflection point in the whole discourse of upwards movement in CEE currencies. Stephen Jen's recent tour of global FX markets is a fine addition to this argument.

As ever, this is obviously still a dilemma for most of these economies since inflation continues to rage ahead. In Romania for example the PPI rose at its highest pace since 2004. However, as long as the credit tap stays open and as long as the purchasing power is increasing so will the the demands for higher wages stay strong. This is particularly true in the context of the CEE economies as these are in possession of structurally broken population pyramids after two decades worth of lowest low fertility and, in the cast of the latter decade, net outward migration.

The main point I would like to emphasise here is that correction is coming and that it will only become harder the higher the currencies move upwards. In a more general light this correction will not be a small one and it most certainly will not be felt exclusively in Eastern Europe. Basically, the big hidden data point in all of this is the dependence of Germany on CEE imports. So far, this has moved along just nicely but Germany is in for a rude awakening once the link breaks ... and break, I am afraid, it will.

Tuesday, August 5, 2008

Romania Wages Accelerate To An Annual 24.4% In June

Romanian annual wage growth, which prompted the central bank to raise the European Union's highest interest rates last week, accelerated to 24.4 percent in June as investment boosted demand for workers. Net monthly wages rose to 1,273 lei ($564) in June, the Bucharest-based National Statistics Institute said in an e-mail today. Growth accelerated from an annual 23.3 percent in May, while wages rose a monthly 2 percent.



Central bank Governor Mugur Isarescu said yesterday that wages are rising too fast, helping boost the inflation rate above 9.1 percent in July and outstripping productivity gains, while the economy is ``obviously overheating.'' The central bank on July 31 raised its Monetary Policy Rate a seventh time to 10.25 percent.




Romania's entry to the EU last year set off labor migration to Italy, Spain and other bloc members, aggravating a labor shortage and further increasing wages. The remittances they send home on a monthly basis has also boosted demand for workers inside Romania.





Unemployment in June was 3.8 percent, the lowest rate in 16 years, the National Labor Agency said on July 10.




Higher paychecks are also helping spark a lending boom as Romanians exercise their increased borrowing power. At end-June 2008, total non-government credit was up year on year by 63.4 percent, or 50.5 percent in real terms, on the back of the 40.0 percent increase in RON-denominated loans (28.9 percent in real terms) and the 89.3 percent advance in foreign currency-denominated loans expressed in RON (when expressed in EUR, forex loans expanded by 62.7 percent).



Romania's construction industry, including commercial and engineering works, expanded an annual 34 percent in May, the fastest pace in the EU, the institute said on July 4.



The Romanian Association of Construction Companies has said builders, who employ 300,000 workers in the nation of 22 million, need another 300,000 workers just to stay on scheduled with current projects.

Monday, August 4, 2008

Romanian Producer Prices Accelerate Again In June

Romanian producer prices rose at the fastest pace in over three years in June as energy prices increased and rising wages hit output costs. The cost of goods produced in factories and mines rose an annual 19.4 percent in June, compared with 16.8 percent in May, the fastest pace since October of 2004. Prices grew 2.1 percent on the month, after rising 1.7 percent in May.




Prices of manufactured goods rose an annual 22.1 percent in June, compared with 19.6 percent in May, while price growth in the mining and drilling industries quickened to 17.8 percent from 11 percent. The costs of electricity, natural gas and water rose an average of 0.1 percent, compared with 3 percent in May, the statistics institute said.

The Banca Nationala a Romaniei last week raised its main interest rate, the highest in the European Union, to 10.25 percent from 10 percent. Monetary policy makers have gradually raised the rate from 7 percent in September.

Thursday, July 31, 2008

Romania's Central Bank Raises Interest Rates

Romania's central bank raised its main interest rate, the European Union's highest, again today to 10.25 percent. The Banca Nationala a Romaniei raised the rate for the seventh consecutive policy meeting as it expects inflation to have accelerated in July from June's two-year high.



A drought last year destroyed a third of Romania's crops, adding to pressure from increasing global food prices and boosting inflation from a 17-year-low of 3.7 percent in March, 2007. The bank has now raised the key rate in stages from 7%.

The leu strengthened as much as 0.4 percent to 3.5138 to the euro after the announcement, from 3.5276 at closing yesterday. The benchmark BET stock index was little changed at 6045.04.


The central bank had previously predicted inflation may slow as early as August as an expected bumper crop counters rising food prices. Central banks in emerging economies, including Brazil, Russia and Turkey raised interest rates this month to stem the effects of surging oil and food prices. The European Central bank on July 3 raised its benchmark lending rate by a quarter point to 4.25 percent, the highest in seven years.

Several east European central banks, including monetary policy makers in Poland and Serbia, are taking stock of their moves to see if they hit their intended target. Slovakia held its main rate on Tuesday and the Czech Republic is expected to do the same next Thursday.

Romania's annual net-wage growth of 23.3 percent in May and a 63.4 percent increase in private lending in June have also pressured prices and boosted economic growth.