The Ups and Downs of the Romanian Leu

Well, one day it goes down, and the next it is up. Romania's leu continues to wobble, and today it rose the most in almost a month against the euro after central bank Vice Governor Christian Popa said Romania may need to raise interest rates to curb inflation. The leu gained today for the second consecutive day after Popa said yesterday this week's depreciation to a three-year low was "an overshoot in the correction" and that the central bank may need to lift its 8 percent benchmark rate further. The currency was also boosted slightly after a rally in global stocks stoked investor demand for higher-yielding, emerging-market assets.

The leu rose as much as 1 percent today, the most since Dec. 24, to 3.6574, and was trading at 3.6767 by 12:30 p.m. in Bucharest, from 3.6939 late yesterday. It fell to 3.7235 on Jan. 14, the lowest level since February 2005.

The Bucharest-based central bank declined to comment on whether it bought the leu in the foreign-exchange markets today.

Policy makers lifted Romania's benchmark interest rate half a percentage point Jan. 7, raising it to the highest in the European Union, to curb inflation after prices rose an annual 6.6 percent in December.

The leu has so far fallen 3 percent against the euro this year, making it the second worst-performing emerging-market currency.

Perhaps the most ominous quote in the press today is this one, since it indicates that central bank policy may now become increasingly driven by the need to stem a collapse in the currency, rather than by a need to regulate internal demand conditions. If confirmed, this tendency would not be a positive one.

``Our rough calculations suggest that the main rate should be above 9 percent to fend-off the pressure on the leu,'' said Ilker Domac, an economist at Citigroup Inc. in Istanbul, adding that he expected another 50 basis-point increase in February.

The Leu Slides Again

The Romanian leu fell for a second day against the euro today, dropping to its lowest level in three years, after a report showed the government's budget deficit widened. The shortfall in the country's budget stretched to 2.4 percent of gross domestic product last year, from 1.7 percent in 2006, Ziarul Financiar reported, citing unnamed government sources. A record trade gap of 2.2 billion euros ($3.3 billion) in November and October underpinned views the leu is being hurt by weak macroeconomic data.

The Romanian currency fell as much as 0.8 percent to 3.7235 per euro, its lowest since February 2005, and was at 3.7126 by 12:26 a.m. in Bucharest. The leu is the worst performer among a group of 26 emerging market currencies so far this year, dropping 3.4 percent.

The Bucharest-based central bank raised its interest rate 50 basis points on Jan. 7, to 8 percent, as inflation quickened to 6.7 percent in November and 6.6 percent in December, exceeding the bank's year-end target of 4 percent, plus or minus one percentage point.

And to top it all, Romania's current-account deficit widened to 13.3 billion euros in October, another record.

Romania Fiscal Deficit 2007

Romania's budget deficit widened to about 2.4 percent of gross domestic product last year from 1.7 percent in 2006, according to a report in Ziarul Financiar this weekend. Increased spending in December apparently widened the deficit from 1.1 percent of GDP in the first 11 months of the year, the newspaper said, citing unidentified government sources. The government had promised to increase spending on social areas and infrastructure in 2007 to bring standards closer to the average in the European Union. Many of these aspirations have a lot of merit, but at a macroeconomic policy level it is NOT adviseable to run a fiscal deficit - and an accelerating one at that - when your economy is at serious risk of overheating.

Romania Inflation December 2007

Romanian inflation rate fell in December to the lowest level since September as the effect of last year's drought on food prices waned. The inflation rate dropped to 6.6 percent from 6.7 percent in November, the National Statistics Institute INSSE said today Consumer prices rose 0.6 percent on the month, compared with 0.9 percent in November.




This slowdown in inflation may, however, be only a temporary respite before rapidly rising consumer borrowing and consumption once more boosts the annual rate in the first quarter of 2008. The central bank raised its benchmark interest rate to 8 percent from 7.5 percent on Jan. 7, citing inflation concerns and it is widely expected that policy makers will lift the rate again next month to what will be the highest in the European Union.

Growth of food prices, the main component of the consumer price index, eased to an annual 9.1 percent in December from 9.4 percent in November. A drought last year destroyed a third of Romania's crops and damaged a further third, pushing up food prices and driving the inflation rate to 6.8 percent in October from a 17-year low of 3.7 percent in March.

The increase in prices of non-food goods slowed to 3.6 percent in December from 4.1 percent in November but services prices were up, to 8.6 percent from 7.3 percent in October.

Thecentral bank, which targeted end-year inflation of 4 percent plus or minus 1 percentage point, said in a statement on Jan. 7 that consumption is at an ``unsustainable level in the context of rapid expansion of credit to the private sector, especially of foreign currency loans.''

The bank has also drawn attention to government spending ahead of November parliamentary elections, a consumer borrowing boom and rising wages as being the main inflation threats in 2008.

The government has promised to increase spending on infrastructure and social areas in 2008, widening its targeted budget deficit to 2.7 percent of gross domestic product from its estimated deficit of less than 2.4 percent of GDP for 2007, againts IMF advice to move towards a budget surplus in an attempt to drain excess liquidity from the economy.

Average net wage increases of an annual 23.5 percent in November and an annual 55 percent rise in private borrowing is also increasing consumption, further pressuring consumer prices, the central bank said.

Further declines in the leu could also pressure inflation this year, and the leu has declined more than 13 percent against the euro since the beginning of August as Romania's current-account deficit widened to a record and international investors grew reluctant to invest in some markets perceived as carrying a higher risk.

Basically the current account deficit is being sustained at the present time by the increasing foreign currency borrowing by Romanian citizens. Whent his stops, this whole process may well come grinding to a halt.

The current-account gap in the first 10 months of 2007 widened to 13.35 billion euros ($19.7 billion) from 7.75 billion euros a year earlier. Much of the deficit was created by a surge in imports as the leu's gain made goods cheaper for Romanians and the country eliminated import barriers as it joined the EU.

Standard & Poor's in November lowered its outlook on Romania's sovereign credit rating for a second time since April, citing the widening current-account deficit, the broadest measure of the trade in goods and services. That gap widened to a record

Romanian Central Bank Raises Rates Again

Romania's central bank raised its benchmark interest rate today for the second consecutive time after inflation accelerated more than previously expected. The central bank increased its Monetary Policy rate to 8 percent from 7.5 percent.

At the last monetary policy board meeting on Oct. 31, the central bank raised its main interest rate to 7.5 percent from 7 percent after cutting it four times earlier in the year. The benchmark rate was 8.75 percent when Romania joined the EU in January, the highest among the 27 members. The bank cut the rate at the first of its four monetary policy meetings in 2007, citing slowing inflation - which fell to a 17-year low of 3.7 percent in March - and a strengthening leu.

``The short-term inflation outlook has worsened in the context of heightened macroeconomic risks, especially those related to the income policy and higher public spending in the run-up to forthcoming elections,'' The bank also cited ``a possible significant deterioration of inflation expectations.''
Central Bank Statement

The Bucharest-based National Bank of Romania had already accepted that it would miss its year-end 2007 inflation target of 4 percent, plus or minus 1 percentage point, as the leu continued to weaken and the Romanian government boosted spending on infrastructure and social programs after joineding the European Union a year ago.

The central bank board also left its minimum reserve requirements on commercial bank deposits at 40 percent for foreign-exchange deposits and 20 percent for deposits in lei.

Inflation was an annual 6.7 percent in November as food prices increased after a drought destroyed a third of Romania's crops, and depreciation of the leu raised the cost of imports and many local goods and services.



The central bank has indicated that government spending is a threat to its inflation target, and that to reduce the overgheating in the Romanian economy fiscal policy needs to be tightened considerably. However, at least in the short term one can imagine that government spending will more than likely increase as the country prepares for next November's parliamentary elections.

The leu, after appreciating throughout 2006 and the first seven months of 2007depreciated almost 13 percent against the euro between the outbreak of the sub-prime bust in August and the end of the year. The leu's drop increases inflation by making items indexed in euros and paid in lei more expensive for Romanian citizens. In Romania, rent, gasoline, phone bills and other goods and services are habitually quoted in euros and paid in lei.




The central bank also indicated that its decision to raise the rate today was influenced by the fact that consumption is at an "unsustainable level in the context of rapid expansion of credit to the private sector, especially of foreign currency loans."

Private debt in Romania increased an annual 55.1 percent in November to 141 billion lei ($58 billion) as individuals and companies took out more loans in foreign currencies, the central bank said on Dec. 28. Total outstanding loans in foreign currencies, mostly euros, increased an annual 74 percent while leu-denominated loans gained 38 percent.







The central bank also said net wage growth, which accelerated to an annual 25.2 percent in October, was further pressuring inflation and outstripping productivity gains, emphasizing the `"risks of deteriorating external competitiveness".







The current account gap in the first 10 months of 2007 widened to 13.35 billion euros ($19.7 billion) from 7.75 billion euros a year earlier. Much of the deficit was created by a surge in imports as the leu's gain made goods cheaper for Romanians and the country eliminated import barriers as it joined the EU.

Romania's trade deficit has steadily deepened during the first ten months of this year, and has already reached over 17.2 billion euro, an increase of over 6 billion euro when compared with the same period of 2006, according to data this week from the National Statistics Institute. The overall trade deficit for the whole of 2006 amounted to "just" some 14.8 billion euro.




Over the same period, the total value of exports grew by 13.2%, rising to 24.2 billion euro, while imports advanced 27.2% to 41.4 billion euro.
In October this year, exports exceeded 2.7 billion euro, a 17.2% increase as compared to the similar month last year. On the other side, imports reached in October the total value of 4.9 billion euro.





The leu has been steadily depreciating as the current account deficit widened and international investors grew more and more wary of investing in countries perceived as higher risk amid the U.S. subprime crisis.



Well, the central bank are now trying to react, but in todays conditions I do fear that this is a question of too little too late.