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Monday, January 7, 2008

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.


Emil Perhinschi said...

"current account deficit"

The first comment to this article attempts to explain away at least a part of the "current account deficit". Here are the arguments presented, in my adaptation:

Companies involved in import or export use tax heavens within EU in order to reduce the amount of taxes they have to pay: supposedly, they export to the tax heaven at a very small profit, then reexport from there to the final buyer and benefit from the smaller profit tax; when importing, they use companies registered in the tax heaven to buy the product at lower prices, then sell it to the company registered in Rumania, once more allowing for only a small margin. The profits are then repatriated as "foreign investments".

As the text I sent you to suggests, the current account deficit would be more relevant for measuring fiscal evasion than for measuring trade imbalances.

Now, I wonder if that guy or gal might be right. Do you think that such schemes might work ?

Unlike novyi ruski (the new Russians - Russian nouveau riches), the "new Rumanians" have managed to avoid public extravagances, so I wonder, if indeed the scheme described above works, how much of the 8 billions in foreign investment could be repatriated profit, how much more of exiled profits could exist, and what would have happened to the current account deficit if the government would have decreased the profit tax even further, compensating for the lost revenue with increases in the sales tax, the way they promised in 2004 ?

Do my questions make sense ?

Edward Hugh said...

hello Emili,

And Happy New Year.

"Do my questions make sense ?"

Yes. They do. I am sure there are all sorts of "book-keeping" issues like this all over the place. The US has its own issues here, which lead to the so called "dark matter" debate, basically that the US curent account deficit didn't matter, since a lot of it was companies moving around profits - for example to Ireland - to take advantage of low tax laws, and pày less profit. As a result Ireland has, for example, a large goods trade surplus, which turms into a negative CA balance due to a high volume of income payments.

"The profits are then repatriated as "foreign investments"."

This is less likely, income payments would be more likely, or intellectual property royalties, since "foreign investments" constitute a debt, and at some point this has to be repaid, and with interest. Of course, we need to distinguish here between tax avoidance and money laundering. The latter obviously takes places, but is covered under a diffent set of legal criteria.

But from the macro economic point of view all of this has very little interest when you come to assess the sutainability of the finances of a government or a nation.

Take Italy. The government in Italy may at some point go bankrupt. But it is no argument to say that Italy is much richer than it seems to be because of the large informal economy, since this informal economy by definition does not pay tax, and hence can't be used to stop the government from going bankrupt. Of course, if you can legalise the activity, then the taxes come in, but often it turns out that such activities cease to be viable once they become visible.

The same sort of thing goes for irregular capital flows and national viability. Basically the CA deficit at the moment is being paid for by money coming in to lend to Romanians in foreign currency. When this stops then the deficit will have to be covered from the reserves of the national bank. But that cannot go on forever. So either you can create a situation where enough people are generating (or declaring) enough of their income in Romania to make the nation solvent (reagrdless of why they are not doing so at present), or you can't, and if you are insolvent.....

I'm not sure how a sales tax would help this, since this might slow consumption, and reduce government debt, but doesn't directly affect the international trading position.