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Thursday, January 17, 2008

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.


Hoosier said...

if the trend in leu devaluation compared with the euro continues this will bring a lot of suffering to the Romanian economy. And it is very likely to continue as the main force taht made the leu stay strong in the last 5-7 years has been the foreign investment and remittances. as the world markets are going through a credit crunch and investor appetite for risk is significantly diminished the foreign investment may dry up. the main sources for remittances are now the Romanians in Spain and Italy. If these economies go into recesssion ( and it seems they are heading that way) this source will also diminish. some may decide to return to Romania which may help local economy and to keep inflation in check. on the other hand those that will remain ( likely the ones who have integrated more in the new country) will likely devote less of the revenue to the relatives in Romania.

making an assuption that Romanian immigrants will behave similarly with the Mexican immigrants in the US we can expect that as time goes by less and less will be sent home to support the local currency. the Mexicans who emigrated more than 10 years ago are sending less money back home than the ones who immigrated within the last 5 years even though they are very likely to be making more. they are more likely to have their families with them, their kids in American schools and to be more engaged in following their own American dream.

so it may come to the point where the value of local currency will depend more on the local economic performance than on transient factors. this is where we come to the chronic problems of the Romanian economy: corruption, lack of intelelctual property rights enforcement and labor market rigidity and shortages. the social contributions that are already quite sizeable will only grow as active population decreases and the number of retirees will continue to climb. there is no plan of attracting more of the 55 to 70 year old people back into economy and culturally the mood is against this.

Edward Hugh said...

Hi Hoosier,

By and large I agree with what you say, so this comment is a bit easier for me to respond to than some of your other ones :).

"as the world markets are going through a credit crunch and investor appetite for risk is significantly diminished the foreign investment may dry up."

This is the basic point I have been arguing on this blog since the summer. My feeling is that this correction is now near, very near.

The Dollar-euro has been going now this way, now that, over the last few days, in a clear indication (IMHO) that investors don't know what to do next, or exactly where to run for cover.

Another indicator would be the steady change of direction in some central european stock markets - the Czech republic and Poland would be two good examples - and this has dragged Austria in its wake, not surprisingly, since Austria has most of the CEE banking and financial services in its basket.

"the main sources for remittances are now the Romanians in Spain and Italy. If these economies go into recesssion ( and it seems they are heading that way) this source will also diminish."

This is the other half of what I have been arguing. Italy has possibly already (in Q4 2007) gone into recession. The Bank of Italy revised the 2008 forecast down to only 1% earlier this week, and even this may now be optimistic.

I am in Spain, and of cousre since Spain had probably the fiercest property booms, it is now one of the(if not the) most severely affected. The slowdown is rapid and dramatic here (as it probably is in Ireland). So yes, the migrants are going to have a problem, since they have the most fragile employment.

They will have a real difficulty knowing what to do if Romania blows at about the same time as the problem deepens here. I expect to see a lot of frantic and desperate coming and going up and down the motorway.

Also what you say about Mexicans in the US is very much to the point here, both in terms of how the remittances flows can reduce during a downturn in the "host" country, and in terms of the longer term attitudes of the migrants. However, since many Romanian migrants do have elderly parents - and few brothers and sisters - back in Romania, we may expect these bonds to hold up rather more in the longer term than they do in Mexico (either that with money going over a longer period, or if the migrants manage to establish themselves adequately in their new country bringing the parents to live with them). Really, Spain's future and Romania's are now very much intertwined here, and nobody really knows what is going to happen next.

I just want to say that I consider all this such a tragedy, for a country which has had such a hard time of things in the past whichever way you look at it (and this goes for the whole EU10). But unfortuantely, as you say in another comment, life is life, and the most important thing would be to try and rescue a discourse out of the ruins that bore some relevance to the nature of the problem. And this applies to Brussels and the World Bank/IMF just as much as it does to local politicians in Bucharest.

I think the first - and actually quite liberating - step would be to recognise that what is happening is happening. Then you can begin the search for solutions.

People are, bit by bit, starting to wake up.Stefan Wagstyl had a piece in the FT yesterday that I have put up in my notebook. He talks of the need for a migration policy, and even in veiled terms about a population one, but he still can't really bring himself to mention that horrible word "fertility". However, progress is progress.

Of course, in the short term all of this is only likely to add to the nervousness of investors, but in my view this is going to happen anyway, since the labour shortages issue is just going to make wage inflation impossible to contain (watch out for what happens next in China on this front). That is high growth and low inflation are going to be impossible to achieve at one and the same time. Of course, if the change in lending conditions also affects Romania, and external credit gets harder to come by while the Bank of Romania continues to tighten inflation will gradually cease to be a problem, since growth will slow (especially if the flow of remittances drops of at the same time) and you will be somewhere near to were Hungary has been for the last 12 months or so: ie in a severe form of stagnation.

The problems here are big, and challenging, but they do not get smaller by being ignored.

Please stick around and continue commenting, as obviously as this turns critical it will be interesting to have some sort of forum and debate. Emil - who often comments here - doesn't agree with me on much of this, but he is watching, and he is thinking, and I personally feel talking about things helps clarify the mind.