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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.


Emil Perhinschi said...

Mr. Hugh, are you enjoying this ? You are going beyond being just wrong.

Cheap loans ? 30% DAE is a cheap loan ? Then give me dodgy credit card contracts anytime, since those are a lot cheaper.

Property prices beginning to fall ? In your dreams: only the prices for 40+ year old apartments began to fall, and fell only by a very small percentage.

Surging inflation ? Inflation stopped "surging" in July, as Mugur Isarescu and other bank analysts are claiming. Anyway, it did not even cover for the increases in the price of energy ...

Last year you were claiming that there are 500000 Rumanians in Italy. Now I see you're changing the numbers. BTW, where did you get the 700000 Rumanians in Spain, since it's pretty well documented that a lot have returned this summer ?

I begin to think you are also betting on CEE economies slowing down, not only writing about it.

Edward Hugh said...

Hi Emil,

I hope you are keeping well.

"heap loans ?"

We are talking here about those who are taking out forex loans, normally in euros as documented in the post using data from the Romanian National Banks.

ECB refi rate is currently 4.25%, 1 year euribor is at an all time high of 5.393%, and many Romanians may well be able to borrow money at 0.75% - 1.5% over 1 year Euribor.

"roperty prices beginning to fall ?"

Well according to my information from Romania this is the case - and according to what happened in the Baltics is only to be expected given the rapid growth, high out migration and ongoing low fertility which no one seems to want to pay much attention to. This produces a boom-bust cycle. Romania would seem to now have had the boom, and we are in the porocess of entering the bust.

My sources are suggestinging that growing restrictions on private borrowing are now begining to produce a crisis in Romania's real estate market.

In a letter published in the Romanian press last month, the Romanian Bankers' Association desperately asked the central bank to impose less credit restrictions otherwise they said (not me) "home prices may collapse."

The central bank is in the process of introducing new regulations aimed to restrict private borrowing, - which increased 63.4 percent over a twelve month period to June.

Sales of new apartments dropped by half in the first six months of this year, compared to the monthly average in 2007.

April and May saw the largest drops due to growing rumours about a real estate market crisis.

"Surging inflation ? Inflation stopped "surging" in July"

Well not according to the lastest data from the INSEE (which is what this post is about) it didn't - annual inflation a three-year high of 9% in July, and month on month it accelerated from a 0.3% in June to 0.7% in July.

"Last year you were claiming that there are 500000 Rumanians in Italy. Now I see you're changing the numbers."

No. I haven't changed any numbers. The latest data on the Italy graph I present is for 2006 is you look. It was ISTAT - the Italian statistics office who published the 500,000 number you quote, not me. I don't "claim" anything, I simply report data other people collect, which is quite a normal practice in economic circles.

We can't possibly hope to collect our own data.

"where did you get the 700000 Rumanians in Spain,"

Again, this is a figure for 1st January 2008 from the Spanish national statistics offoce - INE.

"since it's pretty well documented that a lot have returned this summer ?"

Can you point me to a reputable statistics link for this documentation? It would be most helpful. What is clear from the Spanish end is that Romanians who have been made unemployed by the crisis in construction here have taken up the Spanish government offer of going home and receiving their unemployment benefit their. I think most of them are living in the expectation of coming back here when the situation in Spain improves, but this is unlikely to happen at any point in the immediate future. However the situation in Romania may now also deteriorate sharply, in which case it is not clear what these poor people are going to do, so any information you can provide would be useful.

"I begin to think you are also betting on CEE economies slowing down, not only writing about it."

I have no financial interest in any of this. I am a theoretical economist with an interest in the long run impact of fertility on economic processes. As you will remember from our conversations over the last year, I have been trying to warn that all of this was more or less bound to happen. It doesn't make me especially happy to be right. I would have been much happier if people had taken more notice and had made some of the very necessary changes to stop this sort of thing in its tracks.

Mihail Marcu said...

Well, property prices are not falling yet very sharply, but the number of transactions has decreased consistently.

Sellers are still in denial; I expect a bull trap in September - October, then a sharp correction.

Honestly, there are no chances for a soft landing, especially since 2008 is an election year.

If the budget deficit will go above 3%, then the crisis will appear faster, as Romania will be rated below investment grade.

If they will keep the deficit in line, I expect the hard landing in 2009, in q2 the latest.



Edward Hugh said...

Hi Mihail,

"Well, property prices are not falling yet very sharply, but the number of transactions has decreased consistently."

OK. perhaps I have jumped the gun slightly on this front, since I am not on the ground. But are we talking about asking prices or final selling prices?

This is important, since here in Spain prices have still hardly budged one year into the correction (3.9% y-o-y in July according to the last valuers data), while the developers have long been offering "discounts" of 30% to sell anything.

Private individuals will, as you suggest, be slower to adapt, but what about the builders and promotors, they come under pressure from the banks to at least maintain interest payments on their debts?

If the central bank are serious about tightening credit restrictions (limiting LtV to 80% would do the trick I think almost on its own) then the credit crunch itself will cause an economic correction as we have seen in the Baltics.

"Honestly, there are no chances for a soft landing,"

Well, I agree, the imbalances have just been too massive. Keep following, and keep me posted on what you see.

I am having lunch today with a Bulgarian friend who is visiting, and he assures me that bad as things are in Romania, they are worse in Bulgaria!

Best wishes,


Mihail Marcu said...

Asking prices for old flats have decreased by at most 5 - 7% in the periphery neighborhoods.

Actual selling prices are a mystery, since there is no official index. There may be one starting January 2009, but I'm not holding my breath on this one.

The credit crunch could help reduce the prices of assets; the National Bank will issue new regulations restricting credit affordability, by limiting indebtedness to 40% of family income and enforcing requirements for proof of income.

The prices for new flats have not budged at all; afaik, builders are not yet pressured by the banks, there no fire sales or repossessions of new buildings.

The average cost of mortgage is 9.81%, according to various press clippings.

Emil Perhinschi said...

Oh, you warned a lot, all right. When was the last deadline for the hard landing ?

... at some point it might even happen.

For the last 8 years the real estate agencies announced that "very soon" the prices of homes will fall.

If indeed the number of sold apartments fell and it was not because all that was built last summer was sold before it was painted, and there were none left to be sold until the new batch was completed, it means some people got their brains back and decided to rent instead of paying extortion prices ...

When those prices will fall it won't mean much, since I don't see how could a 42 m2 one room (one room + one small kitchen + one small bathroom) apartment in one of the communist blocks at the periphery of Bucharest be worth over 70000 Euro. Yeah, those gray blocks of flats that get so much publicity ...

As to pointing you to sources of information, I will be excused this time. Last time I did it, you kept on going about how the government of Rumania has no idea where it's citizen are, even if the documents I sent you to had numbers even higher than what you claimed to be the "true" numbers, and I still believe are a bit inflated.

I'll go away now and let you play your game in peace.


"new regulations restricting credit affordability, by limiting indebtedness to 40% of family income and enforcing requirements for proof of income" ... this happened for a long time, and I think the limit was at 30%, but applied to the income of the one who signed for the loan, not for the income of the family (I'm single so did not pay attention to the "family" part).

Mihail Marcu said...

The 35% limit you mentioned and the mandatory down payment of 25% were abolished 12 months ago.

Current regulations allow for 60 - 70% indebtedness and 0 down payment.

The real risk of a property price crash is the fact old flats will drive down the prices of new flats.

Now, it is close to impossible to buy a new flat for less than EUR 2,000 per built sqm, that is for low - medium quality buildings, in non-premium locations.

Premium locations - which are not so rare - may go to 5,000 EUR/built sqm.

Of course, those prices are ridiculous and were inflated by speculators and cheap credit. I think a drop of 30 - 50% would still be enough to keep the builder/developers profitable, after servicing their debt.

As a side note, official inflation rate does not take into account current rental costs (or owner's equivalent rent).

Real-estate is extremely important because current economic growth is based mainly on constructions and retail - two very volatile industries. I will not be surprised to see a violent trend reversal if the budget deficit exceeds 3% and Romania will be downgraded below investment grade.

Edward Hugh said...

Hi Emil,

"Oh, you warned a lot, all right. When was the last deadline for the hard landing ? "

First of all, and to put things in perspective, I only opened this blog in June 2007, so we are not talking about a very long period of time here.

Secondly, I have never put any kind of "deadline" on anything. I have simply limited myself to saying that what was happening was unsustainable, and that a "correction" was, imho, inevitable.

I have identified what has been happening in Romania with property related issues which have arisen in other countries, most notably of course the US, but also the UK, Australia, Ireland, Spain and most importantly and most recently the Baltic countries.

The danger was previously that Romania would get caught up in some emerging markets crisis post the sub-prime issues in the US last August. This crisis has not emerged (yet) and indeed the whole situation has been much more resilient than I imagined. That I freely admit.The point is this has then allowed the "excesses" which have been building up in Romania - year on year in creases in forex denominated household borrowing of over 140% (Feb/March), y-o-y annual wage increases of 24.4% (June), current account deficit of 14% of GDP in 2007, etc, to keep growing, and this means that they will now correct of their own accord, regardless of what happens elsewhere. They have simply become too large.

Mihail directs us to two potential mechanisms whereby this process may accelerate. The removal of investment grade from Romanian sovereign debt, or the tightening in lending conditions from Romanian banks as the criteria being applied get stricter.

I am not really sure how likely the former is, since the ratings agencies are normally pretty reluctant to act when it is obvious that their decision will provoke a crisis - and in this case my feeling now is that it is problems in Romania which could produce contagion elsewhere - Bulgaria, Hungary, the Baltics - simply because Romania is somewhat larger.

But if we look at the rates of increase in new household credit, these have now been slowing since the spring, and since the boom was effectively driven by ever increasing rates of new borrowing, I think we can safely say now that the thing has turned, and it is simply a question of how long things need to become really evident.

As both Italy and Spain are on the frontiers of recession themselves (and of course Spain is offering you a glimpse of what may happen in Romania) then I imagine remittance flows have reduced accordingly, and your suggestion that many who were previously working elsewhere have now returned would confirm this picture.

Of course, at this point there might be a kind of local "race" between Romania and Bulgaria to see who is going to get into the correction first. The Economist had the following to say this week:

Despite the EU’s worries about corruption and organised crime in its newest (and poorest) members, Romania and Bulgaria, their economies have been growing fast at around 7-8% a year. They are now leading candidates for a hard landing. A property bubble in Bulgaria seems to be on the verge of bursting, though this has still to filter through to the rest of the economy. Yet for now, few seem worried. Having dodged sanctions from Brussels (not fully in the case of Bulgaria), politicians in the Balkans seem to think that defying the laws of economic gravity is a cinch.

Edward Hugh said...

Actually Emil,

The only time I even vaguely talked about any kind of deadline would seem to have been in comments to a post on October 16 2007, when pressed by commenter Paul Bowman - you can go back and check for yourself, the post is entitled "Mugur Isarescu Shows Us How Not To Run A Central Bank".

Now, and for the record, here are some extracts from what I actually said on that occassion:

I am intentionally avoiding making any specific predictions since it is really impossible at this stage to see the intensity of what may happen. This will all depend on events which take place outside Romanian frontiers, even if some of these events may themselves be affected by what happens next in Romania. The more important point is that if I am right, and the underlying problem is a structural one, and the issue is labour supply based on long term low fertility and out migration then there is no easy fix in sight. So this will not be a simple "correction" and then onward and upward we go again. Things may well become much more complicated.

"what will happen to the Romanian property market"

Well, in the language of the game, it will have a "correction", how substantial this will be depends. I am sorry for being so vahue, but at this point there is so much that it is very hard to see. We have a sort of fog over the ship, but at some point the mist will clear. Of course, what happens to prices will depend on whether you are talking in euros, or in leu. In leu the prices may well even go up, depending on the scale of the devaluation and the level of inflation produced, but in euros the direction will almost certainly be down. How can you sustain rising property prices with a declining population? You tell me.


"so why not something more concrete when looking at a specific within the economy - namely residential property prices"

Well look, I am not simply trying to be coy here, it really is impossible to say. The thing is, this isn't just a problem in Romania, this is the heart of the current "liquidity crunch" issue.

I don't know how much you have been following this, but the essence of it is that since the middle of August the global market in commercial paper backed by mortgages has effectively seized up. And the reason it has seized up is that no-one knows what the properties which back the paper are worth. This is why noone in their right mind wants to buy such paper at the moment. But you will forgive me if the largest commercial banks and the most important central bankers across the planet freely admit they have no idea how far all this can go, then I really don't have anything more to add, since I have no private crystal ball here.

Of course the central banks are more circumspect than I am, since they don't want to generate panic, but you could look at but you could look at this piece about the BoE and commercial property in the UK, or this thing on the bold efforts of the US banks with the Master Liquidity Enhancement Conduit. But the important thing to note about the MLEC is that at the moment they can't hold back the flood, water keeps seeping though. If this process is not corrected, then it is, of course, most serious. What more do you want me to say?

It is a bit like we need a CAP for housing and land. Instead of buying up surplus tomatoes or potatoes, the US banks want to buy up and effectively put out of circulation large bundles of commercial paper. Maybe the EU Commission needs a property department to buy up all the surplus building land and new properties, now that the global boom is well and truly over. This is what they were forced to do in Japan in the early 90s, since it is the only effective way to stop prices falling and continuing to fall. The correction starts when people are forced to sell since they cannot maintain payments.

This will all really begin in earnest here in Spain when the people who have been caught with two properties - since they "bought over plan" whilst retaining their old home till the new one was finished - cannot maintain two mortgages. These people will then effectively be forced to sell, for any price they can get, and that is when prices can tumble.

In Romania this will be associated with a drop in the value of the leu. If it falls far enough and fast enough then people simple won't be able to maintain payments. Of course we still don't know at this point what is going to happen to euro-dollar. So there are so many things out there right now, this is all very hard.

Let's take an analogy. You probably listen to the weather forecast for tomorrow and the next day. If someone tells you that it will be sunny on xmas day you are probably a bit more circumspect, while if someone tells you I have no idea what the weather will be like on xmas day, but global warming is taking place, then, if you have any sense, you probably sit up and take notice again.

Most of the above still seems pretty valid to me. The situation in Spain has not improved but has deteriorated. There are now over 1 million unsold homes lying on the market, and the Spanish banks had to go to the ECB for record quantities of funding in June (the latest month for which there are records). This isn't all over, it is just begining. And to make matters worse, what Russia has just been up to in Georgia places the whole all the CEE economies at a greater level of risk than they were simply two weeks ago.

Edward Hugh said...

Hi Mihail,

"The average cost of mortgage is 9.81%, according to various press clippings."

Thanks for this and a lot of other details.

"Current regulations allow for 60 - 70% indebtedness and 0 down payment."

My feeling is that it is when the zero deposit condition is withdrawn that property markets come very quickly to a near halt. Much more than interest rate sensitivity. I think the no deposit offer is at the heart of real "sub-prime" - since it means the banks are very quickly exposed when there is any price correction, and not SIVs which are "off balance sheet".

As we can see in places like Spain, the Baltics, Bulgaria and Romania, banks are willing to engage in very risky lending under the right circumstances, even though if there are problems these will eventually work their way all the way back up to the balance sheet.

OK, well thanks again, and please stay in touch.

Edward Hugh said...


"a 42 m2 one room (one room + one small kitchen + one small bathroom) apartment in one of the communist blocks at the periphery of Bucharest be worth over 70000 Euro. Yeah, those gray blocks of flats that get so much publicity ..."

Just like the ones which appear in Cristian Mungiu's excellent film "4 luni, 3 saptamâni si 2 zile" I suppose.

Mihail Marcu said...

Well, new data is out:

H1 growth - 8.6%;

public deficit - 0.64%;

new credit limits will start at the earliest in October and the indebtedness will be around 55 - 65%.



Edward Hugh said...

Hi Mijail,

"Well, new data is out:"

OK, thanks for this. Other data to watch would be remittances (current transfers in the BoP) which is Emil is right and many migrants have now returned home (or are out of work in Spain or Italy) should slow, but there is little sign of this at this point.

Forex bank credit to households, which is slowing - it was "only" 131.5% y-o-y in June - but this has been coming steadily down from the 143% y-o-y peak in January, and as the rate of increase slows domestic - and especially housing - demand will notice, as we have seen in Spain. I expact we will see a lot lower y-o-y rates in the autum as the high base effects drop out, and then things will really start to creak.

A third data point to watch would be construction output, which was only up 12.7% y-o-y in June (according to latest Eurostat data) following a peak of 33.4% y-o-y in January. So the whole thing is slowing now, although undoubtedly your headline GDP will get some uplift from the exceptional year in agriculture.