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Monday, March 30, 2009

Romania What Next?

With capital inflows to the CEE economies slowing to a trickle in Eastern Europe, a sharp correction is now underway in most countries' external imbalances and in particular in their current-account deficits. For the CEE-6 (Poland, Czech Republic, Hungary, Romania, Bulgaria, Turkey), net private capital flows are forecast to slow to $59.5 billion in 2009, down from an estimated $161.9 billion in 2008, according to estimates from the Institute For International Finance. The basic concern is that those countries with significant external deficits are extremely vulnerable to foreign capital reversals, especially in the current environment of global credit tightening.

FDI flows (which are generally considered more stable and less susceptible to rapid outflows than other capital flows) have been the main form of financing for current-account deficits in recent years, but such inflows are set to slow sharply in 2009. The Economist estimates that between 2003 and 20007 FDI inflows (on average) covered almost 100% of the current-account deficit in the ten EU member states. In 2008, this coverage fell to an estimated 55%

As FDI has fallen back, debt - particularly intra-bank lending - has become the main financing vehicle for the current-account deficits. Nevertheless, intra-bank lending – that is, lending between foreign parent banks and their subsidiaries in the region – is falling back sharply in 2009, with nett bank lending to emerging Europe, excluding Russia, being projected at around $22 bn in 2009, down from $95 bn in 2008 (according to the Institute for International Finance)

Now the central issue is that such corrections in external imbalances can take pplace in one of two ways - either domestic demand drops sharply and/or the currencies weaken significantly. In the case of those countries with an exchange rate peg the second route is not open, hence what we are likely to see is a very sharp contraction. Such contractions are already evident in the Baltics, but what about Bulgaria. How sharp will the correction in Bulgaria be? Only today capital economics have come in with a forecast of 5% contraction over the year. But how realistic is this, let's look at some data.

One of the first points I would like to look at is the external trade situation. It is very clear that the Romanian trade deficit is decreasing. The January 2009 goods trade deficit was down to 576.4 million euros, from 2394.7 million euros in January 2008. But as I am saying, it is quite important to understand how this improved trade balance is being achieved. It is not being achieved through an increase in exports, but rather through a decrease in imports, which are falling more quickly than exports are falling. In fact in January 2009 exports were down by 24.3% (in euros) over January 2008, while imports were down by 37.4%, as the following charts make clear.

The consequence of this decline in external trade is that Romania's current account deficit is falling rapidly, and was already down to nearly 12 percent of its gross domestic product (GDP) in 2008, with most of the improvement in the deficit taking place in the last three months of the year. The current account deficit in 2007 was 14 percent of the GDP, and most analysts had been expecting a widening of the gap in 2008, with some predictions even rising as high as 18 percent.

National Bank of Romania Governor Mugur Isarescu is already expressing concern about the pace of the change, particularly because the fact that Romania's government was already operating with a fiscal deficit of around 5% of GDP in 2008, means that the ongoing contraction in private sector activity will need to be accompanied by a contraction in government spending too. Isarescu has been calling for "burden sharing" between the private and public sector, but with the IMF now in on the act, then it is pretty clear that the public sector will not be escaping its share of the pruning.

"I said we have no alternative to adjusting the current account deficit. The entire program of economic policies, be it the former or the current government's, should be focused on this adjustment, that should not be made by the market forces only, since it will be a lot more painful," Isarescu noted.

Central Bank Keeps Interest Rates On Hold

Romania’s central bank kept the Monetary Policy Rate unchanged at 10 percent today. The rate is the highest in the European Union, but the central bank governor Mugur Isarescu said he is pinning his hopes on the International Monetary Fund bailout averting a deepening recession. Romania was awarded a 20 billion-euro financing package last week to help cover the financing needs of the current account and budget deficits. The first 5 billion euros is scheduled to arrive in May.

Global financial turmoil has weakened the leu by 12 percent against the euro and 26 percent against the dollar in the past year as investors pull out of riskier nations. The loan makes Romania the sixth country in eastern Europe to receive an international financing package as the region’s economies struggle with declining demand from the west and growing external deficits, since Hungary, Ukraine, Belarus, Latvia and Serbia have also received bailouts to help avoid defaults and aid banks.

The leu, which has weakened by 12 percent against the euro and 26 percent against the dollar in the past year has recently recovered to some extent from the very low levels hit in January.

Please Check Back Later. Post To Be Completed.


Anonymous said...

I would love to better understand the uses of the recently secured IMF loan (I believe 20bn euros, of which quite a sizable portion will prob go towards financing the budget deficit)...

Edward Hugh said...

Hello there,

"I would love to better understand the uses of the recently secured IMF loan"

Well please hold on, since this post is about to grow over the next couple of days.

I don't know if I can adequately explain the loan, but I will do my best.

Anonymous said...

I think the chart about EUR/RON is wrong. http://www.ecb.int/stats/exchange/eurofxref/html/eurofxref-graph-ron.en.html

Edward Hugh said...


"I think the chart about EUR/RON is wrong. "

It was, thanks. Strange, it came from Yahoo Finance, but still. The ECB ones seem fine.


Anonymous said...

I've been reading your blog for a while and I find it very usefull.
I am from Romania so I know a bit about this loan from IMF and EU.
The reserve requirements for euro are at a record level in Europe at 40% and the ones in RON at 18%, so there are plenty of money to credit the economy if the reserves are lowered. The IMF loan of 13 billion goes to the national bank, 5 or 6 billion finance the budget deficit and 1-2 billion come from BEI, EBRD. EBRD financed banks that were in trouble, Banca Transilvania in October and Erste in March when there was that noise about Austria's exposure. The National Bank will lower to 0% the required reserves for euros with maturities of more than 2 years starting from May (when the loan from IMF arrives). That will free 0.6 billion and will be an incentive for long term loans taken by romanian foreign owned banks. The austrian banks signed a gentlemen agreement with the romanians authorities and the IMF in Vienna to promise they will not withdraw money from Romania. This will hardly be the case when there will be enough liquidity in the market. With a rapidly correcting account deficit and an economy where constructors and importers ensured most of the "growth", banks will be very cautious with businesses.
Why IMF and not simply EU? Because in last autumn's elections most parties promissed unthinkable attrocities, like a 50% rise of the teachers wages and we have 2 more elections this year... There are plenty of measures to reduce government spending now and there will be a new tax on small businesses. Yet the government is a coalition with 70% support in the parlament that could break up and the thought of it is terrifying.
In my view the loan had to be taken for two reasons - most of the private debt that has to be paid this year in euro is scheduled in May and June and the rest in October. We have to avoid a rapid depreciattion of the currency. The second reason is that the rates at which banks lend are way higher than one year ago and the highest in Eastern Europe. The currency has been kept under control at the cost of a credit squeeze. These charts are from December http://www.bruegel.org/Public/fileDownload.php?target=/Files/media/PDF/Publications/Policy%20Briefs/pb_Avoiding-a-Euro-dividde_191208.pdf
You can tell the credit squeeze by watching the traffic in Bucharest. The worst month was January with very little traffic.
The good news is that the FDI grew by 50% compared to last year in January. In Poland it grew by 35%. Not a bad time to invest when currencies are undervalued, there is less traffic, skilled constructors are returning from Spain...


Mihai Marcu said...


Essentially the NBR stuck to their non-sterilized intervention in October for a long time.

Early January - March, they managed the exchange rate through direct intervention mostly, while RON rates returned to normal.

The FDI coverage in 2009 is not necessary good news - we should note that coverage decreased to 52%; most FDI were share capital increases and intragroup loans.