Romania Economy Watch

Eastern European Growth - Coming Rapidly Off The Boil?

2011-08-22T09:31:00.000-07:00

The latest round of EU GDP data, brought to light a reality which many who have been closely following the economies of Eastern Europe already suspected: that the heavily export dependent economies in the region would almost inevitably be dragged down by the rapid slowdown in Europe's principal economic motor, the German economy (see this post for background).

The Czech Republic, Hungary, Slovakia, Bulgaria and Romania all reported slower GDP growth in the second quarter, due in large measure to the disappointing performance of their German neighbour, central Europe’s most important trading partner.

As anticipated on this earlier blog, the Hungarian results were especially weak. Analysts had widely predicted interannual growth of just under 2.5%, but in the end the result came in at 1.5%. Even worse, the economy completely failed to grow in the second three months in the year, since quarter on quarter growth was effectively zero. Thus the increase in industrial activity which accompanied the increased demand for exports was only sufficient to compensate for the drop in internal demand, and this at a time of near record export levels in many European countries. This is doubly worrying since the government, while continuing to reduce the deficit, has appropriated something like 9% of GDP from a one off pension move, paying down debt and, in addition, adding some support to this years spending programme. This factor will not be there to assist growth in the years to come.

This post will examine the growth performance in a number of the region's economies, and attempt to extract some useful conclusions for what we can expect to see in the region in the future.

The Czech Republic Shows Its Weaknesses

Mirroring what just happened in Germany, second quarter GDP growth in the Czech republic slowed from what had been the fastest pace in almost three years achieved in the first three months of the year, to a mere 0.2%, the slowest rate of increase in two years.

While the economy grew 2.4 per cent from a year earlier, compared to 2.8 per cent in the first three months of the year.

Like many economies in the region, the Czech one is now strongly dependent on foreign demand for its products. Exports have surged back up and beyond pre-crisis highs, while industrial output has grown strongly.

What makes the Czech case interesting is that neither the private nor the public sector is heavily indebted - public sector debt was only 41.3% of GDP in 2010, and the country's external debt was only 46.7% of GDP. Nor is the country facing an "investor strike", the central bank policy rate is currently 0.75% , and far from this deterring people from holding the currency, the Koruna has gained nearly 2.4% against the euro so far this year, as compared with a decline of around 10 per cent in the Polish zloty. Indeed some are even talking of the Koruna as a potential safe haven alternative to the Swiss Franc.

The government deficit has been over the EU 3% limit (it stood at 5% of GDP in 2010) and recent government austerity measures to reduce this level have undoubtedly played some part in the slowdown, but this on its own is not enough to fully explain the velocity of the reduction. As I argue in my most recent post on Germany, export driven economies are inherently volatile, and what has happened in the Czech Republic is an almost classic example. But why is the country export dependent? Well, there are probably as many answers offered to this question as there are economists, but my own personal view is that demography is the key. After decades of very low fertility, the country's population is ageing rapidly, and by 2020 the median age will be nearly 45, making the Czech Republic the second oldest nation in the region, after Slovenia.

Many will see no significance in this fact, but from where I am sitting the association is not simply coincidental (see this working paper from Claus Vistesen).

A number of "stylised facts" can be extracted from the Czech example. In the first place, if we look back at the q-o-q GDP chart (the orange/red one), what is most noteworthy is how the rate of quaterly growth since the crisis has fallen to about half its prior level. This, in an economy without major debt problems and with a fairly competitive economy must give us some idea of what the "new normal" looks like. GDP growth is much lower, and likely to remain lower (on average) as far ahead as the eye can see.

In the second place, construction output is down (and falling). This also seems to form part of the brave new world we now live in, at least as far as most of Europe, the US and Japan are concerned. A house is once more becoming something you live in.

And thirdly, as I say, domestic demand is falling steadily, as reflected in retail sales (naturally in the more heavily indebted economies this situation is worse). This weakness in domestic demand is unlikely to be temporary, and those waiting for a turnaround would do better going and waiting for Godot.

This persistent weakness in domestic consumption is all the more striking in the Czech case, given that real GDP is now almost back at pre-crisis levels.

The Czech example is illustrative, since it is one of the best case scenarios, and unfortunately, when we look at the regional neigbours, we find that in general things only get worse.

Romanian Growth Holiday

Romania has struggled far longer than any other CEE economy to emerge from recession, only grew (q-o-q) by 0.1%, following a 0.7% quarterly rate of increase in the first quarter.

Even though there is some discrepancy between the data published by the national statistics office and by Eurostat, it is clear that Romanian GDP is barely up from one year ago.

And indeed is still something like 8.5% below its pre-crisis peak.

This despite the fact that exports have been booming, and are now above the pre-crisis level.

As per the regional pattern, domestic demand has not recovered and retail sales are falling.

Construction is well down, and is unlikely to return to pre-crisis levels.

But Romania and the other countries we are about to look at suffer from an additional problem - the have significant external debt levels, and despite the activation of the so called Vienna initiative they continue to suffer from very tight credit conditions.

Total Romanian government debt is not high (only just over 35% of GDP), but the country does suffer from deficit problems (6.5% of GDP in 2010), while external debt is over 70% of GDP (a lot of this in forex loans to the private sector). The country continues to run a significant current account deficit (4.2% of GDP in 2010):

and inflation has been far higher than is desireable, given that the country cannot easily devalue to restore competitiveness given the external debt exposure.

True, the inflation rate was exacerbated by a 5% VAT rise in July 2010 and the annual rate has now fallen back from 8% in June to 4.9% in July, but I really would question the wisdom of the widespread recourse to VAT rises made by the IMF, since while they do offer a fairly quick short term fix to deficit issues, they only compound growth and external competitiveness problems, in particular in cases where devaluation is not a quick'n easy option.

Bulgaria's Limp-along Economy

The Bulgarian case is not dissimilar to the Romanian one, even though the economy did return to growth in the second quarter of last year. Growth screeched to a virtual halt in the most recent quarter (0.1% q-o-q):

while interannual growth slowed to 1.9% from 3.4% in the first quarter.

Bulgarian GDP has recovered rather more than it has in Romania, but at the end of June it was still more than 7% down from the pre crisis peak level.

The explanation for the weak recovery is the same as elsewhere, with domestic consumption stagnant, and retail sales in tendential decline.

Construction has also slumped significantly.

In addition to the credit crunch which is to be found elsewhere, Bulgaria faces the added difficulty that many banks are Greek owned, and are themselves facing a liquidity stretch at home.

Yet despite the Euro peg the country continues to run a sizeable inflation rate, and competitiveness - as measured by the REER - continues to deteriorate. Thus an export sector which in value added terms is already too small for the job it has to do is facing headwinds which don't exactly encourage expansion.

Hungary Had No Boom, But The "Bust" Continues

Hungary's GDP growth basically stalled in the second quarter (0.0% q-o-q), taking the year-on-year rate down from 2.4% to 1.5% in the first quarter. This is well below consensus expectations (2.5%) and also worse than the central bank forecast of around 2.2%. The pull from net trade evidentally weakened substantially, and in an economy that only has one cylinder to fire on (exports) this makes itself noticed quickly.

Hungarian exports have risen well since early 2009, but in recent months growth in both these and industrial output has tapered off.

Hungarian GDP is still over 8% down from the pre-crisis peak.

Household consumption has not recovered at all, and retail sales continue to fall.

Again, construction activity is trending down.

The Hungarian current account has recovered considerably, and the country now runs a surplus, unfortunately not a large enough one to underpin stable growth.

The stock of CHF private sector loans is equivalent to approximately 20% of GDP, most of it made up of household loans (18% of GDP). Roughly half of these loans are mortgages, and the other half consists of home equity loans. As shown in the chart below (housing loans only, but representative of the whole), most of these loans were contracted in 2005- 08, when the consensus view was that the forint was in a secular appreciation trend versus EUR as well as CHF and Hungarians felt safe about borrowing at much cheaper foreign interest rates. People were focused on the repayment size, and not the capital value movements, rather like people have recently been focusing on public deficit issues, without thinking too much about debt dynamics (until Italy came barging along, that is).

In 2005, the average rate for a home equity loan in CHF was 4.8%, compared to 6.2% in EUR and 17.6% in local currency.The upward surge in the CHF together with increases in interest rates on CHF loans since these were intitially taken out means that the repayments on these mortgages have risen significantly. Morgan Stanley estimate that the average repayment on a CHF mortgage taken out over 2005-07 is up over 50%.

Carrying out some simple back-of-the-envelope calculations they also arrived at the conclusion that servicing this debt at an 8% interest rate costs Hungarians around 2% of GDP every year. Absent the adverse FX shock, servicing costs would have been around 1.4% of GDP. The 0.6% difference can be seen as a kind of growth penalty, hamstringing what would already have been pretty weak domestic consumtion. According to Morgan Stanley calculations, the rise in CHF since 2008 has had the equivalent impact on Hungarian FX borrowers of a 6% rate increase.

And it isn't only householders who are suffering from Forex risk. Hungary's gross external debt is around 135% of GDP. The country has the largest public debt in the region (around 80% of GDP), and although one off measures with the pension system mean that this will fall this year, the upward path may then resume unless the country has a growth revolution. Worse, 45% of public debt is not in Forints (and some of it is even in Swiss Francs), meaning that currency depreciation risk exists. All in all, it is very had to see the country being able to find its way onto a sustainable debt path.

Drifting Towards Export Dependence Too Slowly For Comfort?

The recent enthusiasm we have seen for the East European model has a nasty and worrying precedent, since in the years leading up to the financial crisis those who lauded the merits of the European Union’s newest members were not few in number. They were seen as the high-growth members of the Union who had learnt the costly lessson that big government was to be strenously avoided. Such was the enthusiasm that even the very evident and very substantial current account deficits were considered almost benign. But then, as even, after pride came the fall, as one country after another had financing difficulties and became forced to call in the IMF.

Now countries in the East are cited for their low debt, and capacity to accept sacrifices in avoiding excessive deficits. Two issues stand out as important: the prevalence of unhedged forex debt and the regions unique demographics. Just like in the Euro Area's Southern Periphery the presence of forex borrowing severely limits devaluation as a potential competitiveness restorer, while ageing and declining populations mean that the economies are increasingly export dependent. This means they often have both increased exposure to global slowdowns (or recessions), combined with an external financing dependency when sources of funding may rapidly dry up.

Evidently, societies with young, growing populations can hope that the sheer pace of economic growth will eventually burn down their debt, but societies with shrinking populations, and rapidly rising elderly dependency ratios cannot adopt such a complacent attitude. Older societies are normally lower growth societies, and in addition, with the number of people of working age falling and falling, an ever greater burden falls on an ever smaller labour force. All four countries in our sample are pioneeers in this regard, sounding out the frontiers of a world in constant decline, a world which is ever older.

This post first appeared on my Roubini Global Economonitor Blog "Don't Shoot The Messenger".

From Original Sin To The Eternal Triangle - Lessons From Central Europe

2009-08-14T02:03:00.000-07:00

The non-biblical concept of original sin, as Claus Vistesen notes in this post, when propounded in its standard Obstfeld & Krugman textbook version refers to the situation where many developing economies who are not able to borrow in their own currencies feel forced to denominate large parts of their sovereign and private sector debt in non-domestic currencies in order to attract capital from foreign investors - as evidenced most recently in the countries of Central and Eastern Europe. Well, piling insult upon injury, I'd like to take Claus's point a little further, and do so by drawing on another well tried and tested weapon from the Krugman armoury, the idea of the "eternal triangle".

As is evident, the reality which lies behind the current crisis in the EU10 is complex, and has its origin in a variety of causes. But one key factor has undoubtedly been the decisions the various countries took when thinking about their monetary policy and currency regimes. The case of the legendary euro "peggers" - the three Baltic countries and Bulgaria - has been receiving plenty of media attention on late, and two of the remaining six (Slovenia and Slovakia) are now members of the Eurozone, but what of the other four, Romania, Hungary, Poland and The Czech Republic? What can be learnt from the experience of these countries in the present crisis.

Well, one convenient way of thinking about what just happened could be to use Nobel Economist Paul Krugman’s Eternal Triangle” model (see his summary here), which postulates that when it comes to tensions within the strategic trio formed by exchange rate policy, monetary policy, and international liquidity flows, maintaining control over any one implies a loss of control in one of the other two.

In the case of the Central Europe "four", Poland and the Czech Republic opted for maintaining their grip on monetary policy, thus accepting the need for their currency to "freefloat" and move according to the ebbs and flows of market sentiment. As it turns out this decision has served them remarkably well, since the real appreciation in their currencies which accompanied the good times helped take some of the sting out of inflation, while their ability to rapidly reduce interest rates into the downturn has lead to currency depreciation, helping to sustain exports and avoid deflation related issues.

The other two countries (Hungary and Romania), to a greater or lesser degree prioritised currency stability, and as a result had to sacrifice a lot of control over monetary policy, in the process exposing themselves to the risk of much more violent swings in market sentiment when it comes to capital flows. Having been pushed by the logic of their currency decision towards tolerating higher inflation, they have seen the competitiveness of their home industries gradually undermined, and as a consequence found themselves pushed into large current account deficits for just as long the market was prepared to support them, and into sharp domestic contractions once they were no longer disposed so to do.

A second problem which stems from this "initial decision" has been the tendency for households in the latter two countries to overload themselves with unhedged forex loans, a move which stems to some considerable extent from the currency decision, since in order to stabilise the currency, the central banks have had to maintain higher than desireable interest rates, which only reinforced the attractiveness of borrowing in forex, which in turn produced lock-in at the central bank, since it can no longer afford to let the currency slide due to the balance sheet impact on households. Significantly the forex borrowing problem is much less in Poland than it is in Hungary or Romania, and in the Czech Republic it is nearly non-existent.

The third consequence of the decision to loosen control on domestic monetary policy has been the need to tolerate higher than desireable inflation, a necessity which was also accompanied by a predisposition to do so (which had its origin in the erroneous belief that the lions share of the wage differential between West and Eastern Europe is an “unfair” reflection of the region’s earlier history, and essentially a market distortion). The result has been, since 2005, a steady increase in unit wage costs with an accompanying loss of competitiveness, and an increasing dependence on external borrowing to fuel domestic consumption.

So, if we look at the current state of economic play in the four countries, we find two of them (Hungary and Romania) undergoing very severe economic contractions - to such a degree that in both cases the IMF has had to be called in. At the same time both of them are still having to "grin and bear" higher than desireable inflation and interest rates. In the other two countries the contraction is milder, the financial instability less dramatic, and both inflation and domestic interest rates are much lower. Really, looked at in this light, I think there can be little doubt who made the best decision.

Appendix

Here for comparative purposes are charts illustrating the varying degrees of economic contraction, inflation, and interest rates. GDP contraction rates actually present a little problem at the moment, since one of the relevant countries - Poland - still has to report. However Michal Boni, chief adviser to the Prime Minister, told the newspaper Dziennik this week that the economy expanded at an annual rate of between 0.5% and 1% in Q1. So lets take the lower bound as good, it is still an expansion.

The economy in the Czech Republic contracted by an estimated 4.9% year on year in the second quarter.

The Hungarian economy contracted by an estimated 7.4% year on year in Q2.

While the Romanian economy contracted by an estimated 8.8% year on year.

Inflation Rates

Poland's CPI rose by an annual 4.2% in July.

The CPI in the Czech Republic rose by an annual 0.3% in July.

Romania's CPI rose by an annual 5.1% in July.

Polands CPI rose by an annual 5.1% in July.

Interest Rates

The benchmark central bank interest rate in Poland is currently 3.5%.

The benchmark central bank interest rate in the Czech Republic is currently 1.25%.

The benchmark central bank interest rate in Romania is currently 8.5%.

The benchmark central bank interest rate in Hungary is currently 8.5%.

Romania What Next?

2009-03-30T14:03:00.000-07:00

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.

How Not To Manage Eastern Europe's Financial Crisis (Part 1)

2009-03-04T11:53:00.000-08:00

"Saying that the situation is the same for all central and eastern European states, I don't see that......you cannot compare the dire situation in Hungary with that of other countries."
Angela Merkel, Brussels, Sunday

"Happy families are all alike; every unhappy family is unhappy in its own way"
Tolstoy

In Europe, leaders rejected pleas for a comprehensive rescue plan for troubled East European economies, promising instead to provide “case-by-case” support. That means a slow dribble of funds, with no chance of reversing the downward spiral.
Paul Krugman

Bank regulators from Bulgaria, the Czech Republic, Poland, Romania and Slovakia met today and issued a joint statement, ostensibly to reduce the some of the impact of what they term "alarmist comments" from the Austrian government about how the regional banking system is now in such a precarious state that it requires urgent action at EU level to prevent meltdown. The Austrian government are, of course, concerned about the impact of any meltdown on their own banking system. The result of this "reassuring statement" can be seen in the chart below (10 years, HUF vs Euro).

Within minutes of the joint statement Hungary's currency plummeted to an all-time low against the euro and to a 6.5-yr low versus the US dollar. In fact the HUF rapidly depreciated to 312 per euro from 307.50 before climbing back in later trading to 310. And the reason for this swift reaction? Hungary was not invited to join the statement. As the forint plunged, Hungary 's banking regulator hurriedly signed up to the statement, blaming the original omission on a communications mess-up, but the damage was already done.

“Each of the CEE Member States has its own specific economic and financial situation and these countries do not constitute a homogenous region. It is thus important first to distinguish between the EU Member States and the non-EU countries and also to clarify issues specific to particular countries or particular banking groups."

Well this just takes us back to Tolstoy, each of them have their own specific problems, but the underlying reality is that they all face problems, and are vulnerable, each in their own way.

Hungary's economic fundamentals are clearly much weaker than those to be found in the Czech Republic and Poland as things stand, but what about Bulgaria and Romania? And the Czech Republic and Poland are about to have a pretty hard time of it as a result of their export dependence on the West, and Poland has the unwinding of the zloty options scandal still to hit the front pages. So there is plenty of food for thought here before throwing Hungary to the wolves. A default in Hungary could very easily lead to contagion elsewhere, and then the impact in the West is very hard to foresee. We should not be playing round with lighted matches right next to our fireworks stock. "Hey, it's dark in here" and then "boom".

Yesterday it was Latvia's turn, and the cost of protecting against a Latvian default (Latvia is the first European Union member priced at so- called distressed levels) rose to a record following the announcement that the unemployement level rose from 8.3% in December to 9.5% in January, the highest level in nearly nine years. In fact credit-default swaps linked to Latvia increased nine basis points to an all-time high of 1,109 basis points, according to CMA Datavision in London. The cost is above the 1,000 level, breached last week, that investors consider distressed, and is now about 270 basis points above contracts linked to Lithuania, the next-highest EU member.

So two countries are being systematically detached here - Latvia and Hungary - and statements by EU leaders are unwittingly aiding and abetting the process. But we should all remember, after they have eaten Latvia and Hungary for breakfast, the financial markets will undoubtedly chew on other luckless countries over lunch (Romania's Q4 GDP data was out today, and it was a shocker, and S&P have already said they are "closely monitoring" the situation), before perhaps moving on to bigger game for supper.

And we should remember here, no one is too big to fall, and I have already been warning about the gravity of Germany's situation, with a rapidly ageing population, a hefty bank bailout of its own to swallow, and total export dependence for GDP growth. Final data from Markit economics out today showed that Germany's composite PMI fell to 36.3 in February from 38.0 in January. That was the lowest level registered since the series began in January 1998. And it means that the German economy - which is highly interlocked with the whole of Eastern Europe (Austria holds the finance and Germany the industrial exposure) - is certainly contracting more rapidly in the first quarter of this year than it was in the last quarter of 2008, and may well contract in whole year 2009 by something in the order of 5%. So maybe someone over there in Germany should be reading the poem you will see below aloud to "our Angela" right now (Oh, and if you don't speak German, you can find a translation here).

Als die Nazis die Kommunisten holten,
habe ich geschwiegen;
ich war ja kein Kommunist.
Als sie die Sozialdemokraten einsperrten,
habe ich geschwiegen;
ich war ja kein Sozialdemokrat.

Als sie die Gewerkschafter holten,
habe ich nicht protestiert;
ich war ja kein Gewerkschafter.

Als sie die Juden holten,
habe ich geschwiegen;
ich war ja kein Jude.

Als sie mich holten,
gab es keinen mehr, der protestieren konnte.

What Last Weekend's EU Summit Did And Did Not Achieve

2009-03-04T11:51:00.000-08:00

Well reading the press on Monday morning it would have been fairly easy to reach the conclusion that nothing really happened yesterday in Brussels, and that a great opportunity was lost. The latter may finally be true, but the former most certainly is not.

Let's look first at what was not decided on Sunday. The leaders of the 27 member countries in the European Union most certainly did not vote to back a proposal from Hungarian Prime Minister Ferenc Gyurcsany for a 180-billion-euro ($228 billion) aid package for central and eastern Europe. They did not back it because it was not even seriously on the agenda at this point. These people move slowly and we need to talk them throught one step at a time. So what was on the agenda. EU bonds for one, and accelerated euro membership for the East for a second. And once we have the EU bonds firmly in place, then that will be the time to decide how we might use the extra shooting power they will bring us (boosting the ECB balance sheet would be one serious option they should consider, see forthcoming post from me and Claus Vistesen). That is when the emergency blood transfusion Gyurcsany was rooting for might come into play, but on this, as on so many items, the details of how we do what we do as well as the "what we do" will become important, so the moves we do take need to be well thought out, and systematic, they need to get to the roots of the problem, and not simply respond to problems on a piecemeal, reactive basis.

As Paul Krugman puts it "In Europe, leaders rejected pleas for a comprehensive rescue plan for troubled East European economies, promising instead to provide “case-by-case” support. That means a slow dribble of funds, with no chance of reversing the downward spiral." Amen to that!

But let's look at little bit deeper at what has been decided, or if you prefer, at what has been floated, and may be "decided" at the next meet up. Well for one, we have promised not to be protectionist, and for another, The World Bank, The European Bank for Reconstruction and Development (EBRD) and The European Investment Bank (EIB) have launched a two-year plan to lend up to 24.5 billion euros ($31.2 billion) in Central and Eastern Europe. This sounds a bit like trying to drain an Ocean with a teaspoon, and it is, so predictably the financial markets were not too impressed, expecially when they learned that not much of what was promised was going to be new money (as opposed to theacceleration of existing commitments), and especially when we take this sum and compare it with the likely quantities which are needed to "take the bull by the horms". EBRD President Thomas Mirow (who is more likely to give a low side estimate than a high side one) recentlly told the French newspaper Le Figaro that in his view Eastern European banks could need some $150 billion in recapitalisation and $200 billion in refinancing to stave off the risk of a banking failure in the region. At least.

"(It) sounds like a lot of money, but when (commercial) banks have lent Eastern Europe about 1.7 trillion dollars, 25 billion is peanuts," said Nigel Rendell, emerging markets strategist at Royal Bank of Canada in London. "Ultimately we will have to get a much bigger package and a coordinated response from the IMF, the European Union and maybe the G7."

So let's now move on to the positive side of the balance sheet, since as we know our leaders are a slowish bunch when it comes to grasping what is actually going on here, and an even slower group when it comes to acting on that knowledge once it has been acquired. The biggest plus to come out of last weekend's thrash is most definitely the fact that the idea of accelerating membership of the eurozone for the Eastern countries has now started to gain traction, if with no-one else then at least with Luxembourg Prime Minister (and Finance Minister, he is a busy man) Jean-Claude Juncker, aka "Mr Euro", who was quoted by Reuters on his way into the meeting saying he did not expect any early change to accession criteria for the single currency.

"I don't think we can change the accession criteria to the euro overnight. This is not feasible," Juncker told reporters as he arrived for a summit where non-euro eastern countries are due to call for accession procedures to be accelerated after their local currencies have taken a hammering on markets.

While in the news conference following the meeting he said that there was now a consensus that the two-year stability test required for a currency of a country hoping to join the euro zone should be discussed.

"I can understand that there may be a slight question mark over the condition that one needs to be member of the monetary system (ERM2) for two years, we will discuss this calmly," Juncker told a news conference after a meeting of EU leaders.

So something actually went on during the meeting, even if we are largely left guessing about what. Angela Merkel also left a similar impression that movement was taking place. "There are requests to enter ERM 2 faster," Merkel is quoted as saying. "We can have a look at that."

Now I have already spelt out at some length why I think the Eastern Countries should be offered accelerated membership of the eurozone forthwith (see this post) as has Wolfgang Munchau (in this FT article here).

The Economist, in a relatively sensible leader which I have already referred to, divides the Eastern countries into three groups. Firstly there are those countries that are a long way from joining the EU, such as Ukraine, Turkey and Serbia. As the Economist points out, while it would be foolhardy practically and hard-hearted ethically to simply stand back and watch, European institutions are pretty limited in what they can do apart from offereing some timely financial help or some sound institutional advice, and it is entirely appropriate that the main burden of pulling these countries back from the brink should fall on the International Monetary Fund.

Then there are those East and Central European Countries who are themselves members of the Union, and here it is the EU that must take the leading role. A first group of these is constituted by the Baltic trio (Estonia, Latvia and Lithuania) and Bulgaria, who have currencies which are effectively tied to the euro, either through currency boards, or pegged exchange rates. Simply abandoning these pegs without euro support would both bankrupt the large chunks of their economies that have borrowed in euros and deal a huge psychological blow to public confidence in the whole idea of independent statehood. Yet devalue they must (either via internal deflation, or by an outright breaking of the peg) and either road is what Jimmy Cliff would have called a hard one to travel. As the Economist itself suggests, these countries have suffered the most painful part of being in the euro zone—the inability to devalue and regain competitiveness—without getting the most substantial benefits of participation, so although none of them will meet the Maastricht treaty’s criteria for euro entry any time soon (and since they are tiny - the Baltics have a population of barely 7m, and Bulgaria is hardly bigger), letting them directly adopt the euro ought not to set an unwelcome precedent for others and should certainly not damage confidence in the single currency (any more than it already is, that is).

On the other hand unilateral adoption of the euro is a rather more difficult issue for the third group of countries, those who are EU members, are not in the eurozone and have floating exchange rates: the Czech Republic, Hungary, Poland and Romania. None of these is here and now, tomorrow, ready for the tough discipline of a single currency that rules out any future devaluation, and they are large enough collectively (around 80 million) that their premature entry could expose the euro to more turbulence than it already has on its plate. But so could simply leaving the situation as is, since if these economies enter a sharp contraction (more on this in a coming post) then the loan defaults are only going to present similar problems for the eurozone banking system as their currencies slide. The big vulnerability for Western Europe from the Polish, Hungarian and Romanian economies, arises from the large volume of Euro and CHF denominated debt taken on by firms and households, mainly from foreign-owned banks. As the Economist puts it "what once seemed a canny convergence play now looks like a barmy risk, for both the borrowers and the banks, chiefly Italian and Austrian, that lent to them".

So we now have several EU leaders opening the door for the first time to the possibility of fast-track membership of the eurozone. As we have seen German Chancellor Angela Merkel said after the summit that we "could consider" accelerating the candidacy process, French President Nicolas Sarkozy said that "the debate is open", and Luxembourg Prime Minister Jean-Claude Juncker, who heads the Eurogroup of eurozone finance ministers, said he was willing "to calmly discuss" such a possibility. So the debate is open. When will the next meeting be? On Sunday I hope. A week in all this is a very long time for reflection in this hectic world. We need proposals, and concrete ones for how to move forward here. Especially since at the present time all our attentions seem to be focusing on the East, and there is also the South and the West (the UK and Ireland) to think about. Perhaps our leaders will be able to make time from their crowded agendas for a series of mid-week meetings on this topic.

And while the leaders dither, the markets react, and as Bloomberg reports the dollar surges as everyone seeks a safe haven during the coming storm.

The dollar rose to the highest level since April 2006 against the currencies of six major U.S. trading partners.... and .... The euro dropped to a one-week low against the greenback as European Union leaders vetoed Hungary’s proposal for 180 billion euros ($227 billion) of loans to former communist economies in eastern Europe. The Swedish krona fell to a record versus the euro on speculation the Baltic region’s borrowers may default, and the Hungarian forint and Polish zloty tumbled.

The Hungarian forint led eastern European currencies lower today, falling 3.1 percent to 243.86, while Poland’s zloty lost 3 percent to 3.7796. The forint fell to a 6 1/2-year low of 246.32 on Feb. 17 as Moody’s Investors Service said it may cut the ratings of several banks with units in eastern Europe. The zloty touched 3.9151 the next day, the weakest since May 2004.

EU leaders spurned Hungary’s request for aid at a summit in Brussels yesterday. Growth in Poland, the biggest eastern European economy, will slow to 2 percent, the slackest pace since 2002, the European Commission forecasts.

Is Romania Already Entering Recession?

2009-03-04T09:41:00.000-08:00

I don’t have a chart for this post, or anything of the kind, and the reason will become obvious in a minute. Romanian economic growth, the fastest in the European Union in the third quarter of 2008, slowed dramatically in the last quarter, coming in at an annual rate of 2.9 percent, the slowest in more than three years, and down (dramatically) from a revised 9.2 percent in the July-September period, according to data out today from the Bucharest-based National Statistics Institute.

The point is, we have no idea at all of what the quarter on quarter rate of change is, since the data provided by the Romanian Statistics Office is among the worst in the EU, and more comparable to China than an EU state in this regard. We simply do not know at this point what is happening to the Romanian economy, at least in the sort of detail that matters. Not everyone is so happy to stay in complete ignorance however, and analysts at Raiffeisen Bank did do some calculating of their own. In a research note published on 27 February, they estimate likely fourth quarter growth at 3.5% and put this provisional number through their calculating machines. On this basis they come out with the incredible result that, on a seasonally adjusted basis, the Romanian economy may well have contracted by between 2 and 3 percent from one quarter to the next. This is a very large number, and implies the economy has entered tailspin, especially when we remember that the final result was 2.9 percent year on year (ie below the 3.5 percent number they were working with).

The statistical office will release the GDP figures for Q4 2008 on 4 March. The GDP growth rate in Q4 2008 should be substantially below the levels in the previous quarters. Although GDP expanded by 9.1% yoy in Q3 2008, it may expand by just 3.5% yoy in Q4 2008 (in spite of the still large positive contribution from the agriculture). This is because the final months of 2008 were marked by a rapid deceleration of activity in all sectors of the economy (industry, construction, retail sales). In Q4 2008, industry plunged by 10.4% yoy, while the growth rate in the construction industry stood at 16.8% yoy, down from 28.5% yoy in Q3 2008. Also, the growth rate of retail sales decelerated only to 4.3% yoy in Q4 2008, from 17.4% yoy in Q3 2008. According to our estimations, the rapid deceleration in the annual GDP growth rate reflects a contraction in real GDP in Q4 2008 by 2-3% from Q3 2008 (based on seasonally adjusted data).

Going on the data we do have consumption shrank 2.8 percent year on year, while financial activity fell 1.5 percent. Agricultural output, on the other hand, was up 18.2 percent, sustaining growth to some extent. The statistics institute said it will provide a more detailed breakdown of economic growth on March 19, but since Eurostat reports provide no harmonised Romanian GDP data in their quarterly reports, I am not optimistic.

“I am worried,” Finance Minister Gheorghe Pogea told reporters in Bucharest today. “These are the initial effects of the crisis manifesting itself in Romania. I am thinking about how to compensate for this, to re-launch the economy. The amplitude of the slowdown is big.”

Romania’s prior growth was based on a lending bubble. This has now burst. Private lending growth slowed to an annual 34 percent in January, down from over 63 percent in June as overdue debt payments more than tripled. Exports, which comprise almost a third of Romania’s gross domestic product, fell an annual 17 percent in December. So Romania’s economy is being hit on two fronts, exports are hit by economic contractions among its customers, while the credit crunch has put a sharp brake on domestic consumption.

Since it is more or less certain that the Romanian economy contracted in the last quarter of 2008, and since it is more or less impossible that we see an expansion in the first quarter of this year, I would conclude that the Romanian economy has now entered recession.

Let The East Into The Eurozone Now!

2009-02-22T12:25:00.000-08:00

“It’s 20 years after Europe was united in 1989 – what a tragedy if you allow Europe to split again.”
Robert Zoellick, World Bank president, in an interview with the Financial Times

(Click On Image To View Video)

World Bank president, Robert Zoellick, made a call this week - in an interview with the Financial Times - for a European Union-led and co-ordinated global support programme for the economies of Central and Eastern Europe. I agree wholeheartedly, and even if I have, reluctantly, to accept the point made last week by our Economy & Finance Commissioner Joaquin Almunia that our pockets, though deep, are certainly not bottomless (and thus it is probably beyond our means right now to rescue the non-EU Eastern states), I still feel we should make good on our responsibilities to those who are EU members, and to do so by opening the doors of the Eurozone to those who wish to join. Since this proposal is fairly radical, the justification that follows will be lengthy.

This is not a view I have arrived at lightly, but looking at the extent of the problem we now have before us, a problem which is growing by the day, and taking into account the fact that the origins of the economic crisis in the East must surely rest (at least in part) in the decision to make euro participation a condition for EU membership for these countries (a possibility which was subsequently withdrawn in the critical moment, when the going started to turn rough), and then assessing the risk to the Western European banking system which would be posed by simply sitting back and watching it all happen, I think this move is not only the least damaging of the policies we can now follow, it is the in effect the only viable path left to us if we are to keep the eurozone as an integral entity together.

If this proposal were accepted a new set of membership criteria would need to be drawn up, of course, but the underlying principle would have to be one of offering the certainty of entry as guaranteed forthwith, for those who chose to accept. Rules were made to be broken, and nothing should be so inflexible - not even the Maastricht eurozone membership criteria - that it cannot be ammended as circumstances dictate. And at this point even the undertaking that this - like the long awaited US Stimulus programme - was on the table, would be sufficient to provide immediate, and much needed relief. Flirting with doing nothing here is, in my opinion, flirting with disaster, both in the East and in the West.

Existing Maastricht Criteria

Convergence criteria (also known as the Maastricht criteria) are the criteria for European Union member states to enter the third stage of European Economic and Monetary Union (EMU) and adopt the euro. The four main criteria are based on Article 121(1) of the European Community Treaty. Those member countries who are to adopt the euro need to meet certain criteria.

1. Inflation rate: No more than 1.5 percentage points higher than the three lowest inflation member states of the EU.

2. Government finance:

Annual government deficit: The ratio of the annual government deficit to gross domestic product (GDP) must not exceed 3% at the end of the preceding fiscal year. If not, it is at least required to reach a level close to 3%. Only exceptional and temporary excesses would be granted for exceptional cases.

Government debt: The ratio of gross government debt to GDP must not exceed 60% at the end of the preceding fiscal year. Even if the target cannot be achieved due to the specific conditions, the ratio must have sufficiently diminished and must be approaching the reference value at a satisfactory pace.

3. Exchange rate: Applicant countries should have joined the exchange-rate mechanism (ERM II) under the European Monetary System (EMS) for 2 consecutive years and should not have devaluated its currency during the period.

4. Long-term interest rates: The nominal long-term interest rate must not be more than two percentage points higher than in the three lowest inflation member states.

The Dimensions Of The Problem

European governments, the European Union and international financial organizations need to act fast on risks stemming form banks’ exposure in the eastern part of the continent to avert an escalation of the credit crisis, Nomura Holdings Inc. said. East European countries are struggling to refinance foreign- currency loans taken out by borrowers during years of prosperity through 2007, when economic growth averaged at more than 5 percent. The International Monetary Fund, which has bailed out Latvia, Hungary, Serbia, Ukraine and Belarus, warned on Jan. 28 that bank losses may widen as “shocks are transmitted between mature and emerging market banking systems.” “Swift action is needed to restore confidence and prevent trouble” to financial and economic stability in the euro region and emerging Europe, said Peter Attard Montalto, an emerging markets economist at Nomura International in London. “Any move should be quick. The situation has begun to decline more rapidly since the end of last year and there is risk that any action may come too late.”
Bloomberg

Robert Zoellick is far from being a lone voice in the wilderness about the current level of risk to the coutries in the East, and indeed precisely those EU banks who have been most active in emerging Europe are now busily trying to convince EU regulators, the European Central Bank and Brussels itself to coordinate new measures to counter the impact of the financial crisis confronting the region. The problem in the East certainly now adds a new dimesion to the problems facing us here in Europe, since West European governments are now being simultaneously hit on a number of fronts, and the situation is become more complicated by the day.

In the first place most West European economies are now either in or near recession, and their domestic banking systems are, to either a greater or a lesser extent, struggling. The West European states are thus, by and large, already feeling stress on their own sovereign borrowing capacities. But, with greater or lesser effectiveness, these countries are still able to increase their debt, even if sometimes the surge in borrowing is very dramatic, as in the case of Ireland, which will see gross debt/GDP shooting up from 24.8% in 2007 to a projected 68.2% in 2010 (EU January 2009 Forecast).

The situation in Eastern Europe is very different, and their economies and credit ratings evidently can't support such dramatic increases in their debt levels. Thus, in the case of those countries with a significant home banking presence, like Latvia's Parex, or Hungary's OTP, the support of external organisations (the IMF, the World Bank, the EU) becomes rapidly necessary when the bank concerned starts to have liquidity problems. But as a result of the consequent bailout the debt to GDP ratio starts to rise in a way which then places even subsequent eurozone membership in jeopardy. Latvia's Debt/GDP is, for example set to rise from around 12% of GDP in 2007 to over 55% in 2010. With a 10% plus GDP contraction already in the works for 2009, it is clear that Latvia's debt to GDP will rise beyond the critical 60% level. Hungary's debt/GDP is already above, and rising. If we don't do something soon, these two countries at least are being launched off towards sovereign default.

But the other half of this particular and peculiar coin turns up again in a rather unexpected way, and that is in the form of those West European banks who have subsidiaries in CEE countries, and who find now themselves faced, not with bailouts, but with ever rising default rates. This difficulty evidently and inevitably then works its way back upstream to the parent bank, and to the home state national debt, as the bank almost inevitably needs to seek support from one West European government, or another (in fact Unicredit, which has difficulty getting money from an already cash-strapped Italian government is talking of applying for support from the Austrian government via its Austrian subsidiary).

Austria is, in fact, a very good case in point here, since, as Finance Minister Josef Proell recently indicated, the country had some 230 billion euros of debt outstanding in Eastern Europe, equivalent to around 70 percent of Austria's GDP. The Austrian daily "Der Standard" have also reported the analysts view that a failure rate of 10 percent in Eastern Europe's debt repayments could lead to serious difficulties for Austria's financial sector. And this is no hypothetical "what if" type problem since the European Bank for Reconstruction and Development (EBRD) has estimated Eastern Europe's bad debts could go over 10 percent and could even reach 20 percent in the course of the current crisis. Underlining the mounting concern in Austria, Proell tried last week to convince EU finance ministers to provide 150 billion euros is support to CEE economies as a first step in trying to contain the growing wave of defaults.

The total quantity of debt outstanding is hard to put a precise number on, but the Bank for International Settlements estimated that, as of last September, more than $1.25 trillion had been leant by eurozone banks, and if you add in U.K., Swedish and Swiss bank liabilities the number rises to $1.45 trillion.

Western Europeean banks have a very important market share in the East, ranging from a low of 65 percent in Poland to almost 100 percent in the Czech Republic. This basically means two things, that the region's businesses and consumers are extraordinarily dependent on uninterrupted capital inflows from the West, and that some West European banking systems are extremely sensitive to rising default rates in the East. Of course the problem goes beyond the EU's borders, and while EU bank market shares in the Community of Independent States is rather less significant than in the EU12, due to the still substantial domestic ownership which exists there, exposure to defaults is not unimportant, especially in Ukraine, Kazakhstan and, of course, in Russia itself. Further, there is South East Europe to think about, and countries like Serbia and Croatia.

Large Banks Take The Initiative

Getting near to desperation, some of the largest banks involved - Italy's UniCredit and Banca Intesa, Austria's Raiffeisen International and Erste Group Bank, France's Societe Generale and Belgium's KBC - have launched a common initiative to try to lobby for an EU wide solution to the problem.

UniCredit is the largest lender in Poland and Bulgaria, while Erste is number one in Romania, Slovakia and the Czech Republic, with KBC occupying the position in Hungary, Intesa in Serbia, and Raiffeisen in Russia and Ukraine. Hungary's OTP Bank, emerging Europe's number 5 lender and the largest one in its home country, does not formally belong to the group. On the other hand OTP is actively looking for support.

OTP Bank Nyrt., Hungary’s biggest bank, said it’s in talks over a “role” for the European Bank for Reconstruction and Development, as it announced a 97 percent drop in fourth-quarter profit and “substantial” job cuts. As well as a possible EBRD involvement, OTP may also seek funds from Hungary’s emergency loan package from the International Monetary Fund, the European Union and the World Bank to “better serve the economy,” Chairman and Chief Executive Officer Sandor Csanyi said at a press conference in Budapest today. “There’s a chance the EBRD will assume a role in OTP, but I must stress that we plan no issue of new shares,” he said. OTP “doesn’t need to be saved,” Csanyi added.

Chancellor Angela Merkel, while expressing support for the bank initiative, has stopped short of offering concrete assistance or suggesting measures beyond those which are already in place.

The president of the European Bank for Reconstruction and Development, Thomas Mirow, wrote in the Financial Times this week the bank proposals "deserve full support as a worsening crisis in emerging Europe will threaten Europe as a whole".

The Austrian government has already announced it is trying to raise support for a general European Union initiative to rescue the region’s banking system. The government has set aside 100 billion euros in cash and guarantees to stabilise its banking sector. Next in line in terms of exposure are Italy ($232 billion), Germany ($230 billion) and France ($175 billion).

Unicredit is publicly rather dismissive of the problem (as can be seen from the slide below which from a presentation they gave earlier this week, please click on image to see better), but Italian investors are far from convinced by their arguments, as witnessed by the fact that their stock has plunged 41 percent this year, and by the fact that they were forced to sell 2.98 billion euros in 50 year bonds this week to shore up their Tier I capital after investors only bought about 4.6 million shares, or 0.48 percent, from their most recent rights offer. UniCredit, which said last month it is considering asking for government assistance, has also been disposing of assets to raise money and it plans to pay shareholders their dividends in yet more shares. Nationalisation of banks to supply credit lines to the private sector is one hypothesis currently being studied by Silvio Berlusconi, according to a Financial Times report this morning.

(Click on image for better viewing)
The Austrian proposal includes funds from the European Investment Bank, the European Central Bank and the EU Cohesion Fund. The Austrian government has offered money of its own and has been urging Germany, France, Italy and Belgium as well as the EU itself to contribute. One feature, however, stands out in all of the proposals which have so far been advanced: they are loan based-support. What Soros calls the "tricky question" of fiscal allocation from Europe's richer member states has not so far been raised, but it will be, since it will have to be.

And of course, Austria's concern is far from being altruistic, as Austria's economy and sovereign debt stability depend on finding a solution. It is hardly surprising to learn that credit-default swaps linked to Austrian government debt soared this week - by 39 basis points to a record 225 - on concern the country will need to bail out the domestic banks itself as they report losses and writedowns linked to eastern European investments. Erste, which said last week that full-year profit probably slumped by almost 26 percent, is in talks with the government to get 2.7 billion euros ($3.4 billion) in state aid. RZB has asked for 1.75 billion euros.

The European Central Bank on the other hand, seems reluctant to extend emergency financial help to crisis-hit countries beyond the 16-country eurozone. The ECB did not have “a mandate to be a regional United Nations agency”, Yves Mersch, governor of Luxembourg’s central bank, recently told the Financial Times. Such comments reveal the level of resistance which exists within the ECB’s 22-strong governing council to the idea of offering financial support to countries outside the zone.

The ECB has so far offered loans to Hungary and Poland, but has attached what some consider to be excessively strong conditions on facilities allowing them to borrow up to 5billion and 10billion euros respectively. Mr Mersch, whose views are thought to be widely shared in the ECB, suggested the central bank was worried about setting precedents if it relaxed its stance on helping individual countries. While some euromembers might favour assisting nearby nations, “we must not forget that other people might be sensitive to different countries”.

Who Bails Out The West European Banks In The East?

Governments and EU officials are struggling to formulate a coherent response to the economic and financial turmoil that has started to engulf the eastern part of the old continent. EurActiv presents a round-up of national situations with contributions from its network. Leaders of EU countries from central and eastern Europe will meet on 1 March ahead of an extraordinary summit on the same day with the bloc's other members, it emerged on Thursday (19 January). Polish Prime Minister Donald Tusk has invited his counterparts from the Czech Republic, Slovakia, Slovenia, Romania, Bulgaria, Lithuania, Latvia and Estonia for the talks to ensure the 27-nation meeting on the financial crisis is not dominated by the interests of Western member states. See full Euractiv article on background.

The EU has so far provided emergency balance-of-payments assistance to two of the East European member states in difficulty - Hungary and Latvia, and EU ministers did agree in December to more than double the funding available for such emergency lending to 25 billion euros ( so far Hungary has been allocated 6.5 billion and Latvia 3.1 billion). It is also quite probable that such lending will now have to be extended to the two newest southeast European members, Romania and Bulgaria, since their ballooning current account deficits and dramatic credit crunches mean that they are steadily getting into more and more difficulty.

The core of the problem is that the East European economies enjoyed strong credit driven booms, which fuelled higher than desireable inflation and lead to strong foreign exchange loan borrowing which simply bloated current account deficits. Now capital flows into emerging Europe have dried up as the global financial crisis has raised investors' risk aversion and prompted them to dump emerging market assets, leaving foreign-owned banks as the only source of loans for companies and consumers.

Italy's UniCredit, the biggest lender in emerging Europe, warned at the end of January that there was a clear risk of the global credit crunch gripping the region. UniCredit board member Erich Hampel stated at a Euromoney conference in Vienna that the bank was committed to fund its subsidiaries in the CEE countries and would continue to lend, but at the same time made absolutely clear that in order to do this his bank would need government support, whether from Austria, or Poland, or Italy itself.

Hampel said Bank Austria would decide during the first quarter whether to tap the Austrian government's banking stability package for fresh equity. " he said. "Our budget is under discussion now and clearly assumes growth in lending and in funding to the East. "

And according to a report from the Austrian central bank the fact that a relatively small number of Western European groups - including three Austrian ones - own most of the banks in Central and Eastern Europe means that there is the risk of a "domino effect", implying the crisis would spread quickly from one country to another. "How capital flows into (emerging Europe) will develop depends on the financial strength of the parent groups and of the sister banks, and on whether the parents are willing and able to fund their subsidiaries," the bank's half-yearly Financial Stability Report said. "The risks to refinancing are increased by the danger of a domino effect, because a large part of the foreign capital in many countries comes from a relatively small number of Western European banks," .

"What we see is that the emerging European economies have lost all sources of funding but banking," said Deborah Revoltella, chief economist for central and eastern Europe of UniCredit, the region's biggest lender. The task to carry whole economies through a downturn comes at a time when parent banks already face a double challenge: a likely sharp rise in loan defaults at their eastern subsidiaries and more difficult and expensive refinancing for themselves. "The international banks cannot solve this situation," Revoltella said. "They can do their part, and it's fundamental that they do their part but we have to take care of the other sources of funding which are missing now."

And it isn't only Austria who is worried, since Greek central bank governor George Provopoulos warned Greek banks only last Tuesday against transferring funds from the country's bank package to the Balkans, where they have invested heavily.

Regional Risks

In our view GDP growth is like to be negative in all CEE countries this year. In those countries least affected by the crisis (i.e. Poland, the Czech Republic, Slovakia and Slovenia) GDP is like to drop at least 2-5%, while those countries worst affected (i.e. the Baltic States, Bulgaria, Romania and Ukraine) are likely to face double digit declines in GDP. In other words, in terms of expected output lost in the region this is as bad as or even worse than the Asian crisis of 1997-98.
Danskebank - CEE: This Looks Like Meltdown

The problem that the EU has in adressing the situation in the Eastern member states is that what we have on our hands is not only a banking crisis, there is also a strong credit crunch at work, one which is now having a severe impact on the real economies in the region. Most of the economies in the region are already in recession, and those that are not soon will be (I have intersperced a number of relevant graphs throughout this post which should give some general impression of what is happening). Thus these countries are all taking multiple hits at one and the same time.

1/ In the first place they have an economic contraction on their hands, in some cases becuase they are struggling with a steep decline of export demand from western Europe, in others because their externally financed credit boom has now come to a sharp and painful end.

2/. Most countries in the region have some form of foreign currency exposure, although at present this is largely household and corporate rather than sovereign. In a number of countries -notably Hungary, Romania, Bulgaria and the Baltics this is particularly onerous since most of the mortgages were taken out in euros or Swiss Francs, and the default risk is now rising as their economies either deflate (internal devaluation) or their currencies fall as part of the regional sell-off. The danger is that as the bailouts are implemented at local level this exposure is steadily transferred over to the sovereign level, creating a dangerous dynamic which can endanger future eurozone membership. States which default will be unlikely candidate members.

3/. These countries are also suffering the impact of significant asset writedowns, as those assets bought at very high prices during the boom - some at up to six times their book value - now have to be written down, further weighing on earnings and weakening financial and corporate balance sheets.

4/ Finally there is significant contagion risk. The comparatively small number of foreign lenders involved has lead IMF economists and the credit ratings agencies alike to repeatedly warn of how the risk that a seemingly isolated incident in one country may rapidly spread right across the region.

"I don't think it's an exaggeration to say that the whole banking sector and financial system (in the region) rests on the response of parent banks," said Neil Shearing, economist at Capital Economics. "If they withdraw funding it's not very difficult to see how there would be a very severe financial crisis sweeping across the region, and the whole region en masse would have to go to the IMF," he said.

Governments in the region have already taken what measures they can. Most increased deposit guarantees from 20,000 to 50,000 euros following the EU October Paris meeting. Lithuania went further and upped the limit to 100,000 euros, while Slovakia, Slovenia and Hungary all now offer unlimited protection. But this begs the question, who guarantees the government guarantees in the event they are called on.

So the problem has now become a very delicate one, since the banks want to maintain their presence in the region even while almost every factor imaginable is working against them. The latest such factor is the threat of credit downgrades for their core business in Western Europe, and Moody’s Investors Service warned only this week that some of Europe’s largest banks may be downgraded because of loans to eastern Europe, a warning which sent Italy's UniCredit to its lowest level in the Milan stock market in 12 years.

Moody’s argues there will be “continuous downward rating pressure” in the region as a result of worsening asset quality and western banks’ reliance on short-term funding. UniCredit’s Bank Austria subsidiary earned almost half its pretax profit from eastern Europe in 2007, Raiffeisen International Bank-Holding almost 80 percent and Austria’s Erste Group Bank more than 60 percent, according to Moody’s.

“The most risky parts of the western European banks’ businesses are in eastern Europe and when you decide to cut risks, you cut back on the most risky assets first,” Lars Christensen, an analyst at Danske Bank A/S in Copenhagen, said by telephone today. “This could add further risk in the region as the economies there may face large current account deficits if funding from western European banks is withdrawn.”

As a result last Tuesday we saw a surge in the cost of protecting bank bonds from default, lead by Raiffeisen International Bank-Holding and UniCredit. Credit-default swaps on Vienna-based Raiffeisen climbed 26 basis points to a record 369 and those for UniCredit soared 23 basis points to an all-time high of 213, according to data from CMA Datavision in London. Credit-default swaps on Erste increased 24.5 to 307, Paris- based Societe Generale rose 6 to 116 and KBC in Brussels was unchanged at 240, according to CMA prices.

The rising cost of insuring against default by a “peripheral” European government is likely to weigh on the euro, according to Merrill Lynch & Co. “This remains an important background negative for the euro,” Steven Pearson, a strategist in London at Merrill Lynch, wrote in a note today. “European banking-sector exposure to Eastern Europe, often via foreign currency lending, is an additional euro negative story that is gaining air-time.” Emerging market central banks may move away from holding European government bonds in their reserves as widening yield spreads between debt of different euro-zone economies makes bonds more difficult to trade, Pearson said.

So Why Would The Euro Help?

Well, in the first place, four of the Eastern economies - Bulgaria, Latvia, Lithuania and Estonia, are effectively stuck, since their currencies are pegged to the Euro. They are in the unenviable position of being stuck between the proverbial rock and the hard place. They are now faced with US depression type economic slumps, and massive internal wage and price deflation all at the same time. Would Euro membership help? Well lets look at what the IMF said in their most recent report on the stand-by loan arrangement for Latvia.

Accelerated adoption of the euro at a depreciated exchange rate would deliver most of the benefits of widening the bands, but with fewer drawbacks. Unlike all other options for changing the exchange rate, the new (euro-entry) parity would not be subject to speculation.

By providing a stable nominal anchor and removing currency risk, euroization would boost confidence and be associated with less of an output decline than other options.Euroization with EU and ECB concurrence would also help address liquidity strains in the banking system. If Latvian banks could access ECB facilities, then those that are both solvent and hold adequate collateral could access sufficient liquidity. The increase in confidence should dampen concerns of resident depositors and also help stem non resident deposit outflows.

However, this policy option would not address solvency concerns and has been ruled out by the European authorities. If combined with a large upfront devaluation, there would be an immediate deterioration in private-sector solvency, which could slow recovery. Privatesector debt restructuring would likely be necessary. Finally, the European Union strongly objects to accelerated euro adoption, as this would be inconsistent with treaty obligations of member governments, so this option is infeasible.

Basically, devaluating the Lat and entering the euro directly was the IMF's preferred option for Latvia, "euroization with EU and ECB concurrence" was the second option, and keeping the peg and implementing massive internal deflation only the third. The problem was that the EU, in its wisdom felt euro adoption "would be inconsistent with treaty obligations of member governments" - as would I suppose bailing out Austria and Ireland be "inconsistent with treaty obligations of member governments under the Maastricht Treaty. Go tell it to the marines, is what I say!

And this is not just Latvia, but four entire countries (little ones, but still countries) that are effectively being thrown to the wolves here.

Downward Pressure On Currencies, Upward Pressure On Interest Rates

Nor is the position of those with floating currencies - Poland, Hungary, the Czech Republic and Romania - much better, since their currencies are now coming under substantial pressure, and as a result defaults are growing, defaults which will only work their way back upstream to the Western Countries whose banks will have to stand the losses.

At the same time, the risk of a sharper, 1997 Asian-style adjustment cannot be excluded, given the similarities between Asia before the eruption of the crisis there in 1997 and the situation in emerging Europe. Beyond any considerations about valuation, the FX market may overreact as it did during the Asian or Russian crises in 1997 & 1998. To halt the downward spiral of currency depreciation, a substantial rise in interest rates combined with a tight fiscal policy under an IMF programme could be necessary.
Murat Toprak & Gaelle Blanchard, Societe Generale

Obviously there is now a sense of urgency here, and the warning signs are everywhere, for those who know how to read them. According to Zbigniew Chlebowski, the chairman for the Polish ruling party’s parliamentary group speaking in an interview earlier this week, the Polish government has been in official talks with the European Central Bank over joining the pre-euro exchange-rate mechanism “for several days.” So consultations are getting to be fast and furious.

And Hungarian, Polish and Czech government debt, which has been among the highest rated in emerging markets, is now being downgraded by bondholders. Investors are currently demanding 20 basis points more yield to own Hungary’s bonds than similar-maturity Brazilian debt, which is rated four levels lower by Moody’s Investors Service, according JPMorgan bond indexes. The risk of Poland defaulting is currently running at about the same as Serbia, ranked six levels lower by Standard & Poor’s, based on credit-default swap prices, while Czech 10-year bonds yield the most compared with German bunds since 2001.

“Everybody is running for the door,” said Lars Christensen, head of emerging-market strategy at Danske Bank A/S in Copenhagen. “The markets have decided the central and eastern European region is the subprime area of Europe.”

The currencies of these currenciies are tumbling on investor concern the region’s economies are among the most vulnerable to the global credit crisis. Poland’s zloty has fallen 35 percent against the euro since August, the forint - which has fallen around 13% since the start of the year, and about 25% since last August -weakened to a record low of 309.71 this week. At the same time the Koruna hit the lowest level since 2005.

(Chart above - Polish Zloty vs Euro)

The zloty has risen - against the previous trend - by 3.2 percent this week, following a decision by the Finance Ministry to enter the market (on Wednesday) and started selling euros from European Union funds for zlotys. Prime Minister Donald Tusk said yesterday the currency must be defended “at any cost.” The Czech central bank stated it regards the buying and selling currencies to manage the koruna as an “exceptional” tool that it’s resisted using since 2002, with the implication that it may not be able to resist much longer, although interest rate hikes (as practised in Hungary) seem to be the more likely approach in the Czech Republic. Such gains as have been obtained for the zloty are likely to be short lived (intervention is a tool of desperation, not of strength, and rarely has any lasting effect) and they can hardly exhaust EU funding they badly need to spend on stimulus type projects in the face of the downturn defending the indefensible, as Russia has been learning to its cost in another context.

“It [currency intervention ]is for us an exceptional tool at our disposal,” Tomas Holub, head of its monetary policy department, said in a telephone interview today. “Of course it’s one of the potential tools, but so far no decision has been taken in this direction.”

After intervention the only real tool left is interest rate policy, and fear of further currency falls is now acting as a serious brake on monetary policy as the pace of economic contraction gathers speed in one country after another. “A lowering of interest rates at the current levels of the exchange rate is completely out of the debate,” Deputy Governor Miroslav Singer told E15 newspaper earlier this week. “The question is whether to raise, and by how much.”

Really the suggestion that all these countries simply traipse off to the IMF (one after the other) in search of help is shameful. There is simply no other word for it, shameful. As Oscar Wilde put it, losing one child may be an accident, but losing all your children, now that has to be negligence! Let them in, and let them in now, before the whole house of cards collapses on top of each and every one of us.

Postcript

This article is the second in a series of five I am in the process of writing on ways forward with Europe's financial and economic crisis.

The first was Why We Need EU Bonds.

Subsequent articles will deal with:

a) The need for Quantitative Easing In The Eurozone
b) What might a new Stability and Growth Pact look like?
c) Why as well as rewriting the banking regulations we also need to do something about Europe's demographic imbalances.

Update: The Danskebank View

With which I wholeheartedly agree.

This week the crisis in the CEE markets has intensified dramatically after the publication of a number of reports putting a negative focus on Western European banks exposure to the overly leveraged CEE economies. The crisis is clearly developing in an explosive fashion and there is a very clear risk of an Asian crisis style meltdown. The economies in the region are already in free fall, and at least one country Ukraine is dangerously close to sovereign default. Rapidly rising concerns have led policy makers across Europe to call for immediate action to avoid a dangerous collapse that potentially could spill into the euro zone. However, policy makers seem very divided on what to do in the current situation.

Earlier this week Lithuanian Prime Minister Andrius Kubilius called for coordinated action from the EU to try to solve the problems in CEE. Later in the week the World Banks president Robert Zoellick echoed Kubilius cry for help.

However, the EU Commission does not seem very excited about a coordinated effort to avoid meltdown. Rather Joaquín Almunia, EU monetary affairs commissioner, this week said that he would prefer a country-by-country approach to crisis management. In our view, a country-by-country approach to crisis management entails a number of risks, as there is a strong potential for contagion from one CEE country to another due to the significant integration in the financial sector across the region. Therefore, we think that there is urgent need for a more coordinated effort to stabilise the situation otherwise this crisis will drag out and uncertainty remain elevated for an extended period.

Romania Accepts Budget Deficit Exceed 3% GDP, Industrial Output Falls Sharply

2008-12-16T08:10:00.000-08:00

Romania’s premier-designate Emil Boc admitted today that the 2008 budget gap may exceed the European Union limit of 3 percent of gross domestic product.

“Our budget deficit stands between 3.5 percent and 4 percent of GDP this year, we’re outside the EU treaty,” Boc, who was nominated yesterday to be prime minister, said in Bucharest today.

The outgoing government had previously targeted a shortfall of 2.3 percent of GDP this year and 2 percent next year. The EU stability and growth pact requires governments to keep their budget deficits below 3 percent of GDP, and provides for financial penalties for countries that breach the ceiling. Even if the policy is likely to be flexibilised in 2009 given the severity of the economic slowdown, this stance is hardly applicable to the Romanian case, since the economy was in effect booming during most of 2008, and the bubble only finally burst during the financial crisis of October.

The spending program of the new government, which was published today by Romanian newswire Mediafax, includes plans to reduce spending next year to narrow the budget deficit to 2.5 percent, but we will see if this move is now enough to satisfy officials in Brussels and analysts at the credit ratings agencies. Romanian sovereign debt was effectively lowered to junk bond status by Standard and Poor's last month, and there is of course no possibility of euro membership with such a rating.

The draft also includes a 45 percent pension increase and an increase in the minimum wage to 600 lei ($208) from 540 lei as of Jan. 1, a reduction of the value added tax for staple foods, infrastructure investments and incentives to companies to stimulate growth and create jobs. Contrarian voices were thus not hard to find and Varujan Vosganian, the outgoing Liberal finance minister, told Realitatea TV in an interview today that the measures included in the working draft will push the budget deficit to 6 percent of GDP next year.

The Liberal Democrats and the Social Democrats, who formed a governing coalition with a two-thirds parliament majority on Dec. 14, also agreed to keep a 16 percent flat tax over the next years.

Industrial Output Falls Back Sharply In October

More evidence that a major contraction of economic activity is now underway in Romania came in today with the publication by Eurostat of the harmonised industrial output data for October. Output in Romania fell a seasonally adjusted 3.4% from September, and 3.2% from October 2007. In fact the rate of expansion in Romanian industry has been slowing since the spring, and as you can see in the chart below we are simply moving over to negative readings on a year on year basis. Still this data will now start to give us a nice handle on the actual rate of contraction as it takes place.

The Leu Being Dragged Down By The Zloty

Poland's currency is falling very sharply at the moment, as the slowdown in Western Europe reduces demand for its industrial products and an internal credit crunch slows down domestic demand. The zloty had its biggest intra-day drop in a month today, falling to its lowest level in more than two years, amidgrowing concern the economic slowdown is worsening. The zloty was down as much as 2.5 percent at one point, falling to 4.0812 per euro, its weakest level since July 10 2006, and passing through the psychologically important 4 per euro level. The zloty has been the worst performer over the last month among regional peer currencies when compared with the euro.

The Romanian leu fell today to 3.9462 per euro from 3.9426 late yesterday, while the Hungarian forint dropped 0.2 percent to 268.34.

Romania's Economy Heads Off Quietly And With No Fanfares Into It's Deepest Crisis in a Decade

2008-12-06T03:48:00.000-08:00

Before I go any further, let me first apologise to any regular readers this blog may still have. Daddy has been very much away on business I'm afraid, and for far too long. What with all the things that have been happening out there, I just haven't had the time to put pen (or my thoughts) to paper on Romania. This absence has been doubly regretted by me at least, since while I think the economic outcome of Romania's boom-bust cycle is unfortunately all too predictable, we are still sitting in the waiting room, and the emergency dentist (which in this case will probably be the IMF) will only be able to get to grips with the patient when the root problem afflicting the tooth becomes more apparent (and simply unbearable), and at this point we are still some way little way off from that stage. Meanwhile we simply apply the antibiotics and the anti-inflamatories, in order to calm the troubled nerve as best we are able.

Controversy surrounding the Romanian economy is nothing new, nor, as Manuel points out in his post on the recent election, are Romanian politics strangers to tumult. Nonetheless the intensity of controversy has grown considerably of late, with a wide variety of assessments being offered concerning the likely impact of the intensifying international credit crisis on the short to medium term outlook for the Romanian economy. National Bank of Romania (NBR) governor, Mugur Isarescu, has been consistently arguing that the country should be able to avoid an excessively "hard landing"as the bank attempts to cool its evidently overheated economy and engages of fire-extinguising activities in the banking sector trying to control the impact of set of adverse external circumstances that are largely beyond its control. But most of these comments (or at least the more convincing ones) preceded the meltdown in the international financial markets which followed the Lehman Brothers bankruptcy, the fallout from which has surely had a strong negative impact on Romania's economy and greatly complicated the task of conducting macroeconomic policy which faces the new government to be be formed following last weekends elections.

The other complicating factor has been the "own goal" scored recently by the Romanian political process, with one politician after another proposing fiscal deficit raising policies, at just a time when the international financial markets have become extremely sensitive to just this development in countries which are, due to their large current account deficits, mainly dependent on external borrowing to finance their lending needs. The accommodative fiscal policy being run by the Romanian government has also been extremely ill advised at a time when the central bank was busy trying to cool overheating by applying a restrictive monetary policy. For policy to be coherent, the two main levers need to be operated in tandem, and not at cross purposes.

However, despite all odds, Romania has been hanging on in there, and GDP remained strong in the third quarter, a situation which has lead some commentators to use the term "gravity defiers" to describe those East European economies, like Romania and Bulgaria, that have so far avoided having a sharp adjustment, despite having evidently unsound macroeconomic fundamentals, and in particular unsustainably large external deficits.

Not everyone has been convinced by the positive posture being assumed from within Romania, however, and Fitch Ratings agency had already downgraded Romania's outlook (together with that of the Baltic states and Bulgaria) from stable to negative by August pointing out in the process that the economy was extremely vulnerable to external financial pressure. This association of Romania with the Baltics is not incidental, since the Baltic economies were until only very recently - as Romania is now - the fastest growing in the European Union (with rapid credit expansion and large current-account deficit, sound familiar) but have subsequently experienced a very sharp growth slowdown following a sharp tightening in domestic credit demand and a dropping-off of external demand after high internal inflation fuelled by very large annual wage rises destroyed competitiveness. Indeed both Latvia and Estonia are now in deep recession, and have moved in a matter of months from being the EU's fastest growing to being the EU's most rapidly contracting economies. This is precisely what the expression "boom-bust" really means.

The million dollar question at this point is whether or not the Romanian economy is destined to follow along the same path. In the analysis that follows I will basically be arguing that this is exactly where the Romanian economy is now headed. Some evidence to back the view can be seen in the latest reading on the EU economic confidence indicator (see below) which after months of trending slowly and steadily downwards suddenly lurched sharply south in October and November. Another detail which we would do well to bear in mind is that after many months of consecutive rises, seasonally adjusted retail sales fell in Romania (by 2.1%) in October over September. Indeed a growing quantity of anecdotal evidence now suggests that something important changed in Romania in October, even if we may yet need to wait several months to see the in the cold clear light of day the actual consequences of what happened. Another signal we have is that all is not exactly well, is that the number of newly-established companies increased only 0.7 percent in the year up to mid-November when compared with the same period last year, while bankruptcies soared according to the latest data from the Trade Registry Office (ONRC) - and in fact October was the month with most cases of insolvency, up a whopping 79 percent over October last year. In addition Romania's banks experienced a sharp liquidity crisis in mid October (see more below) and needed to borrow a total 49 billion lei (13 billion euros) in October from the central bank (using its lombard credit facility). This is 28 times the total amount borrowed between January and September 2008, according to NBR data. Banks only borrowed 20 million lei in lombard credits in September, while the total value of the loans issued was 1.75 billion lei between January and September.

Events Take Their Course

A capital-inflow-driven absorption boom has underpinned rapid catch-up growth but also fuelled macroeconomic imbalances. In particular, the external current-account deficit has risen to unsustainable levels. And, since mid-2007, headline CPI inflation has surged well above the central bank’s target, in part reflecting the firstround effects of food and energy price shocks. Rapid credit growth has raised risks to financial stability, although the largely foreign-owned banking system remains wellplaced to absorb shocks. In this setting, fiscal policy has been highly procyclical and lacked medium-term orientation.
IMF Article IV Consultation, July 2008

The IMF quote above basically spells out the general understanding economists have of what has been happening in Romania. Real GDP growth has been robust,but has increasingly been running up against capacity bottlenecks. Largescale emigration, notably to Italy and Spain, and high demand for workers, especially in construction, have resulted in tight labor market conditions. As a result, real wage growth has outpaced productivity growth, with buoyant public-sector wages adding to private-sector wage pressures. With core inflation under pressure, headline inflation has surged, partly owing to the firstround effects of shocks to energy and food prices, and to some extent reflecting the 2007 drought. However the initial shock has evidently moved over into second round effects, and price setters, faced with higher unit labor and other input costs, have been struggling to maintain their markups, as also indicated by surging producer-price inflation.

It is in this context that the fact that fiscal policy stance in 2007 was highly procyclical becomes a problem. The fiscal deficit increased in 2007 to 2.25 percent of GDP, up from 0.5 percent of GDP in 2006. Adjusted for the automatic effects of the booming economy on the fiscal position, the IMF estimated that the 2007 structural deficit rose to almost 4 percent of GDP. As a result, the fiscal stance was highly expansionary, adding an estimated net fiscal stimulus of 2 percent of GDP to an already overheating economy. Thus the Romanian economy was simply booming along just waiting for something unfortunate to happen, and, of course, true to form and as was to be expected, it eventually did.

Octobers "Sudden-Stop" Credit Crunch

Bank lending seems to have ground to a virtual halt in Romania in mid October (and October is the latest month for which we have statistics from the National Bank of Romania). After rising at a monthy rate of 4% (or a 50% annual rate) in September, total lending to households and non financial corporations actually fell in October (when compared with September) by 0.6%. For an economy which has been experiencing a debt driven consumer and construction boom it is hard to overstate the significance of this single fact. We seem to have what is known as a "sudden stop" in aggregate bank lending here, and the Romanian economy may now well fall rapidly into recession, following the tried and tested path so recently pioneered by Latvia and Estonia.

While RON denominated lending continued to advance slightly, the largest hit appears to be being taken - not really surprisingly - by forex loans, which fell in total by 1.5% in total month on month (-1.9% corporates, -1.2% households). Given that the RON strengthened slightly against the euro during the month the decline was probably less than it appears (since the book value in RON of forex loans falls when the Leu strengthens - and vice versa - and this revaluation is of course the great danger represented by a sudden Leu slide, since not only will the monthly payments on the mortgages shoot up, so too will the capital value of the outstanding mortgage, as anyone unfortunate enough to have taken out a loan in Japanese Yen, or CHF, surely already knows to their cost). But basically, since the currency fluctuated wildly but was actually up against the euro by 1.5% in October, we really do need to wait till we get to see what happened in November to have a clearer picture.

However, if we look back over the two months of September and October (where the currency fluctuations to some extent cancel each other out, but that overall the leu weakened 4.5% against the euro) then it is clear there has been a sharp slowdown in forex lending, and the effects of this slowdown will gradually be felt over the next six to nine months. Well, gradually or not so gradually, since new car sales (which obviously normally need finance) fell by nearly 30% year on year in October (to 20,478 from 29,347 a year earlier), according to the latest data from the Romanian Association of Automobile Producers & Importers. Basically if we look at the pattern which we can see in other economies which have been affected by the credit crunch, what started off as a slowdown in demand for cars as oil prices rose "transited" to an inability to finance purchases as oil prices fell back again. Hence the current difficulties of motor industry "majors" like Ford and General Motors.

Fiscal Deficit Issues

Another area of concern has been Romania's budget deficit, which stood at 2.4% in 2007, and is expected to widen in 2008 and 2009 . A number of factors are contributing to this steady deterioration:

1) the rising cost of government borrowing;
2) forecasts of a sharp decline in GDP growth for 2009
3) enactment of spending pledges made by candidates ahead of Nov-08 elections

Romania's loose fiscal policy stance and the growing public spending commitments were among the key reasons cited by credit ratings agencies for the recent downgrades in Romanian debt to what is effectively 'junk' status. Indeed Finance Minister Varujan Vosganian recently estimated that spending increases authorised by parliament before last weeks elections could widen the budget deficit considerably beyond the EU’s 3% of GDP limit, and some estimates suggest that, on a worst case scenario, it could possibly even amount to as much as 7% of GDP in 2009.

Indeed it looks as if the deficit could even pass the 3% level in 2008 (the year of such a rapid expansion, there is surely no excuse for this) since the 11 month budget deficit widened to 2.9% of GDP following a sharp drop in budget revenues over the last two months according to Varujan Vosganian last week. Vosganian told a press conference that budget revenues in October and November were 1.3 billion euros below the projected level.

Perhaps the highest profile decision in the context of the recent Romanian fiscal deficit "cause celebre" was the one taken on 8 October by the Romanian Parliament, when it agreed to a pay rise for teachers which was calculated to be in the region of 50%, and this against the explicit wishes of Calin Popescu Tariceanu, the prime minister, who headed the then minority liberal government. The main worry arising from the teachers’ pay increase, aside from the concerns over how it will be funded, centres on the impact it will have on the pay demands of other public-sector workers and, in turn, of private-sector workers. If such wage pressures are not resisted, then they will obviously only weaken further an already weakened Romanian competitiveness and in all probability would drive inflation back above the 10% mark in 2009. This would be the result in normal circumstances, but the Romanian economy is not in normal circumstances right now, and it is highly unlikely that the present credit crunch and the pressure from the international financial markets will leave time for this inflation spiral to run its course. Much more urgent matters are likely to make their presence felt first.

Varujan Vosganian seems to be tirelessly explaining in the face of deaf ears that the proposed increase could push the budget deficit up in the direction of 7% of GDP in 2009, as no provision had been made to raise taxation, and the outgoing government issued an emergency ordinance on October 28th postponing the increase, following a warning from the IMF about the likely fiscal consequences.

Defenders of the recent decisions, however, are quick to point out that Romania's accumulated public debt, at around 12% of GDP, is still extremely low. But this is to miss the force of the macroeconomic argument against running such annual deficits at time of high GDP growth. Basically, at this point, the Romanian economy has been overheating (and has not been stuck deep in recession), so the principal macro argument would be in favour of fiscal surpluses (and substantial ones, say 3% or 4% of GDP) to try and drain excess demand from the system. This is doubly the case when you look at the underlying difficulties of applying standard monetary policy (the central bank has been raising interest rates since to try and keep inflation better under control) in a context where foreign exchange denominated loans have been freely available at what effectively amount to negative interest rates.

Although the government has made an effort to promote a more prudent fiscal policy, the temptation to win more voters has proved to be stronger. Consequently, the government decided to increase the benchmark index for calculating individual pensions by 20 % to RON 697.5 as of November earlier than originally planned. The benchmark index was already increased in November 2007 by 35 % and by another 7.5 % in January 2008. It will be further raised next January to complete the promised reform of the pension system aimed at bringing the average pension to 45 % of the average gross wage from the level of 35.5 % in November 2007. Doubtless we will soon here complaints about how "internation financial speculators" have brought the Romanian economy to its knees, but such voices would do a lot better looking at the degree of responsibility exercised by Romanian politicians in the face of the world's worst financial crisis in over 75 years, in a climate were concerns about procyclical fiscal deficits are known to be widespread.

Substantial Inflation Pressures Remain

Inflation lies at the heart of the mechanism which has been steadily - via the expansionary fiscal posture - undoing the Romanian economy, and, right on cue, Romanian inflation increased again in October, hitting 7.4 percent, after dropping back to 7.3 percent in September. Consumer prices were up 1.1 percent month on month.

In the Romanian context it is impossible to relate this inflationary pressure exclusively to rising energy and food costs, doubly so since these latter have now been falling steadily since July. The Romanian economy has been running at a much faster pace than it can comfortably sustain, and nowhere has this been clearer than in the strong upward pressure on wages, with net wages growing at an annual 24.6 percent in September while unemployment continued to hover near a 16-year low. In fact annual net wages increases have averaged around 24% over the last 6 months (see chart below), while real wage increases (allowing for inflation) have averaged around 15% throughout 2008.

Monthly unemployment has been running at around 3.9% of the labour force (or 350,000 people) according to data from the Romanian Labour Ministry, or at around 5.9% according to the EU harmonised rate published by Eurostat (the difference between these two numbers is due to the different methodologies and criteria used). In either case these are historically quite low rates for the Romanian economy, and it needs to be borne in mind that there are at least a million Romanians (or another 10% of the labour force) working abroad (largely in Spain and Italy) most of them sending monthly remittances home to their families and relatives, remittances which in their turn fuel domestic demand, demand which the economy lacks sufficient capacity to meet without putting pressure on inflation.

Of course, having made the point so forcefully about how much of a problem inflation has been in the Romanian economy, I think I should point out that this problem may well be set to disappear, or at least become somewhat less important in the general picture, should the Romanian slowdown prove to be as dramtic as I fear it might. We could move very rapidly from a situation of undercapacity and overheating to one of excess capacity, and sharp cooling as domestic demand folds and exports stagnate. Naturally everything depends on what happens to the Leu, since if we see a further substantial weakening in the currency this in itself will tend to add to inflation pressures, depending on how large a fall in the currency we are talking about.

Monetary Policy and the Leu

The Romania central bank which has been using monetary policy as best as it is able to try and fight the inflation threat, kept its key policy rate - which is the second highest in the EU after the 11% rate in Hungary - unchanged at 10.25% in October, although they did lowered reserve requirement on leu deposits (to 18% from 20%, as of November 24) in an attempt to ease the growing pressure on domestic liquidity which has been so evident since the mini financial crisis of mid October.

Further monetary tightening (following the Hungarian example) might have seemed a more prudent strategy, particularly given the current comparatively low level of the real policy rate (only 2.75% above inflation), the continuing inflation pressures, the continuing loose fiscal stance and the recent credit rating downgrade from S&P. There is also the credibility issue to take into account, since Romanian inflation is still running well above the central bank year end target of 3.8%. On the other hand, if we take account of the rapid deterioration in the internal economic climate since October, then exercising caution may have been more sensible than it seems at first sight. The problem is that the Romanian central bank - like its Hungarian counterpart - is now caught between the need to protect the value of the Leu (given the prior level of forex borrowing) and the need to try to offset the rapid and dramatic decline in internal demand.

Just what kind of pressure we could see on the Leu in the coming weeks was illustrated during the days between 10 and 20 October, when the tremendous pressure on the currency (see spike in chart above) forced the Romanian cenbank to intervene directly in the foreign exchange market to defend the currency. Questions remain about the extent to which any local tightening policy can work while private indebtedness continues to be fueled by forex denominated (largely euro) loans and the NBR is sure to face increasingly difficult decisions as growth slows in the coming months

In fact central bank Governor Mugur Isarescu argued that the bank responded to an "attack on the leu'' which had drained lei from the market and driven overnight interbank market rates sharply higher. The Banca Nationala a Romaniei sold 40 million euros on October 10 for lei on the interbank market and the Finance Ministry sold 291 million lei of three-year bonds on October 16. Overnight Interbank Bid Rates (ROBID) soared to 19 percent on October 17 (up from 16.53 percent on October 16) as banks frantically tried to get their hands on lei. Rates have subsequently come back down again, but at the start of December they were still hovering in the 12% to 13% range, well above the 7% to 8% range of January 2008, and also well above the 10.25% targeted central bank policy rate. Basically these rates seem to have gotten completely out of alignment with central bank policy towards the end of August, and there seems to be little evidence (or likelihood) that they will be coming back into line anytime in the near future (see the time series for yourself here - also anyone looking for a quick and handy list of banks with exposure to the Romanian market, the quoting banks for ROBOR are ABN Amro, Bancpost, Banca Transilvania, BRD Groupe Société Générale, BCR, CEC, EximBank, ING, Raiffeisen Bank and UniCredit Tiriac Bank).

Some analysts question whether Romania can finance its 59 billion euros in external debt without International Monetary Fund support of the kind secured by neighbours Hungary and Ukraine if such "attacks" continue to occur. The leu has now slipped 7 per cent against the euro since August, while the Romanian stockmarket is down 71% in the year to date and the leu has weakened by 21% against the US dollar over the same period.

Romania's GDP Continues To Grow Strongly

Romania's economy continues to put in a very strong performance and grew by an annual 9.1 percent in the third quarter, driven forward by the continuing consumption and lending boom, although most observers - including the the government - are agreed that all of this is now about to slow, and sharply. Indeed the government itself has forecast that growth will slow to about 4.5 percent next year, although others consider this to be rather overoptimistic under the circumstances and the big question is, just how "sharply" is sharply? Are we about to see one of those famous "hard landings"? There are reasons for believing that we may well be.

At this point it is very hard to see just how far the economy actually slowed in the third quarter (at an annual rate it fell back from 9.3% to 9.1%, which really doesn't seem like very big beer), in the first place since we still lack detailed data, and in the second because don't publish or supply to Eurostat seasonally adjusted quarter on quarter data, which is really the most informative number we could get are hands on at this point, if it existed. So we are really stuck with "proxies" like short term retail sales data, and confidence indicators (unfortunately Romania doesn't seem to have much in the way of PMI surveys).

Despite all this, you could say, couldn't you, that Romanian GDP growth still does look pretty robust. You could say this, that is, until you look at what actually happened to Latvian GDP growth following the onset of a credit crunch in that country. As we can see in the chart below, the Latvian economy was cruising along at a nifty 11% annual growth rate until the third quarter of 2007, at which point things started to go nastily wrong, and headline GDP growth fell off a cliff, reaching the dizzy low of around minus 5% a mere four quarters later. And of course Latvia is now stuck in a very, very deep slump.

So just what happened? Well basically, the Latvian economy was being driven to grow way too fast by a rapid increase in foreign exchange credit. And Latvia, like Romania, had large numbers of workers outside the country, busily sending home remittances, while wage inflation at home went up and up. As we can see in the chart below, this credit was effectively cut back sharply in the spring of 2007, and down came the Latvian economy on the back of the cut. As we can see in the earlier chart I presented, year on year increases in Romanian forex lending have now been slowing since the mid summer, and I think it is not unreasonable to suggest that there is a strong danger of following the Latvian path, especially after the "short sharp shock" of mid-October.

So just when will Romania enter recession? At this point it is hard to say, but if the Latvian pattern is anything to go by, negative year on year growth could arrive as early as Q3/Q4 2009, and we might even see quarter on quarter contractions starting with Q1 2009 (although we won't necessarily know this, since, as I say, the data we need simply isn't published).

Government Aid Package

In response to this deteriorating outlook the outgoing government did announce a stimulus package, which is scheduled to take effect in January, and involves items like exempting reinvested dividends from a 16 percent tax, giving companies a bonus of 1,000 euros for every person they hire who has been unemployed for more than three months and faciliating 500 million euros worth of investments and other aid for farmers. There is also an allocatation of 3 billion euros for job-creating investments, lower social insurance payments and a 250 million-euro credit line for medium and small businesses via a cash injection into state-owned bank CEC.

The government will grant aid of as much as 50 million euros to companies planning to invest more than 100 million euros and create at least 500 jobs, according to the plan. Investments of less than 100 million euros that generate at least 300 jobs stand to receive aid which could total up to 28 million euros. It will also give companies a 5 percent reduction in their tax bill in exchange for paying taxes on time and exempt new car sales for a year from a "pollution tax'' that ranges from 150 euros to 700 euros per car.

Credit Downgrades

But all of this is likely to be of little avail, since it is mainly small scale counter cyclical stimulus if the international financial standing of Romania continues to deteriorate. In late October the international ratings agency Standard & Poor’s (S&P) cut Romania’s long- and short-term foreign-currency sovereign credit ratings from BBB-/A-3 to BB+/B, and its local-currency long-term rating from BBB to BBB-. S&P pointing out the growing risks posed by high and rising private-sector leverage and dependency on an increasingly uncertain external financing channel. Given the size of Romania’s macroeconomic imbalances, they argued, the economy is highly vulnerable to any sudden tightening in external financial conditions which could cause a sharp downturn in economic growth.

On November 10 Fitch followed suit, and downgraded Romanian debt - together with that of Bulgaria, Hungary and Kazakhstan - two notches to what is effectively 'junk' status (specifically BB+) as a result of their "concerns about the macroeconomic policy framework in Romania" and the country's ability to avoid a severe economic and financial crisis. Noting the widening current account deficit - which is expected to exceed 14% of GDP this year - a deficit which Fitch believes has been fuelled by excessive credit growth, the agency argued that a much stronger policy adjustment, especially in the fiscal policy area, would have been needed to avoid a currency crisis. Fitch specifically drew attention to the private sector foreign currency balance sheet mismatches, and argued that any imminent currency crisis would "require substantial external financial support from the international community to prevent a sovereign credit crisis."

Fitch specifically singled out Emerging Europe as the most vulnerable Emerging Market region to the deterioration in the global financial and economic environment owing to the fact that so many countries have large current account deficits and relatively high levels of short-term external debt, and that these render them particularly susceptible to reduced capital and financial market flows (including from foreign parent banks).

Since the onset of the credit crunch in August 2007, Fitch has now downgraded the foreign currency ratings of nine countries in emerging Europe (by a total of 11 notches), and this contrasts with just three upgrades that have been made over the same period. Eight countries are now on Negative Outlooks - which a record level for the region - while no countries are on Positive Outlooks, signalling that ratings remain under downward pressure.

IMF Aid In The Pipeline?

Obviously with the EU institutionally bogged down in its own issues of core and systemic bank bailouts, it is clear that the community's ability to offer meaningful assistance to Romania is going to be limited. Thus all eyes in Eastern Europe have been looking hopefully over in the direction of Washington, and the International Monetary Fund. The IMF has already offered aid to Hungary, Iceland, Serbia and Ukraine to help them cope with the difficult coktail of a credit drought, falling investment and shrinking government revenue. Romania, has so far not openly sought IMF help, although this does not mean that channels of communication and "dialogue" have not been opened. The sheer size of the current account deficit and the short term increase in the very sensitive area of government spending may make it increasingly difficult to fund the country’s $75 billion in external debt without IMF aid. In a statement to the local media, Juan Jose Fernandez-Ansola, the International Monetary Fund's (IMF) senior representative for Romania and Bulgaria recently observed that "The initiative to increase teachers' wages by 50% may need to be reconsidered. We estimate the impact on the budget would be modest in 2008, but would reach over 0.75% of GDP in 2009. In addition, if the increase were extended to other public sector employees, the impact could reach over 4% of GDP in 2009. This would send a wrong signal to financial markets." So it is not hard to see the kind of tack the IMF will be taking in any negotiations.

However, there are important differences in the monetary systems of Romania on the one hand and the Baltic states and Bulgaria on the other, and these differences may facilitate rather than complicate the issue of IMF aid. The Baltics and Bulgaria all operate some variant of the currency board system, whereby the currencies are pegged to the euro at a fixed exchange rate (or within a narrow band), a feature which effectively prevents these economies from conducting their own independent monetary policy, thus placing the entire burden of macroeconomic adjustment on fiscal policy. The appreciation of the euro against the US dollar damaged the competitiveness of those economies vis-à-vis those economies whose currencies are linked to the dollar. Romania's managed-float on the exchange rate side has, in contrast, provided it with greater flexibility and some ability to utilise monetary policy as part of its macroeconomic stabilisation programme.

Thus Romania has been able to resort to some degree of exchange rate depreciation to preserve external competitiveness over the past 12 months, while the central bank pushed up interest rates to keep real rates at positive levels and contain inflationary pressures. The complicating factor here has been the availability of substantial foreign exchange credit, at rates well below those imposed by the NBR. This has undoubtedly taken much of the cutting edge off central bank monetary policy in the short term, although as we are seeing, this supply of cheap credit has now, suddenly, "run dry".

At the end of the day there is substantial agreement between all the main institutional actors (leaving aside Romania's own political class) - the NBR, the IMF, the EU Commission and the ECB - that Romania's external deficits are unsustainable in the long run; that fiscal policy has been ill-advisedly pro-cyclical; that wage growth has been excessive; that rapid credit-growth has been fuelling an unsustainable growth in consumption; and that a sharp and significant correction is now about to take place.

The Immediate Outlook

This year's extremely good agricultural harvest has undoubtedly offered strong support to headline GDP growth in recent quarters, but this fortuitous virtuous circle may well repeat itself in 2009. On the other hand, the financial position of private households, after becoming ever more strained as domestic interest rates have steadily risen, together with the costs of servicing a growing volume of private debt, may well now deteriorate substantially as the lack of available credit and the rising layoffs in manufacturing industry exert an ever-tighter grip. In general terms, private consumption was already slowing before the onset of the credit crunch in October, and increased by 12.2 % yoy in Q2, following the record high of 14.3 % yoy in Q1.

Investments also continued at a strong pace in Q2, driven mainly by new construction projects (up 34.8 % yoy), while investments in equipment was already slowing (down to 23.8 % yoy in Q2). In the first half of the year the construction sector absorbed 20 % of total investments in the economy, and it is this sector which will now be particularly hard hit.

Slowing construction activity is now expected for the rest of the year, and should become more pronounced as we enter 2009 and new project steadily dry up. Prices of new housing and real estate transactions generally have been losing momentum in recent months, especially in the capital city Bucharest. This slowdown can also be observed in the national construction activity index, which has seen the value of construction works drop to an annual 19.1 percent rise in October (down from 28.3 percent in September, and down even further from the average 33 % yoy increase registered in the first half of 2008) . Month on month, construction growth slowed to 5 percent in October from 8.5 percent in September. More importantly, the number of new building permits issued has now been showing a steady monthly decline. Evidently the volume of construction activity continues to rise (even if at a slower pace) since existing projects need to be completed - credit crunch or no credit crunch, and regardless of whether there will actually be buyers for the completed properties. But at some stage activity may well grind to a near halt, as the appetite for new building projects suddenly evaporates. This is what we have seen in other similarly affected economies, and there is no good reason why Romania should be any different here.

This view is reflected in the recent press statements made by Gabor Futo, executive manager of real estate developer Futureal Group. Futo takes the view that no new real estate projects will be started in the next two years and that 90 percent of the forthcoming ones already announced will be called off for lack of financing. Futo testifies to the way in which banks are now much more cautious in making loans and how developers are experiencing increasing difficulties in obtaining financing. Futureal recently started work on the new commercial center "Gold Plaza" in the northern city of Baia Mare. The center will have 30,000 square meters - all of them available for rent. The project aims to be completed in the first quarter of 2009 and will cost about 97 million euros. The company is a leading developer in Central and Eastern Europe, with projects worth more than 1.6 billion euros, including more than 6,000 residential units and some 500,000 square meters of commercial area.

And, of course, it isn't only the construction sector which is getting hit. Since the problem is the availability of credit rather than interest rates per se, then anything which can't simply be bought on a credit card will be affected, and first in line here is the Romanian auto industry which could register its first bankruptcies towards the end of the first half of 2009 according to Alin Tapalaga, Manager of Porsche Inter Auto, the retail division of the Porsche Romania . Tapalaga feels the most affected companies will be those who have recently built showrooms, and especially in the past year using bank loans as finance,.

The Romanian banks themselves are expecting a massive drop in lending to individuals in the last quarter of the year, especially for mortgage loans, despite forecasts of cheaper land and properties, following a worsening in lending conditions, according to a recent survey carried out by the central bank. Not surprsiningly, credit cards are the only lending product for which banks expect to see a slight increase in use in the last quarter, but even here they expect a much smaller increase than the one registered between July and September 2008.

And all this reticence to spend comes despite (or perhaps because of) the fact that property prices are now falling. Three-room apartments in Bucharest have fallen by around 15 percent since the beginning of the year according to the the ZF real estate index. ZF suggest that prices nationally have dropped by 2 percent to 3 percent over the last six months, following stagnation or even slight increases earlier in the year. ZF compile their index by analysing prices asked by sellers on the anuntul.ro website. The value at which the deal is actually closed may be as much as 20 percent below the asking price they say. Whereas a typical seller was asking an average of 140,000 euros for a 70-square metre three-room apartment in January, the price reached 118,000 euros in November, or over 20,000 euros less. The sharpest monthly decline was registered in November, when the average price per square metre reached 1,686 euros, 5 percent lower than in October, according to the ZF analysis.

Exporting Your Way Out Of Trouble?

With domestic demand now set to fall sharply, as people buy less property and large ticket items, while companies prune back investment in response, the only way forward for Romania to achieve economic growth - and pay off its debts - would appear to be through exports, since the fiscal policy arm has, as we have seen, been basically frittered away during the good times. But here we hit a big snag, since Romania runs a large goods and services trade deficit. In fact, between January and September 2008, Romania's balance-of-payments current account posted a deficit of 12.7 billion euros, up 14.8 percent over January-September 2007. The deterioration was largely a result of the wider trade deficit (13.7 billion euros), which was up 11.7 percent over the same period of last year. On the positive side exports did grow (19.4%) more rapidly than imports, but that will be of little consolation if exports need to drive an economy where domestic demand is either flat (best case) or declining.

And funding this deficit could become increasingly problematic, since foreign direct investment now covers only around one third of the gap in the current account, which means that foreign debt is on a strong upward spiral. Effectively this situation makes Romania susceptible to capital outflows in the medium term, and, were this to happen it would trigger a harsh real adjustment for Romania's economy and its citizens.

Romania needs to attract capital inflows (including FDI) in the region of 15 billion euros per year to cover a current-account deficit which is expected to exceed 13% of GDP. In 2008 alone it is estimated that the net external indebtedness of Romania will rise by some 6 billion euros. Non-publicly guaranteed external debt came in at 31.501 billion euros at the end of September, up 25.9 percent from year-end 2007. The NBR has, of course, built up a strong foreign exchange reserves (27 billion euros at the end of November, or around 8 months imports) and can more than likely ride out the change in market sentiment in the short run. Also foreign direct investment of 7.2 billion euros covered 56.6 percent of the current account deficit over the January-September period, with equity stakes and reinvested earnings making up 52.7 percent of the total, while intra group loans accounted for the other 47.3 percent.

But at the end of the day, having the reserves to ride out the crisis (with or without the aid of the EU and the IMF) isn't really the problem. The problem is how you turn a credit-driven internal-demand-boom economy into one where new-found export competitiveness means external demand drives growth. And how you do this, while protecting all those heavily-forex-leveraged households form the more or less inevitable downward correction in the value of the leu. Obviously the path from one point to the other passes through a hell of a lot of what we economists call "creative destruction", but lets just hope for the sake of all those who have to live through this "correction" inside Romania don't find the whole process a far too painful one.

Romania Producer Prices Accelerate Again In July, Wages Continue To Rise

2008-09-03T12:39:00.000-07:00

Romanian producer price inflation accelerated to the fastest pace in four years in July as energy and labor costs soared and a weaker leu nudged up import prices. The cost of goods produced in factories and mines rose an annual 20.3 percent the fastest rate since August 2005, compared with 19.4 percent in June, according to data from the Bucharest-based National Statistics Institute. Prices grew 1 percent on the month, following a 2.1 percent rise in June.

Prices of manufactured goods rose an annual 23.2 percent in July, compared with an increase of 22.1 percent in June. Price growth in the mining and drilling industries slowed to 16 percent from 17.8 percent and costs of electricity, natural gas and water rose an annual 5.5 percent after a 0.1 percent increase in June.

Wages Up An Annual 25.8%

Romanian annual wage growth, a key factor behind the central bank's recent interest rate increase drive, accelerated further in July as rising investment continued to boost demand for workers.

Net monthly wages rose an annual 25.8 percent to 1,273 lei ($564), compared with a 24.4 percent increase in June, according to the latest data from the Bucharest-based National Statistics Institute. Wages rose 2.7 percent on the month.

Wage increases have helped boost retail sales and imports, and propelled economic growth up to 9.3 percent in the second quarter. The central bank has also said higher wages drove annual inflation to a three-year high of 9 percent in July and forced it to raise its key interest rate to 10.25 percent, currently the highest in the EU.

Domestic demand has also been fuelled by strong inflows of worker remittances and a lending boom. Total private sector debt (households and companies) was up by an annual 55.8 percent in July. Now the interesting thing is that this rate of increase is now slowing, and if the slowdown in the rate of increase continues then construction will gradually grind to a halt as we have seen in other credit and construction boom driven economies.

The rate of increase has been slowing since it hit a peak in January at 66.8%. But a word of warning needs to be added here, since the stock of loans includes a very large proportion - 54% in July - which are forex denominated (mainly euros), and the leu has been rising against the euro until very recently (driven by the high yields on offer following the interest rate rises at the central bank), which means that the leu value of the stock would decline, so there is a valuation component here. Nonetheless I think it is a pretty safe call to say that the credit boom in Romania is now past its peak, and what awaits us is the inevitable slowdown.

Romania's Economic Growth Accelerates In Q2 2008

2008-09-01T07:40:00.000-07:00

Romania's economy grew faster than generally expected in the second quarter, fuelled by a lending boom, increased investment and rising wages. The economic expansion accelerated to an annual 9.3 percent from 8.2 percent in the first quarter, according to preliminary data out today from the Bucharest-based National Statistics Institute.

Net wages were up 24.4 percent in June, while annual private debt was up 65%. As a result domestic investment grew in the second quarter by 30 percent from the same period last year - and reached 6.5 billion lei ($2.7 billion) - led by a 35 percent increase in construction. Central bank Governor Mugur Isarescu forecast 9 percent growth for 2008 last month, and warned the economy is "overheating" with upward pressure on inflation and a deteriorating current-account deficit.

To try to restrain domestic deman the central bank raised its main interest rate to 10.25 percent in July, the highest in the EU, as the inflation rate rose to a three-year high of 9 percent.

Romania Inflation Accelerates Again in July

2008-08-12T07:41:00.000-07:00

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.

Romania Industrial Output and Retail Sales June 2008

2008-08-07T06:50:00.001-07:00

Romania's industrial output increased year-on-year in June, according to the latest data from the National Institute of Statistics. However, on a monthly basis, output fell over May. Industrial output grew at a 4% year on year pace in June, helped by a 5.1% rise in production from the manufacturing sector. However, output of utilities fell 2.3%, and that of mining and quarrying declined by an annual 3.1%.

Month-on-month, industrial output fell 1.5% mainly because of a fall in production from the manufacturing and utilities sectors. However, output from mining increased. Most industries showed evidence of a decline in output. The steepest fall in output of 2.8% was for intermediate goods, followed by a 2.4% fall in the production of capital goods. Production of energy fell 0.7%, while consumer goods output fell 0.5%.

Meanwhile, in another report published this morning, the statistical agency said that the volume of retail sales excluding motor vehicles expanded 19.3% in June. This was helped by double digit growth from both the food and non-food sector. Retail sales of non-food items grew 27.1%, while that food, beverages and tobacco was up 10.9%.

Sales volume for the maintenance and repair of motor vehicles, motorcycles, which includes also retail sales volume of motor fuel, increased 23.5% in the month. The rise was mainly due to a 24.3% increase in the sale of motor fuels. Turnover in business services were up 7.3% in the month. Retail sales, excluding motor vehicle sale, increased 9.7%. Sales volume of motor vehicles and cycles, including repair and maintenance fell 13.7%. On the other hand, retail sales of services grew 23.6%.

Where Now for CEE and Baltic Currencies?

2008-08-06T06:12:00.000-07:00

By Claus Vistesen: Copenhagen

Ever since the illusive credit turmoil began sentiment in the market place has been fickle and essentially, like the assets of which it consists, volatile. We started off with an adamant focus on downside risks to growth which then turned into a focus and fear of inflation. Now, as the cyclical data has turned for the worse in Europe and many places in Asia the focus seems to be reverting to growth. Now, I won't go into the whole decoupling v recoupling discussion at this point since I think that this dichotomy is a false one. It never was about de-coupling à la traditionelle but moreso about two interrelated points. The first would be the extent to which the world already has decoupled from the US in the sense that a key group of emerging economies are now set to ascend in economic prowess. The second would be the extent to which the de-coupling thesis always built on a fallacy. The main point would be that the main fault line of slowdown was observed across economies with external deficits; something which, I am sure most will agree, is sure to impact surplus economies too.

Now, that does not completely let the ECB off the hook since by maintaining a focus on inflation it also assumed the role, if only temporary, of the new anchor in a re-wamped version of Bretton Woods II as the Euro ascended to new highs. This bet on global re-balancing was always going to end in tears and in this light the Eurozone could not decouple from the US; that much, I think, is true.

The key issue here however, as I have argued time and time again is represented in two crucial interlocked questions which together form a key structural trend in the global economy. One is what happens when the surplus economies slow down and there is not sufficient demand to pull the economy back up? Demographics and a high median age are key variables to watch in this regard. The second question is the extent to which hitherto deficit nations can turn the boat around and increase savings (i.e. rely more on exports) and what it will mean for global capital flows when they begin this process?

In the context of the CEE economies the themes above are also present. In a recent note I detailed the change in sentiment from growth to inflation and what it might mean for Eastern Europe's economies and their respective currencies. The key situation as I sketched it was one of a dilemma.

On the one hand, the rampant inflation levels suggest that the exchange rate be loosened to allow appreciation and thus pour water on the roaring inflation bonfire. On the other hand however the Baltics, as well as many other CEE countries, are saddled with extensive external deficits financed by consumer and business credit denominated in Euros. It is not difficult to see that this represents a regular vice from which it will be very difficult to escape since as long as the peg remains deflation seems the only painful alternative as a mean of correcting.

(...)

Another point which is specifically tied to Eastern Europe is that if domestic nominal interest rate increase to keep up with inflation rates it will have a strong substitution effects towards Euro denominated loans. This can become a dangerous cocktail should the tide turn against the currencies.

Now that the focus seems to be changing back again it appears to be a good time to revisit the situation

Within this global nexus of what exactly to do with inflation relative to growth, many Eastern European economies has so far opted to go for inflation by raising interest rates. At an initial glance this seems quite reasonable and in many ways the CEE central banks merely latched on to market sentiment and expectations that many emerging economies would seek to use nominal appreciation as a tool to flush out inflation.

Consequently we have seen how both Ukraine and Hungary have chosen to loosen the peg to the Euro as well as other floating currencies in Eastern Europe have seen their yield advantage increase in an attempt to flush out inflation. This has not been without problems though or more specifically it is not clear that an appreciation of the currency is all for the good. Two points here would seem particularly important. One is the simple question of whether in fact an appreciation is deflationary in a world where capital flows, and in particular the hot kind, act strongly on yield. However, another point would be specifically tied to the situation in Eastern Europe. As such, nominal appreciation of the currency also increases the purchasing power which is not what many CEE economies need at the present time as they stand before the task of correcting a rather large external balance. Moreover, rising domestic interest rates will increase and exacerbate the credit channel by which loans denominated in Euros and Swiss francs become more attractive. I have shown this to be true, for example, in the context of Lithuania. The important thing to do note here would what would happen to the servicing of these liabilities should the domestic currencies depreciate.

What happens next then? Or more concretely, even though CEE currencies, in general, have enjoyed a rally on the back of market expectations of nominal appreciation fed by hawkish central banks what happens if and when central banks reverese course?

An initial warning shot across the bow was handed to us as the governor of the Czech central bank mused that he might lower rates come next meeting due to the strenght of the Koruna and the subsequent effect on exports. Also Poland recently opted to abandon the hawkish stance as rates were kept steady. In light of this event Macro Man managed, as ever, to hit the proverbial nail on the head.

There is little more bearish for a currency these days than abandoning the inflation fight in a pursuit of growth; this is particularly the case when the market is heavily positioned the other way.

This is exactly the issue which now confronts many Eastern European economies. What to do as growth visibly tanks at one at the same time as inflation stays high. One thing here would be for the central banks to hold their raising cycle which in itself should ease the pace of appreciation but what if they need to lower rates.

Now the numbers above do not, in themselves tell anything remotely interesting. For one, the difference between the economies are quite big. For example the Czech Republic has been able to gain, with a comparatively low interest rate, currency appreciation which has actually helped the external balance in so far as it has made imports cheaper. Obviously, at this point the benign effect on the trade balance is just as much down to decreasing domestic demand as the value shield of a dear currency. On the other hand, if we consider especially Ukraine, Romania, and Hungary the price has been dearer and the subsequent effect on inflation less pronounced. One could always argue that the situation would have been much worse, but one thing is certain; the ensuing loss of competitiveness has not been compensated for with a decrease in inflation. And one has to wonder whether pushing nominal interest rates ever higher would be a sound solution.

The key here is that these high interest rates carry with them a high lock-in premium which makes it difficult to reduce them without causing substantial pain to the currency. Add to this that as long as interest rates stay in this territory the incentive to borrow in foreign currency remains very appealing. In fact, the incentive structure here is quite disruptive as many of these economies have higher rates on domestic currency deposits and lower rates on foreign credit. This incites consumers and companies to place their deposits in local currency while funding themselves in foreign currency. Finally, there is of course the more standard economics 1-0-1 point that whatever nominal rate is ascribed to a currency and an economy the latter needs to be able to provide the structural demand for which to satisfy the yield. Otherwise you just pour more gasoline on an already raging bonfire.

Obviously, as long as the local currency remains strong and on an upwards march or the trading band is kept in place the show goes on. But the longer this structure lingers the more difficult it will be to break free; and break free they must since I am quite sure that Eurozone membership is off, for the immediate future at least.

Another more hard hitting point would simply be that whatever growth momentum these economies had going into 2008 it is now steadily levelling off. Now, these economies need to rebalance their external accounts at the same time as they labour under the yoke of slowing growth, high interest rates which are difficult to reduce and/or a quasi fixed exchange rate to the Euro. Can you feel the chilling cold of deflation blowing across the Urals? I can.

Basically, the past years' rapid process of nominal convergence will now need to be kicked into reverse, since it is quite obvious that many CEE economies have been riding a blade too tough.

Be Careful Indeed

Last time I massaged this specific topic I summarised by ominously stating that the CEE economies and their central banks should be careful what they wished for in terms of using higher interest rates and subsequent nominal appreciation of their currencies to flush out inflation. The key point was that the effect would likely be limited and only further worsen the imbalances in the economies. And thus, here we are.

Another more subtle point in the context of market reactions would be the boomerang effect which comes from the currency appreciation as interest rates are increased (and the peg/band abandoned) to the subsequent plunge when the economic tide turns. In line with the change in global sentiment towards growth and deflation (see e.g. here) and the fact that other hitherto strong yielders (e.g. the Kiwi and Aussie) are beginning to falter we may be at an inflection point in the whole discourse of upwards movement in CEE currencies. Stephen Jen's recent tour of global FX markets is a fine addition to this argument.

As ever, this is obviously still a dilemma for most of these economies since inflation continues to rage ahead. In Romania for example the PPI rose at its highest pace since 2004. However, as long as the credit tap stays open and as long as the purchasing power is increasing so will the the demands for higher wages stay strong. This is particularly true in the context of the CEE economies as these are in possession of structurally broken population pyramids after two decades worth of lowest low fertility and, in the cast of the latter decade, net outward migration.

The main point I would like to emphasise here is that correction is coming and that it will only become harder the higher the currencies move upwards. In a more general light this correction will not be a small one and it most certainly will not be felt exclusively in Eastern Europe. Basically, the big hidden data point in all of this is the dependence of Germany on CEE imports. So far, this has moved along just nicely but Germany is in for a rude awakening once the link breaks ... and break, I am afraid, it will.

Romania Wages Accelerate To An Annual 24.4% In June

2008-08-05T05:15:00.000-07:00

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 yesterday 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.'' The central bank on July 31 raised its Monetary Policy Rate a seventh time to 10.25 percent.

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.

Romanian Producer Prices Accelerate Again In June

2008-08-04T03:02:00.000-07:00

Romanian producer prices rose at the fastest pace in over three years in June as energy prices increased and rising wages hit output costs. The cost of goods produced in factories and mines rose an annual 19.4 percent in June, compared with 16.8 percent in May, the fastest pace since October of 2004. Prices grew 2.1 percent on the month, after rising 1.7 percent in May.

Prices of manufactured goods rose an annual 22.1 percent in June, compared with 19.6 percent in May, while price growth in the mining and drilling industries quickened to 17.8 percent from 11 percent. The costs of electricity, natural gas and water rose an average of 0.1 percent, compared with 3 percent in May, the statistics institute said.

The Banca Nationala a Romaniei last week raised its main interest rate, the highest in the European Union, to 10.25 percent from 10 percent. Monetary policy makers have gradually raised the rate from 7 percent in September.

Romania's Central Bank Raises Interest Rates

2008-07-31T05:24:00.000-07:00

Romania's central bank raised its main interest rate, the European Union's highest, again today to 10.25 percent. The Banca Nationala a Romaniei raised the rate for the seventh consecutive policy meeting as it expects inflation to have accelerated in July from June's two-year high.

A drought last year destroyed a third of Romania's crops, adding to pressure from increasing global food prices and boosting inflation from a 17-year-low of 3.7 percent in March, 2007. The bank has now raised the key rate in stages from 7%.

The leu strengthened as much as 0.4 percent to 3.5138 to the euro after the announcement, from 3.5276 at closing yesterday. The benchmark BET stock index was little changed at 6045.04.

The central bank had previously predicted inflation may slow as early as August as an expected bumper crop counters rising food prices. Central banks in emerging economies, including Brazil, Russia and Turkey raised interest rates this month to stem the effects of surging oil and food prices. The European Central bank on July 3 raised its benchmark lending rate by a quarter point to 4.25 percent, the highest in seven years.

Several east European central banks, including monetary policy makers in Poland and Serbia, are taking stock of their moves to see if they hit their intended target. Slovakia held its main rate on Tuesday and the Czech Republic is expected to do the same next Thursday.

Romania's annual net-wage growth of 23.3 percent in May and a 63.4 percent increase in private lending in June have also pressured prices and boosted economic growth.

Construction and Forex Lending Still Booming In Romania

2008-07-29T11:32:00.000-07:00

Romanians were awarded 6 percent more homebuilding permits in June than in June 2007 as higher wages and a lending boom continued to drive construction activity. The government issued 6,137 homebuilding permits last month, compared with 5,791 in June 2007, according to the latest data from the National Statistics Institute. Month on month permits awarded were down 2.4 percent from May.

Rising wages, a lending boom and growth in real estate prices have given Romanians more money to invest in housing. Wages increased an annual 23.3 percent in May:

Bank lending continued to drive up debt - both corporate and household - at a very fast annual rate again in June, according to the latest data from the Romanian central bank.

In June 2008, totat non-government credit grew 3.7 percent, or 3.4 percent in real terms, from May 2008 to reach RON 178,180.2 million. RON-denominated loans went up 2.1 percent (1.8 percent in real terms) and foreign currency-denominated loans rose by 5.0 percent when expressed in RON and by 4.3 percent when expressed in EUR.

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.

Romania's Current Account Deficit Widens in May 2008

2008-07-16T05:40:00.000-07:00

Romania's current-account deficit widened in the first five months of the year as rising wages and a lending boom encouraged citizens to buy more imported goods. The gap widened to 6.53 billion euros ($10 billion) from 5.88 billion euros in the same period of last year, according to the Bucharest-based Banca Nationala a Romaniei earlier today.

A lending boom, which saw private debt shoot up by more than an annual 61 percent in May, and annual net wage increases of 23.3 percent in that month encouraged Romanians to buy more imports, widening the trade and current-account gaps.

The European Union has warned Romania to narrow the gaps or risk instability of the local currency because of global economic uncertainty. Fitch Ratings and Standard & Poor's have lowered their outlooks on Romania's credit rating, citing the deficits.

The trade deficit, the main component of the current-account gap, widened to 6.9 billion euros in the first five months of the year from 6 billion euros a year earlier, the National Statistics Institute said on June 9.

Net money transfers to Romania, mainly from the estimated 2 million citizens living abroad, increased to 2.25 billion euros in the first five months from 1.88 billion euros a year earlier, the central bank said today.

The services component of the gap, including tourism and transportation, saw a net inflow of 194 million euros, from an inflow of 422 million euros a year earlier.

Foreign direct investment in the first five months totaled 4.1 billion euros, compared with 2.1 billion euros in the same period of last year, the bank said.

Romania Inflation Rises Again in June 2008

2008-07-11T14:29:00.000-07:00

Romania's inflation rate rose in June, and pushed back up the two-year high reached in June. Inflation accelerated to 8.6 percent from 8.5 percent in May according to data last week fromthe Bucharest-based National Statistics Institute. On the month, prices rose 0.3 percent, compared with 0.5 percent in May.

Inflation has now accelerated from a post-communist low of 3.7 percent in March 2007 and the central bank has raised the main interest rate at every policy meeting since October - to the current level of 10 percent, the highest in the European Union. The bank, which next meets on July 31, has forecast inflation will slow starting in August.

Food prices are accelerating worldwide, pushing up inflation particularly in eastern Europe and other emerging markets, where people spend a larger portion of their income on food. Latvian inflation was 17.7 percent in June and Ukraine's was 29.3 percent.

Food prices in Romania were up 11.8 percent year on year while non-food items rose 5.9 percent. Services rose an annual 8.7 percent. And the immediate future looks non too promising on the inflation front, since gas prices are about to rise 12.5 percent and electricity prices 5.3 percent effective July 1. The government has also just raised the tobacco tax to 50 euros per 1,000 cigarettes from 41.5 euros.

However there are some positive trends, agriculture, for example. Farm output will probably double this year over 2007 due to better weather and increasing investment. Agriculture accounted for 9.4 percent of all investment in the first quarter, compared with 1.5 percent in Q1 2007.

Romanian Wages Rise 23.3% in May 2008

2008-07-07T02:46:00.000-07:00

Romanian net wages grew an annual 23.3 percent in May as increasing labor shortage lead to higher salaries and increased investment raised demand for workers. The average net monthly wage rose to 1,248 lei ($539), according to today's data from the Bucharest-based National Statistics Institute. The rate of increase was close to the 24.8 percent annual increase registered in April.

Romania's entry to the European Union 18 months ago sparked an increase in labor migration to western Europe, particularly to Spain and Italy, aggravating difficulties which were inevitably going to arise from the long term below replacement fertility the country has experienced. At the same time a boom in consumption and construction fuelled in part by remittances these very same migrant workers sent home has boosted demand for workers who just aren't available.

The Banca Nationala a Romaniei said wage growth is a main factor in inflation and is encouraging a lending boom as citizens' borrowing power expands. The central bank has increased its main interest rate at every meeting since October to slow inflation, which was close to the fastest pace in two years in May, at 8.5 percent.

Romanian unemployment fell to 3.8 percent in May, from the 5.2 percent level which prevailed when Romania joined the EU. The Romanian Association of Construction Companies has said builders need another 300,000 workers simply to stay on schedule with current projects.

Romania Construction Output May 2008

2008-07-04T06:44:00.000-07:00

Romania's construction industry, which is currently the fastest-growing in the European Union, gathered additional steam in May as investors built offices and shops and rising wages spurred homebuilding. The value of construction works rose an annual 34 percent in May, compared with 31 percent in April according to data released by the National Statistics Institute this morning. Construction output was up 10.5 percent month on month.

Homebuilding jumped an annual 36 percent in May as rising wages and a lending boom encouraged Romanians to invest more in residential property. Net wages rose 25 percent on the year in April.

Private debt grew by 61 percent in May, the central bank said on June 24.

Construction in the first quarter contributed strongly to a year on year economic growth rate of 8.2 percent pace, the second-fastest in the EU after Slovakia. Construction accounted for 1.5 percentage points of the growth.

Romania Producer Prices April 2008

2008-07-02T03:41:00.000-07:00

Romanian producer prices rose at the fastest annual pace since November 2004 in April as rising energy prices and a weaker local currency increased the cost of imported materials. The cost of goods leaving Romanias factories and mines rose at an annual 16.8 percent rate in May, compared with 15.5 percent in April, according to dat from the National Statistics Institute today. Prices rose 1.7 percent on the month, after a gain of 1.1 percent in April.

The leu has weakened almost 15 percent against the euro in the past year, making imports of capital goods and raw materials more expensive. Higher global energy prices also increased costs for producers. Producer-price growth is an early indicator of inflation, which in May was 8.5 percent, more than twice the pace of the euro region.

Prices of manufactured goods rose an annual 19.6 percent in May, compared with 17.7 percent in April, while price growth in the mining and drilling industries slowed to 11 percent from 13.2 percent. The costs of electricity, natural gas and water rose an average of 3 percent, compared with 2.9 percent in April, the statistics institute said.

In another indication of the growing stresses and strains which are now accumulating in the Romanian economy, we learnt today that overdue private debt almost doubled in April from a year earlier as the local currency weakened, making loans in euros more expensive to repay. Loan payments that are more than 30 days overdue rose to 691 million lei ($300 million) in April from 380 million lei a year earlier, according to the Banca Nationala a Romaniei.

Private debt in Romania rose an annual 61.3 percent in May from a year earlier in a lending boom spurred by rising wages and competition among banks, the central bank said on June 24. Borrowing in euros accounted for most of the lending.

In May 2008, non-government credit grew 1.8 percent, or 1.3 percent in real terms, versus April 2008 to RON 171,834.3 million. RON-denominated loans went up 2.4 percent (1.9 percent in real terms) and foreign currency-denominated loans rose by 1.4 percent when expressed in RON and by 2.9 percent when expressed in EUR. At end-May 2008, non-government credit climbed year on year by 61.3 percent, or 48.8 percent in real terms, on the back of the 41.7 percent increase in RON-denominated loans (30.6 percent in real terms) and the 82.6 percent advance in foreign currency-denominated loans expressed in RON (when expressed in EUR, forex loans expanded by 65.0 percent).

If we look at the annual rates of increase in loans and forex loans (see chart below) we can see that the rate of increase in RON denominated household has been falling slowly now for some time, but that the rate of increase in Total Forex loans and Household Forex was very very fast, but peaked in January, and is now declining. This could mean that the lending boom has now past its peak, and that we are into the downside, if so we should start to see some reflection of this in real economy data in the not too distant future.

Romanian Central Bank Raises Interest Rates Again In June

2008-06-26T04:35:00.000-07:00

Romania's central bank raised its main interest rate (currently the European Union's highest) for a sixth consecutive meeting today and indicated it may rates again again as rising global fuel prices and soaring local wages stoke inflation.

The Banca Nationala a Romaniei raised its Monetary Policy Rate to 10 percent from 9.75 percent. The rate-setting board is ``ready to use the bank's entire array of instruments to counteract inflationary pressures and ensure disinflation will resume,'' the bank said in a statement.

The central bank today also left its minimum reserve requirement on commercial bank deposits at 40 percent for foreign-exchange deposits and 20 percent for deposits in lei. Monetary policy makers use the rate as a benchmark to drain excess cash from commercial banks through weekly auctions of one-month deposits and monthly auctions of three-month certificates of deposit to keep lending in check.

Romanian monetary policy makers, who have targeted an inflation rate of 3 percent in 2010 (inflation was running at 8.5 percent in May) have raised the main interest rate at every meeting since October, when it was 7 percent.

Inflation is being driven by food and fuel prices, a forex dominated lending boom, rising local wages, higher government spending and a weaker local currency.

The central bank is still targeting annual end-year inflation of between 3 percent and 5 percent for this year, and objective which currently seems unlikely to be attained.

Romanian producer-prices, which are normally regarded as an early predictor of inflation, rose at close to their fastest pace since 2004 in April as energy prices increased a weaker leu raised the cost of imported raw materials.

The cost of goods produced in factories and mines was up 15.5 percent in April over April 2007. This compares with a 15.6 percent rate in March, according to the latest data from the Bucharest-based National Statistics Institute. Prices rose 1.1 percent on the month, after rising 1.7 percent in March over February.

Economic growth this year may be as much as 8 percent, and may well be boosted by a good harvest this year following the drought which destroyed a third of Romania's crops in 2007. Gross domestic product grew an annual 8.2 percent in the first quarter, the second-fastest pace in the EU after Slovakia.

Romanian retail sales growth accelerated to the fastest pace in seven months in April as a lending boom and soaring wages continued to boost consumer spending. Sales rose an annual 26.6 percent, compared with 11.2 percent in March, according to the latest data from the Bucharest-based National Statistics Institute. Sales increased 15 percent on the month.

Growing consumer lending, rising wages and government spending are driving growth and are also key in boosting consumer prices, the central bank has said.

Romanian net wage growth, which the central bank says is a main driver of inflation, accelerated in April due to growing labour shortages. The average monthly net wage increased 24.8 percent from a year earlier to 1,282 lei ($546), the Bucharest-based National Statistics Institute said today. Growth accelerated from an annual 17.7 percent in March. On the month, wages increased by 7.6 percent. In real terms wages are up 16.2% year on year, since inflation in April was running at 8.6%.

Private debt in May increased an annual 61.3 percent, driven by increased competition among banks and rising net wages, which rose 25 percent on the year in April.

According to data from the Romanian central bank, household borrowing in euros continued to rise in March.

Total credit (including the coporate sector) was up by 66.3% year on year. Household borrowing in RON was up by 43% while household forex borrowing (mainly euros) was up a massive 140.3%. This latter number, large as it seems, was actually down slighly y-o-y from the 142.3 % registered in February and the peak 143.4% in January. The monthly rate of increase - 3.4% - was the lowest in at least a year, and again is well down from the 14.2% m-o-m peak hit in August 2007.

Government spending was up 39 percent in the first five months from a year earlier.

A weaker currency, which has declined more than 13 percent against the euro in the past year, has also made imports more expensive, along with gas, rent, telephone bills along with a number of other items traditionally indexed in euros in Romania and paid in lei.

Romania Inflation May 2008

2008-06-10T05:27:00.000-07:00

Romania's inflation eased slightly in May to 8.5 percent but still exceeded market forecasts.

The Romanian central bank has raised rates by 275 basis points since October to bring the cost of borrowing to 9.75 percent. Bank officials accept inflation may well be running at around 6 percent at the end of this year, well above the 2.8-4.8 percent target.

Romania's economy grew a hefty 8.2 percent in the first quarter, compared with 6.1 percent in the same period in 2007. The growth beat expectations of a 6.4 percent increase during the period.

This has triggered warnings from central bankers about the economy possibly overheating as increased consumption and vast credit growth fuel a large expansion of the country's current account deficit. The current account deficit was at around 14 percent of GDP, last year, raising concerns about possible trouble financing it should foreign cash flows dry up.

The International Monetary Fund will revise upward Romania's economic growth forecast for this year, following strong first quarter GDP data, but said it was still expecting a slowdown in 2009. Romania's economy grew by a higher than expected 8.2 percent in the first quarter, fanning overheating concerns as the new European Union member also struggles with a ballooning current account gap and resurgent inflation. After April's annual consultations with authorities, the Fund came in with a 5.5 percent growth forecast for this year and a 4.7 percent estimate for 2009, compared to 6 percent in 2007.

It has said the potential slowdown could be caused partly by the knock-on effects of the global tensions. "The latest (growth) data were on the strong side, and the IMF team will revise up the projection of GDP growth for 2008, compared with the April visit,"

Central bank Governor Mugur Isarescu said at a seminar in Bucharest today that first-quarter growth is ``risky.''

``An economy growing this fast has vulnerabilities,'' Isarescu said. ``A high speed of growth means high risk. Among the vulnerabilities linked to this high speed of growth is the difficulty in transitioning from growth that generates imports to growth that generates exports.''

The trade deficit widened to 2.02 billion euros ($3.2 billion) in April, compared with 1.61 billion euros in the same month of last year, the Bucharest-based National Statistics Institute said on June 9.

The government predicted on May 14 that farm output will probably double this year from last year, when drought destroyed a third of Romania's crops, further boosting growth in the second half.

``It's very likely that, under conditions of a good farm harvest, growth will be well above the estimates from the beginning of the year,'' central bank Governor Mugur Isarescu said at a seminar in Bucharest today. ``A good harvest will add a billion euros ($1.5 billion) to economic growth.''

The current-account gap widened in the first quarter to 3.52 billion euros from 3.17 billion euros a year earlier. Fitch Ratings and Standard & Poor's have lowered their outlooks on Romania's credit rating, citing the gap.

Romania Retail Sales April 2008

2008-06-06T01:34:00.001-07:00

Romanian retail sales growth accelerated to the fastest pace in seven months in April as a lending boom and soaring wages continued to boost consumer spending. Sales rose an annual 26.6 percent, compared with 11.2 percent in March, according to the latest data from the Bucharest-based National Statistics Institute. Sales increased 15 percent on the month.

Wage increases accelerated to an annual 25 percent in April sparked by foreign investment and labor shortages since Romania joined the European Union in 2007. A lending boom, fueled partly by competition among banks, has pushed up household debt more than an annual 60 percent and given Romanians more disposable income.

The services industry, including retail sales, added 4 percentage points to economic growth in the first quarter, the institute said yesterday. That's almost half the 8.2 percent pace of growth, which is now the second fastest in the European Union after Slovakia.

The retail sales data released today doesn't include car sales and isn't adjusted for any difference in the number of working days.

In a separate release INSSE said that industrial output was up year on year in April by 13.3%.

While construction output was up 31.4% year on year in April 2008.

Romania Wages and Salaries April 2008

2008-06-04T01:22:00.001-07:00

Romanian net wage growth, which the central bank says is a main driver of inflation, accelerated in April due to growing labour shortages. The average monthly net wage increased 24.8 percent from a year earlier to 1,282 lei ($546), the Bucharest-based National Statistics Institute said today. Growth accelerated from an annual 17.7 percent in March. On the month, wages increased by 7.6 percent. In real terms wages are up 16.2% year on year, since inflation in April was running at 8.6%.

Romania's entry to the EU last year has sparked an increase in foreign investment in construction and manufacturing, raising demand for workers. Romania has had below replacement fertility for many years now, and in addition at least one million romanians (out of a labour force of about 12 million) are currently working abroad and sending home remittances (at least 500,000 are in Spain, and the same number are estimated to be in Italy. The World Bank estimated remittances to be running at 5.5% of GDP in 2007. In macro economic terms this is virtually equivalent to a 5.5% fiscal stimulus from the government, since the effect on domestic demand is effectively the same.

The central bank, which has raised interest rates at every meeting since October to 9.75 percent, the highest in the EU, has said wage growth threatens to further accelerate inflation, which was near a two-year high of 8.6 percent in April.

The jobless rate fell to 3.9 percent in April, from 5.2 percent when Romania joined the EU on Jan. 1 of last year. The Romanian Association of Construction Companies has said builders need another 300,000 workers just to stay on scheduled with current projects.

Romania Producer Price Growth April 2008

2008-06-03T01:03:00.000-07:00

Romanian producer-prices, which are normally regarded as an early predictor of inflation, rose at close to their fastest pace since 2004 in April as energy prices increased a weaker leu raised the cost of imported raw materials.

The cost of goods produced in factories and mines was up 15.5 percent in April over April 2007. This compares with a 15.6 percent rate in March, according to the latest data from the Bucharest-based National Statistics Institute. Prices rose 1.1 percent on the month, after rising 1.7 percent in March over February.

Romania already has the European Union's highest interest rates, at 9.75 percent, after a pick-up in inflation to the fastest pace in two years led policy makers to raise borrowing costs at every monetary policy meeting since October. The central bank expects inflation to exceed its target for a second consecutive year in 2008.

The leu has weakened almost 10 percent against the euro over the past year, the second-worst performance in Europe behind the Icelandic krona, making imports of capital goods and raw materials more expensive.

Prices of manufactured goods increased an annual 17.7 percent in April, while prices in the mining and drilling industries rose 13.2 percent. The costs of electricity, natural gas and water rose an average of 2.9 percent, the statistics institute said.

Consumer-price growth in April remained at a two-year high of 8.6 percent from an annual 8 percent in February.

Romania GDP Q1 2008 (Preliminary)

2008-06-02T06:06:00.003-07:00

Romania's economic growth accelerated more than economists expected in the first quarter of 2008 as credit growth and rising wages boosted consumption, threatening to push up inflation even further.

Gross domestic product grew at an annual rate of 8.2 percent in the first quarter, the fastest pace since the third quarter of 2006, according to the latest data from the Bucharest-based National Statistics Institute. This compares with 6.6 percentrate in the fourth quarter of 2007.

The rate of growth in the Romanian economy - which is the second-fastest after the 8.6% achieved in Slovakia among the 20 European Union members that have so far released first-quarter reports, may well drive up inflation even further despite the best monetary policy efforts of the central bank. Consumer prices rose a two-year high annual 8.6 percent in April.

The central bank, which raised its main interest rate five times since October, has warned that inflation may not slow until the third quarter.The Banca Nationala a Romaniei has raised its Monetary Policy Rate to 9.75 percent currently from 7 percent eight months ago and next meets to decide on the rate on June 26.

The leu gained as much as 0.8 percent to 3.5984 per euro, the strongest since April 29, and was at 3.6024 at 11:29 a.m. in Bucharest, from 3.6257 on May 30.

First quarter was described last month as "the best for the Romanian economy in modern history'' by Finance Minister Varujan Vosganian who attributed the phenomenon to rising wages, increased tax collection and growing foreign investment.

Net wages grew at an annual rate of nearly 18 percent in March while household debt has been surging at around 64 percent year on year.

In April 2008 non-government credit in Romania was up by 2.5 percent from March (or 2.0 percent in real terms), and reached RON 168,734.1 million according to the latest data from the national bank. RON-denominated loans were up 3.4 percent (2.8 percent in real terms) and foreign currency-denominated loans rose by 1.8 percent when expressed in RON and by 3.2 percent when expressed in EUR.

At end-April 2008, non-government credit was up year on year by 64.4 percent, or 51.4 percent in real terms, on the back of the 44.5 percent increase in RON-denominated loans (33.0 percent in real terms) and the 85.8 percent advance in foreign currency-denominated loans expressed in RON (when expressed in EUR, forex loans expanded by 68.2 percent).

RON denominated household credit was up by 42% year on year in April, while household foreign currency-denominated loans were up at an annual rate of 137.7%. The rate of increase in these latter has slowed a little in recenent months from the peak, so the whole process may now be slowing. We will have to wait and see.

Romania's unemployment rate fell in April as farmers and construction companies boosted seasonal hiring because of favorable weather conditions. The unemployment rate fell to 3.9 percent in April from 4.2 percent in March, according to data from the National Labor Agency. Unemployment fell from 4.5 percent a year earlier.

Romania's jobless rate has been falling steadily since last year when it joined the European Union, increasing investment in the nation of 22 million and allowing many Romanians to emigrate to find better-paying jobs in other EU nations such as Italy and Spain. A growing labor shortage and a booming construction industry has helped boost average net monthly wages in Romania by an annual 17.7 percent in March.

Retail sales expanded 11.2 percent from a year earlier, government tax collection rose 44 percent on the year, the construction sector grew 32 percent and increasing job offers lowered unemployment to 3.9 percent.

Vosganian also indicated that the government expects a large agricultural harvest this year, which may further accelerate growth. A drought last year destroyed a third of Romania's crops, shaving more than a percentage point off GDP growth last year, according to government estimates. Romania's statistics institute will provide a detailed breakdown of first quarter economic growth on June 5.

Romania Unemployment and Wages April 2008

2008-05-25T10:23:00.000-07:00

Romania's unemployment rate fell in April as farmers and construction companies boosted seasonal hiring because of favorable weather conditions. The unemployment rate fell to 3.9 percent in April from 4.2 percent in March, according to data from the National Labor Agency. Unemployment fell from 4.5 percent a year earlier.

Romania's jobless rate has been falling steadily since last year when it joined the European Union, increasing investment in the nation of 22 million and allowing many Romanians to emigrate to find better-paying jobs in other EU nations such as Italy and Spain. A growing labor shortage and a booming construction industry has helped boost average net monthly wages in Romania by an annual 17.7 percent in March.

Romanian labor costs rose in the first quarter from a year earlier. Labor costs for employers, including taxes and social contributions, rose 19.5 percent in the first quarter from a year earlier, although they fell 1.7 percent from the fourth quarter of last year, when employers paid holiday bonuses. I think it is quite clear from the chart (see below) that Romanian wages spiked in the last quarter before enetering the EU and that the pace of increase has been slowing steadily ever since. Basically the real value of these increases is also reducing as inflation has risen, so the sum total of all this is that we should expect economic growth to continue to slow, although we need to remember that the pace of borrowing can also offset this slowdown to some extent in the short term.

Romania Inflation April 2008

2008-05-12T11:26:00.000-07:00

Romania's inflation rate remained at a two-year high in April as wage increases and a lending boom spurred consumption and a weaker leu increased many services prices. Inflation was an annual 8.6 percent last month, the same as in March, the National Statistics Institute INSSE said today. Consumer prices rose 0.5 percent on the month, down from a 0.7 percent month on month increase in March.

A drought that destroyed a third of Romania's crops last year continued to pressure food prices in April while rising lending and wages prompted Romanians to shop more. The leu's decline against the euro also raised prices of services such as rent and mobile phone bills that are measured in euros. The leu has weakened 11 percent against the euro in the past year.

In March, net wages rose an annual 17.7 percent and household debt rose an annual 66 percent.

Perhaps even more importantly Romanian producer prices continue to accelerate, and the annual rate reached 15.6% in March, which means there is plenty of evidence of "second round" effects now building up in the pipeline.

Mugur Isarescu, governor of the Banca Nationala a Romaniei, has predicted that inflation will end the year at an annual 6 percent, above the bank's inflation target of between 3 percent and 5 percent. The bank also missed its 2007 inflation target of between 4 percent and 6 percent as consumer prices increased by 6.6 percent in 2007.

The central bank raised its Monetary Policy Rate a quarter of a percentage point to 9.75 percent on May 6 to fight inflation. It has raised the rate at every policy meeting since October, when it was 7 percent. The board next meets on June 26.

It's a little bit early to be drawing any strong conclusions here, but retail sales did slow noticeably in March - rising at an annual rate of 11.2%, down from February's 23.5% - and if we look at the chart below we could get the impression that the "great wave" may now be over. What we will now be likely to see - if what has happened in the Baltics is anything to go by - if a steady slowing in the economy, even as inflation continues to push upwards. By the look of it there may be a six to eight month lag (or slightly more) before movements in the producer price index hit the CPI.

Romania Household Forex Borrowing March 2008

2008-05-07T02:58:00.000-07:00

According to data from the Romanian central bank, household borrowing in euros continued to rise in March.

Total credit (including the coporate sector) was up by 66.3% year on year. Household borrowing in RON was up by 43% while household forex borrowing (mainly euros) was up a massive 140.3%. This latter number, large as it seems, was actually down slighly y-o-y from the 142.3 % registered in February and the peak 143.4% in January. The monthly rate of increase - 3.4% - was the lowest in at least a year, and again is well down from the 14.2% m-o-m peak hit in August 2007.

So in fact this may all now be slowing slightly, and it is not clear why, since of course euro denominated loans are not affected by the interest rate changes in the Romanian central bank. Perhaps the general expansion is losing momentum, but we need to wait and see some clearer signs in the real economy data before reaching this kind of conclusion. Certainly there may be some sort of tightening in credit conditions going on after all the IMF and other warnings. The real question is what is going to happen about the current account deficit once the borrowing which is attracting the funds to plug the whole really slows down.

In a not entirely unrelated piece of news the Romanian Statistics Office announced today that the construction production index rose in March at an annual rate of 32.9%.

Romania Central Bank Raises Interest Rates

2008-05-06T07:14:00.000-07:00

Romania's central bank raised its main interest rate, already the highest in the European Union, by a quarter of a percentage point again today after inflation accelerated to a two-year high. The central bank raised the rate to 9.75 percent from 9.5 percent, effective from tomorrow.

The Banca Nationala a Romaniei has raised its Monetary Policy rate at every meeting since October, when it was 7 percent, as rising global food and fuel prices and a weaker currency spurred inflation, which accelerated to 8.6 percent in March.

The central bank board today also left its minimum reserve requirements on commercial bank deposits at 40 percent for foreign-exchange deposits and 20 percent for deposits in lei. It also set its next rate decision date for June 26.

``Annual inflation is likely to temporarily remain above the upper limit of the variation band around the target in the following months,'' the central bank said in a separate e-mailed statement today. Inflation pressure in recent months stemmed partly from ``a substantial increase of incomes and continued acceleration of expansion in credit to the private sector.''

Central bank Governor Mugur Isarescu, who targets inflation of between 3 percent and 5 percent this year, has predicted year- end inflation of 5.9 percent. The central bank missed its 2007 inflation target of 4 percent, plus or minus one percentage point, as consumer prices surged an annual 6.6 percent.

IMF Calls For Interest Rate Hikes in Romania

2008-04-22T04:53:00.000-07:00

Romania's central bank should raise interest rates further to curb inflation as the economy continues to ``boom'' this year, the International Monetary Fund has said.

``Inflation is now quite high,'' IMF country Mission Head Albert Jaeger said, speaking to reporters today in Bucharest. ``The booming economy is increasingly becoming a driver of inflation. More monetary policy tightening may be needed, principally in interest rates.''

Banca Nationala a Romaniei lifted its monetary policy rate half a percentage point to 9.5 percent last month as the inflation rate to an annual 8.6 percent. The bank, which makes its next interest rate decision on May 6, has raised the key rate at all four meetings since October, when it was 7 percent.

The bank missed its 2007 inflation target of 4 percent, plus or minus one percentage point, as consumer prices surged an annual 6.6 percent. The IMF said in a news release today that inflation will end this year at an annual 6 percent, above the central bank's target of between 3 percent and 5 percent.

Romanian inflation accelerated in March to the fastest pace in more than two years as a weaker leu boosted the cost of services and imports and rising wages and lending spurred consumption.

Romania must cut the inflation rate to 3 percent by the end of 2010 or risk missing its target of adopting the euro in 2014, central bank Governor Mugur Isarescu has said.

Jaeger predicted the economy will grow 6 percent this year, the same rate as last year. He said growth will probably slow to 4.7 percent in 2009 as richer countries import less and international investors grow wary of higher-risk investment.

``The slowdown in 2009 could be much sharper,'' Jaeger said. ``Global financial turmoil will spill over to Romania. External financing, which has been cheap in the past, will become more expensive.''

He also urged the government to refrain from increasing spending or lowering taxes in the near future, particularly in the lead-up to November 2009 parliamentary elections. The government targets a budget deficit this year of about 2.2 percent of gross domestic product although Jaeger said the government ``overestimates'' revenue for this year.

Jaeger said Romania's current-account deficit, which widened in the first two months of this year to 2.19 billion euros ($3.5 billion) from 2.08 billion euros a year earlier, is ``unsustainable.'' Fitch Ratings and Standard & Poor's have both lowered their outlooks on Romania's credit rating, citing the continuing current account shortfall as justification.

IMF Hard Landing Warning

The latest IMF Global Financial Stability report (published last week), warns thata number of Eastern European countires now face a continuing and growing risk of experiencing a "hard landing" as the global financial crisis continues to spread. The fund also drew attention to the possibility of serious of spillover problems arising for the Scandinavian, Italian and Austria banks that have lent heavily in the region, and this warning will not be taken lightly by these banks (whose benevolence and cooperation was, it will be remembered, thought to be the principal lifeline for the Romanian and Baltic economies in times of distress).

At the heart of the IMF's concerns are the large current account deficits being run in certain CEE countries, deficits which have now reached extreme levels in some cases, running to the tune of 22.9pc in Latvia, 21.4pc in Bulgaria, 16.5pc in Serbia, 16pc in Estonia, 14.5pc in Romania and 13.3pc in Lithuania.

"Eastern Europe has a cluster of countries with current account deficits financed by private debt or portfolio flows, where domestic credit has grown rapidly. A global slowdown, or a sharp drop in capital flows to emerging markets, could force a painful adjustment,"

The IMF said lenders in Eastern Europe had built up "large negative net foreign positions" during the boom, especially in the Baltic states. "Liquidity for these banks has all but dried up and [interest] spreads have widened 500 basis points."

Many of these countries concerned rely on credit from branches of West European and Nordic banks, but these foreign lenders are now themselves having difficulty raising money in the wholesale capital markets.

"A soft landing for the Baltics and south-eastern Europe could be jeopardised if external financing conditions force parent banks to contract credit to the region. Swedish banks, the main suppliers of external funding to the Baltics, could come under pressure,"

As the IMF note in their report, awareness of higher risks in the CEE countries has been rising in recent months, and this rising awareness has been been reflected in the performance of bank stocks exposed to the region, in Credit Default Swap spreads, and in the performance of the Romanian leu (see chart below) given that the leu is the only floating currency with a liquid forward market among the group of eastern European countries with large external imbalances. As we have seen it has depreciated substantially since July 2007, as investors have been expressing their negative views on the region as whole The stocks of Swedish banks exposed to the Baltics have underperformed other Nordic bank shares (and here) partly owing to significant short-selling and CDS spreads on sovereign debt have surged since August 2007, as investor demand for credit protection has pushed up prices. The interesting point to observe is how this is now all moving in tandem.

Romania Inflation March 2008

2008-04-14T01:56:00.000-07:00

Romanian inflation accelerated in March to the fastest pace in more than two years as a weaker leu boosted the cost of services and imports and rising wages and lending spurred consumption. The annual inflation rate rose to 8.6 percent, the highest since January 2006, from 8 percent in February, according to data from the Bucharest-based National Statistics Institute this morning. Consumer prices rose 0.7 percent in the month, the same pace as in February.

Food prices, affected by a drought that destroyed one-third of Romania's crops last harvest, rose an annual 10.8 percent in March. Service costs, the most directly affected by a weaker local currency, increased 10.7 percent, the institute said. Prices of non-food goods rose an annual 5.9 percent.

The leu has fallen 15 percent against the euro since August which also puts some upward price pressure on imported products, although it does make Romanias exports cheaper, something which is badly needed given the ongoing trade and current account deficits.

These increases could well trigger well trigger yet another interest rate hike when the central bank next meets on May 6.

The central bank increased its Monetary Policy Rate half a percentage point to 9.5 percent last month, saying that inflation wouldn't likely slow until mid-year. The bank has now raised the key rate at its last four meetings (starting last October, when the rate was 7 percent). Romania's central bank has consistently highlighted wage growth as a main driver of inflation and the main threat to this year's inflation forecast. The difficulty is that further increasing the policy rate may simply drive more people to take out euro denominated loans at the cheaper interest rates which are associated with them.

The central bank missed its 2007 inflation target of 4 percent, plus or minus one percentage point, as consumer prices surged an annual 6.6 percent. The bank, which targets inflation of between 3 percent and 5 percent this year, has predicted year-end inflation of 5.9 percent.

Central bank Governor Mugur Isarescu also said last week that rising wages, which increased an annual 20.5 percent in February, risk sparking a ``second round'' of price increases in coming months. Household debt also rose an annual 66 percent in February amid a lending boom, giving citizens more disposable cash.

Romanian Wage Growth February 2008

2008-04-11T04:07:00.000-07:00

Romanian net wage growth, which the central bank says is a main driver of inflation this year, slowed in February compared with January, when the government gave pay increases to public employees. Net wages rose at an annual 20.5 percent rate, as compared with a 30.7 percent in January, bringing the average net monthly wage to 1,134 lei ($493), according to data from the Bucharest-based National Statistics Institute this morning. Month on month net wages fell back 5.7 percent from January's high.

Central bank Governor Mugur Isarescu said on April 9 that rising wages are a main threat to inflation this year and may spur a ``second round'' of price increases in coming months.

Romanian inflation in February accelerated to an annual 8 percent, the fastest pace in two years, prompting the central bank to increase its main interest rate in March to 9.5 percent.

Update

The recent settlement in the Dacia strike gives some indication of how extensive the labour supply problem now really is in Romania. basically Employees of Dacia, which is the Romanian carmaking unit of France's Renault today ended an 18-day strike at their Pitesti plant - located about 100 kilometers northwest of Bucharest - after accepting a higher pay offer.

The 13,000 employees returned to work this afternoon after accepting a monthly pay increase of 360 lei ($158). Dacia employees started the strike on March 24, halting production of 1,300 cars a day from the factory, to back demands of a wage increase of 550 lei a month each. This pay increase brings the average wage of a Dacia employee to 2,256 lei a month before tax. The company had originally offered a raise of 155 lei per month per employee. Dacia's sales increased 17 percent last year to 230,000 vehicles as it boosted exports to France and Germany and Romanian wages and lending soared, giving citizens more purchasing power. Average net wages increased an annual 20.5 percent in February.

Dacia, which has more than a 30 percent share of Romania's car market and exports Logan sedans worldwide, produces more than 1,300 vehicles per working day at its Pitesti factory. Dacia is also a main Romanian exporter, with exports rising 44 percent last year from 2006 to more than 128,000 cars, the company said.

And here's another one:

GALATI, Romania, April 16 (Reuters) - Workers at Romania's top steel mill, owned by steel giant ArcelorMittal (ISPA.AS: Quote, Profile, Research), ended a two-day strike on Wednesday after a local court ruled their protest was illegal.

Trade unionists said the strike had halved production at the eastern Romanian facility. The company declined to comment.

Around 4,000 workers or one third of the plant's workforce started the protest this week, asking for a 30 percent increase in wages, now at 950 lei ($416) after-tax.

The strike followed three weeks of protest at a plant owned by French Renault (RENA.PA: Quote, Profile, Research), which agreed to raise employees' wages by around 23 percent on average in 2008.

"Striking workers returned to work following the court decision to suspend the strike for 30 days. But if our demands are not met, we will use all legal weapons to accomplish them," trade union leader Ilinca Diaconu told Reuters.

Management had offered a 9.5 percent pay increase.

Wage pressures are on the rise IN Romania, which joined the European Union last year, as the economy grows robustly.

Economists warn that double-digit percentage salary increases in the private sector and insufficiently restrictive fiscal policy are fanning consumption and inflation, threatening long-term economic stability.

Romanian Retail Sales February 2008

2008-04-10T01:49:00.000-07:00

Romanian retail sales growth accelerated in February as rising wages and increased household borrowing gave citizens more disposable income. Sales increased an annual 23.5 percent in February, compared with 16.6 percent in January, the Bucharest-based National Statistics Institute said today. Sales increased 8.3 percent from January.

A lending boom in Romania, with household debt increasing more than an annual 66 percent in February, and a yearly net wage increase of more than 31 percent in January, have increased sales of most retailers. This retail sales data released today doesn't include car sales.

Romania Trade Defict February 2008

2008-04-09T02:19:00.000-07:00

According to the IMF Global Financial Stability report (published this week) parts of Eastern Europe now face a continuing and growing risk of having a "hard landing" as the global financial crisis continues to spread. The fund also drew attention to the possibility of serious spillover problems arising for the Scandinavian, Italian and Austria banks that have lent heavily in the region.

At the heart of the IMF's concerns are the large current account deficits being run in certain CEE countries, deficits which have now reached extreme levels in some cases, running to the tune of 22.9pc in Latvia, 21.4pc in Bulgaria, 16.5pc in Serbia, 16pc in Estonia, 14.5pc in Romania and 13.3pc in Lithuania.

"Eastern Europe has a cluster of countries with current account deficits financed by private debt or portfolio flows, where domestic credit has grown rapidly. A global slowdown, or a sharp drop in capital flows to emerging markets, could force a painful adjustment,"

"A soft landing for the Baltics and south-eastern Europe could be jeopardised if external financing conditions force parent banks to contract credit to the region. Swedish banks, the main suppliers of external funding to the Baltics, could come under pressure,"

So Why Not start With The Trade Situation

Behind the current account deficits lie - more often than not - trade deficits, and in Romania's case the trade deficit widened again in February as rapidly rising wages wages and a consumer lending boom lead citizens to buy more imports even as the currency weakened. And it is here that the heart of the problem exists, since a rapidly accelerating wage price spiral is raising producer prices in a way which will ultimately make domestic industries uncompetitve in their export markets without a strong downward adjustment in the currency, and this downward adjustment will not be possible in Romania's case without considerable pain in the household sector due to the presence of rapidly growing unhedged foreign exchange (mainly euro) loans .

This tendency towards lack of competitiveness is already attested to by Romania's February trade deficit, which totalled 1.46 billion euros ($2.3 billion), compared with 1.4 billion euros in February 2007 and 1.41 billion euros in January, according to data fromthe Bucharest-based National Statistics Institute this week, although it should be noted that Romanian industrial output has been rising, and as a result the deficit is now significantly down from the record highs touched last October and November.

Import consumption has risen in Romania on the back of rapidly rising wages and soaring household borrowing, although again we can note how domestic demand seems to have weakend slightly back in November and December (possibly on the back of interest rate rises at the central bank, and the initial shock of the falling leu), but that imports are now once more starting to pick up pace again, even if at a slightly slower rate than exports (see chart below). So we can say that rising disposable income has in the longer run more than offset the effects of a weaker leu, and imports in February rose at an annual rate of 14.2 percent to 4.24 billion euros.

On the other hand exports were up an even larger 20.3 percent to 2.78 billion euros. This reading confirms the strong picture we have been getting for industrial output, which was up in February by 7.7 % on February 2007 as Romania's new factories steadily ramp up production.

Romania's trade deficit is, as I have been suggesting, the main component of it's current-account deficit, which widened in January to 1.135 billion euros from 972 million euros a year earlier. Fitch Ratings and Standard & Poor's have both lowered their outlooks on Romania's credit rating, citing the continuing current account shortfall as justification.

Foreign Exchange Debt

At the same time part of the recent boom in consumer spending is a result of growing indebtedness. Romanian retail sales growth accelerated in February as rising wages and increased household borrowing gave citizens more disposable income. Sales increased by an annual 23.5 percent in February, compared with 16.6 percent in January, according to the latest data from the Bucharest-based National Statistics Institute. Sales increased 8.3 percent from January.

And a lot of this spending is being financed by borrowing, much of it in euros. According to the latest figures from the National Bank of Romania, in February 2008, non-government credit grew by 2.7 percent in money terms, or 1.9 percent in real terms, from January 2008 reaching a level of RON 158,345.4 million. RON-denominated loans went up month on month by 3.0 percent (2.3 percent in real terms) and foreign currency-denominated loans rose by 2.4 percent when expressed in RON and by 1.6 percent when expressed in EUR. At end-February 2008, non-government credit climbed year-on-year by 65.8 percent, or 53.6 percent in real terms, on the back of a 44.4 percent increase in RON-denominated loans (33.7 percent in real terms) and a 88.9 percent advance in foreign currency-denominated loans expressed in RON (when expressed in EUR, forex loans expanded by 72.1 percent). Forex credit in the household sector was up a whopping 142.3% year on year in money terms.

The possible inflationary consequences of all this borrowing are not far from anyone's mind and especially not from those who are responsible for making policy over at the central bank. Rising wages and economic growth in Romania may spur a "second round" of price increases in coming months, central bank Governor Mugur Isarescu warned only this week.

Romania's economic expansion remains strong, and in fact accelerated in the last quarter of 2007, adding to expectations that the central bank would continue to raise interest rates in an attempt to contain the strong upward movement in inflation which was further fuelled by a strong increase in end of year spending from the Romanian government and the steady household consumption boom. Gross domestic product rose at an annual rate 6.6 percent in the fourth quarter, the fastest pace since the last quarter of 2006, and up from 5.7 percent in the third quarter.

Against this background Romania's inflation has continued to rise and accelerated again in February, reaching the fastest pace in two years and increasing the chances of another interest rate increase, as the government raised natural gas prices and a weaker leu boosted the cost of services. The inflation rate rose to 8 percent, the highest since March of 2006, and up from 7.3 percent in January. Consumer prices rose 0.7 percent in the month, from 0.9 percent in January.

Inflation may continue to suffer further pressure from wage growth, central bank governor Isarescu said at a conference in Bucharest earlier this week , and if we look at what is happening to producer prices - which were up by 13.6% in February - we can see why he is concerned.

``The danger is that a second round of price increases, a so- called inflation spiral, will appear because of higher wages,'' Isarescu said. ``Economic growth is OK, but you have to not push it. I have to accept that politicians address
economic growth because this seems like a simple success.''

Romanian net wage growth, which the central bank says is one of the main drivers of inflation at the present time, slowed somewhat in February when compared with January, but was still very very strong. Net wages rose at an annual 20.5 percent rate, as compared with a 30.7 percent in January, bringing the average net monthly wage to 1,134 lei ($493), according to data from the Bucharest-based National Statistics Institute this week.

Romania's central bank has highlighted wage growth is a main driver of inflation and the main threat to this year's inflation forecast. The central bank increased its main interest rate last month by a half point to 9.5 percent, its fourth consecutive increase. The difficulty is that further increasing the policy rate may simply drive more people to take out euro denominated loans at the cheaper interest rates which are associated with them.

One of the problems monetary policy faces in Romania is the ability of consumers to resort to foreign exchange loans to circumvent it, another is the fact that Romania's labour force is not expanding rapidly enough to feed the economic growth. If we look at the chart below for both economically active and employed population we will see that both of these have been almost stationary since 2002, so what we are seeing here is almost "jobless" growth.

On the other hand Romania's official unemployed population has been trending down, from nearly one million at the start of 2002 to just over 600,000 at the present time.

Only last November Romanian Labor Minister Paul Pacuraru was arguing that Romania needs at least another 300,000 workers to meet current needs and will need more than 1 million within a decade. The labor shortage, Pacuraru said, is caused partly by a migrating workforce and partly by a declining population, and is most acute in construction, and the textile, automobile and food processing industries.

And finance minister, Varujan Vosganian, aims even higher, saying Romania lacks half a million workers."We need more engineers, mechanics and bricklayers," he is quoted by the UK Daily Telegraph as saying "We have a labour deficit of 500,000 employees."

And Vosganian wasn't simply talking about the elites - doctors and IT programmers gone to make their fortune elsewhere, though that would be damaging enough. Romania needs its skilled labourers to return - the people who are going to build up the infrastructure that the country so severely lacks. But when we look at the wage differentials, this idea of a mass return - rather than a steady trickle - would seem to be a forelorn hope to me, whether we are talking about Latvia, Poland, Ukraine or Romania.

So the simple issue is, what is now the normal capacity neutral growth rate for Romania at this point (remember this rate will tend to get gradually less as the population continues to decline)? That is, what is the annual growth rate which Romania is capable of without seeing the sort of inflation we are seeing at the moment? Noone really knows, but it is obviously well below the rate Romania is currently growing at.

This tendency towards "labour market pinch" is in part produced by Romania's long term low fertility - which makes sustained growth in the 6% range over any lengthy period of time look frankly virtually impossible - and by strong out-migration in recent years - in particular to Italy and Spain where there are a combined total of over 1 million Romanians (out of a population of around 20 million) now living and working.

Romania needs to cut its inflation rate, and rapidly. In particular it needs to be down to 3 percent by the end of 2010 or -among other issues - it will risk missing its target of adopting the euro in 2014, according to the latest statements by central bank governor Isarescu. Isarescu also suggested that he found the leu's current exchange rate "more sustainable'" than the level the leu was tradinga t in early 2007. The leu has dropped 9 percent against the euro in the past year and was trading at 3.6566 to the euro as of 9:30 a.m. in Bucharest.

As the IMF note in their report, awareness of higher risks in the CEE countries has been rising in recent months, and this rising awareness has been been reflected in the performance of bank stocks exposed to the region, in Credit Default Swap spreads, and in the performance of the Romanian leu (see chart below) given that the leu is the only floating currency with a liquid forward market among the group of eastern European countries with large external imbalances. As we have seen it has depreciated substantially since July 2007, as investors have been expressing their negative views on the region as whole The stocks of Swedish banks exposed to the Baltics have underperformed other Nordic bank shares (and here) partly owing to significant short-selling and CDS spreads on sovereign debt have surged since August 2007, as investor demand for credit protection has pushed up prices. The interesting point to observe is how this is now all moving in tandem.

In fact the IMF specifically notes how in Bulgaria and Romania, tighter credit risk controls by parent banks have not been effective in slowing aggregate credit growth, as new entrants, notably Greek and Portuguese banks, have sought to expand market share. Since Bulgaria and Romania only recently joined the European Union, they are still seen by many banks as offering attractive growth opportunities. However, there is a danger that local banks may underestimate the deterioration in the quality of loan portfolios that often accompanies rapid credit growth.

Banks active in Eastern Europe also face risks on the asset side of their balance sheets. House prices have soared in tandem with domestic credit growth, and the credit portfolios of banks in emerging Europe have increasingly become exposed to the real estate sector. In Estonia and Latvia, house prices have now started to fall, which has led banks to curtail lending to many construction projects, while more developers have resorted to preselling apartments - thus sending the credit risk back on round to the banks via the circuitous route of household default risk - in order to receive financing up front for them. Banks have not experienced a significant increase in loan losses so far, and they have centralized and strengthened risk management in a manner similar to mature market banks. Internal risk controls could force a sharp reduction in credit at some point simply to protect bank capital, if asset quality is thought to be about to deteriorate sharply. So a win-win dynamic could rapidly turn into a lose-lose one under the right circumstances. True the ratio of household credit to GDP is considerably higher in Estonia and Latvia (above 40 percent in 2007), than it is in Romania (18 percent in 2007), but credit dependence is growing rapidly, and as we have been seeing there are special difficulties in Romania which make sustainable and inflation free 3 per cent plus growth structurally difficult over any lengthy period of time, and this reality should, at the very least, be making people rather nervous at this point.

By Way of Conclusion

So what gets to happen next in Romania? At this point this is very hard to say. Emerging markets have - as the IMF argues - so far proved broadly pretty resilient to the global financial turmoil. Improved fundamentals, abundant reserves, and strong growth have all helped to sustain flows into emerging market assets. However, important macroeconomic vulnerabilities do exist - especially in the context of quality labour supply and inflation free growth potential, coupled with the dangers of a current-account-deficit/capital-flows unwaind - in a number of the CEE countries which make them rather susceptible to any significant deterioration in the external environment (see chart below).

(Please Click On Imgage For Better Viewing)

Eastern Europe contains a hard core of countries with current account deficits financed by private debt or portfolio flows, and where domestic credit has grown rapidly. A global slowdown, or a sharp drop in capital flows to emerging markets, could lead to a very painful adjustment process in those countries. The IMF identify - as follows - a number of distinct risks to CEE economies arising from the current turmoil.

First, mature market banks may pare back funding to their local subsidiaries, particularly in circumstances where external imbalances are large.

Second, balance sheet contraction by global financial institutions may reduce funding for investments by hedge funds and other institutions, raising their dollar funding costs, and inducing fi nancial stress within some emerging markets.

Third, emerging market corporate credit risks may continue to increase. Emerging market corporate debt spreads have already moved ou about as much as those of similarly rated credits in mature markets.

Fourth, emerging market financial institutions may yet prove vulnerable to financial contagion through exposure to subprime or other structured credit products.

Fifth, a spike in exchange rate volatility could slow or reverse fl ows into emerging market fixed-income assets, leading to higher funding costs. Negative terms-of-trade shocks could raise diffi culties for emerging markets in Latin America and elsewhere that have benefi ted from the commodity price boom. More broadly, a global slowdown could affect fl ows into emerging market assets.

If we add to this list the fact that a number of Eastern European economies are now visibly overheating while others seem getting near to the point of doing so, then the risk and the dangers of the potential outcome seem plain enough to see.

Romania Industrial Output February 2008

2008-04-01T04:23:00.001-07:00

Romanian industrial output was up in February by 7.7% on February 2007 and by a seasonally adjusted 1.3% on January according to data released today by the Romanian Statistics Office (INSSE).

Romanian Building Permits February 2008

2008-03-27T01:50:00.000-07:00

The Romanian government issued 4,096 homebuilding permits last month, compared with 3,169 in February 2007, which was a year on year increase of 29.3 percent, according to data released this morning by the National Statistics Institute (INSSE).

Rising wages, which increased an annual 31 percent in January, and consumer lending, which saw private debt grow more than 60 percent over the same period, have been significant factors in fuelling construction in Romania, as have remittances sent back from the large number of Romanian migrants working in Spain and Italy.

In January, the value of construction works rose by an annual 30 percent, spurred by an increase in government-sponsored engineering works and more commercial real estate development as foreign companies entered the country according to INSSE:

Romanian Central Bank Raises Interest Rates Again

2008-03-26T07:17:00.000-07:00

Romania's central bank raised its main interest rate, the highest in the European Union, by half a percentage point as inflation threatens to accelerate and the local currency weakens. The Banca Nationala a Romaniei increased its Monetary Policy Rate to 9.5 percent today. Policy makers also made clear that they are ready to raise rates further if they feel that this is necessary. The leu rose 0.1 percent to 3.7157 against the euro after the decision today, from 3.7179 late yesterday. In fact the leu had previously weakened 2.3 percent since February 4, when the central bank last raised its interest rate. The leu's drop makes items prices in euros more expensive. In Romania, rent, gasoline, phone bills and other goods and services are quoted in euros and paid in lei. The question we all need to ask ourselves here is whether the Romanian authorities are about to discover - in the context of interest rates and the need to defend the leu - that "what goes up, doesn't necessarily come down again".

The central bank will ``closely monitor developments in macroeconomic indicators and assess their outlook, standing ready to adjust instrument settings to counteract inflationary pressures,''

The bank has raised rates at every meeting since October to counter rising prices. Inflation in February was the fastest in two years as a drought boosted food prices and a weaker leu raised the cost of imports and services.The inflation rate rose to 8 percent in February, the highest since March of 2006, from 7.3 percent in January and 6.6 percent in December, the National Statistics Institute said on March 11.

The central bank also said inflation will likely remain above its targets ``in the following months'' because of higher food and fuel prices. It set its next rate decision for May 6.

One of the issues that all of this raises is the extent to which any local tightening policy can work at all whil private indebtedness - which grew an annual rate of 66.8% percent in January - continues to be fuelled by foreign exchange denominated (largely euro) cheaper interest loans, which grew at an astonishing and alarming 143.4% annual rate year on year in January. If you look at the chart below you will see that the level of leu denominated loans is virtually stationary, while the forex ones go through the roof. This situation reduces the central bank to the a role of a virtually impotent bystander.

Romania Consumer Inflation February 2008

2008-03-11T14:17:00.001-07:00

Romania's inflation accelerated in February to the fastest pace in two years, increasing the chances of another interest rate increase, as the government raised natural gas prices and a weaker leu boosted the cost of services. The inflation rate rose to 8 percent, the highest since March of 2006, and up from 7.3 percent in January, according to the Bucharest-based National Statistics Institute earlier today. Consumer prices rose 0.7 percent in the month, from 0.9 percent in January.

The government gave the go ahead for an 8.5 percent increase in the price of natural gas starting Feb. 1. Food costs have risen particularly rapidly in Romania partly as a result of a drought that destroyed a third of Romania's crops before last autumn's harvest. The inflation problem is partly aggravated by fluctuations in the value of the leu, which has fallen by 16 percent against the euro since August, making goods and services gauged in foreign currencies more expensive. In Romania, telephone bills, gas rent and other items are quoted in euros and paid in lei. The price of services, which is the area that is most susceptible to changes in the value of the leu, increased by an annual 9.9 percent in February as food costs rose 10.2 percent and the prices for non- food goods rose 5.3 percent.

The National Bank of Romania, which raised its main interest rate 1 percentage point to 9 percent last month, is rightly concerned the inflation rate may remain high in the first half because of the weaker leu, wage increases that exceeded an annual 30 percent in January, a consumer lending boom and sizeable government spending. The central bank is scheduled to make its next interest-rate decision on March 26.

The central bank on Feb. 7 raised its end-year inflation forecast to an annual 5.9 percent, from a previous forecast of 4.3 percent, meaning it expects to miss its end-year inflation target of 3 percent, plus or minus a percentage point.

Romanian Wage Growth January 2008

2008-03-07T04:47:00.000-08:00

Romania's leu continued its rise against the euro for the fourth consecutive day yesterday after a report from the statistics depaterment showed wages growth accelerated again in January, increasing speculation that the central bank will raise what is already the European Union's highest interest rate.

Net wage growth accelerated to an annual 30.7 percent in January, from 15.2 percent in December, bringing the average monthly wage to 1,200 lei ($496).

Romania's central bank has highlighted wage growth is a main driver of inflation and the main threat to this year's inflation forecast. Romania's key lending rate is currently 9 percent.

As I said above,the leu advance continued yesterday, and it rose by as much as 1 percent to 3.6745 per euro, its highest level in a week, although it had fallen back to 3.6982 by 12:16 p.m. in Bucharest, still up from 3.7123 late Wednesday.

Obviously this whole situation is very "perverse" since the leu is being driven up by expectations of extra yield given that the bank may well have to raise rates. The problem is that the excess inflation means that in the longer term the leu is likely to depreciate rather than appreciate - perhpas towards the 3.80-3.90 range - and that under these circumstances, and when the domestic demand driven overheating has died down the bank may well (like its Hungarian equivalent) be forced to maintain higher than desireable interst rates simply to protect the currency and attract the funds needed to cover the current account deficit, which, given its magnitude, one would surely not wish to see unwind overnight.

In another sign of the continuing overheating, INSSE also reported yesterday that construction activity increased in January by 29.5% over January 2007, up from the 28.2% increase in December.

Romania GDP Q4 2007 - Evident Signs of Strong Overheating

2008-03-04T05:51:00.000-08:00

Romania's economic expansion accelerated in the last quarter of last year, raising expectations of further interest rate increases from the central bank in an attempt to contain a strong upward movement in inflation which has been fuelled by a Romanian government increase in end of year spending and a steady household consumption boom. Gross domestic product (according to preliminary data, fuller details on March 12th) rose at an annual rate 6.6 percent in the fourth quarter, the fastest since the last quarter of 2006, and up from 5.7 percent in the previous quarter according to data released by the National Statistics Institute (INSSE) on Tuesday.

Romania's entry to the European Union on Jan. 1 2007 has seen a sharp increase in foreign investment and inflow of bank funds (and remittances as Romania's workers have moved abroad), and all of this has served to boost wages, lending and consumption to rates which are hard for the Romanian economy to absorb and sustain. Around 10% of Romania's workforce of around 10 million are currently working outside the country (largely in Italy and Spain), and of course many of these potential workers who have been lost are skilled and in the most economically productive age groups.

Spain and Italy have in fact been the principal destinations for Romanian migrants, athough surprisingly, and as can be seen in the Spain chart below, far from attempting to actually measure the extent of the problem, the official data - which only identifies those who have formally declared themselves to be permanent migrants - bears little relation to reality. According to the Spainsh national institute of statistics, the number of Romanians in Spain has increased in the following fashion in rcent years:

More detailed explanation of this phenomenon can be found in this post). The number of Romanians in Italy has also increased dramatically as the following chart from the Italian statistics office makes clear.

The problem is that while all these Romanians may be working out of the country, they are at the same time busily sending remittances home, and these remittances in their turn only serve to fuel domestic demand even further. Basically it is hard to get an accurate picture of the actual volume of remittances which are being sent home. One estimate comes from the World Bank, who openly recognise that what they provide is absolute minimum data. Noththeless, and even if the true numbers do not accelerate quite as sharply as the IMF data seem to show (which may be rather an indication of better data in more recent years), a sharp uptick has obviously taken place.

Another way of looking at the remittances issue is to take the current transfers item in the monthly balance of payments data published by the National Bank of Romania, and since this shows a rather smoother upward curve, and one which seems to be closer to the actual pattern of migrant outflow, perhaps it gives us a better general indication.

While such data is of limited validity in absolute terms - since it includes other kinds of transfer - in relative terms it can give us a much better appreciation of how the remittances situation has evolved over the years than the World Bank data can.

Be all this as it may, the world bank estimate the 2006 volume of remittances to have amounted to some 4.1% of GDP, and that is very large, and with significant macroeconomic consequences as we are currently seeing. I think what no-one had thought about before all this started happening over Eastern Europe was the way in which these remittances could be treated as an income stream and used to finance mortgage borrowing to fuel construction, with all the distortionary consequences we are now observing. Basically, the lesson from Romania (and elsewhere in the CEE) has to be that if you have very low fertility over a long period you certainly cannot live by exporting labour in the same way that high fertility societies like Philippines, Pakisatn or Ecuador do.

Signs of Overheating Everywhere

As a result of these pressures on capacity, Romanian inflation accelerated to 7.3 percent in January (up from 6.6 percent in December). Obviously the National Bank of Romania now looks set to raise and raise its main interest rate throughout the first half of this year.

More strength to their elbow will come from this weeks PPI reading which showed that producer-price growth in January accelerated for the fifth consecutive month, reaching an annual rate of 13 percent, the fastest pace since August of 2006, according to a separate INSSE report today.

The central bank raised its main interest rate to 9 percent from 8 percent at its last meeting on Feb. 4. This was the third consecutive increase, and the bank cited "inflationary pressures that have been amplified by persistent excess demand as a consequence of strong wage increases and fast growth of credit to the private sector".

The central bank next meets on March 26 to discuss its main interest rate.

One of the problems they will need to be thinking about is private indebtedness since this grew an annual rate of 66.8% percent in January, while foreign exchange loans to households grew at an astonishing and alarming 143.4% annual rate.

At the same time net monthly wages have been rising rapidly, with the rate slowing slightly in December but still increasing at an annual rate of around 15 percent.

Further indication of the kind of overheating which is currently going on can be found in the fact that retail sales grew in December at an annual rate of 20 percent in December while the construction industry increased its activity by 28 percent on the year.

Central Bank Double Bind and Currency Risk

In the face of all of this it is evident that the Romanian central bank will continue to increase its benchmark lending rate, which is already the highest in the European Union. The question is, what will be the objective of these increases? If we look over our shoulders a little to see what has been happening in Hungary, we can begin to see that the Romanian central bank will now be increasingly faced with conflicting policy objectives. Looking just a little further ahead - oh why is it that so many people have so much difficulty seeing what must be coming only round the next corner - at some point what can't continue won't, bank lending criteria will change (indeed it may well already be doing so, since only last week Hungarian mortgage bank OTP announced it was ceasing to offer unsecured loans in the Romanian market due to the high level of loan delinquency) and overheating will transform itself into its opposite, "rapid overcooling", or engine seize-up if you prefer (as we are now seeing in the Baltics).

At this point the central bank will face a dilema: whether to lower interest rates to give support to what at that point will be crumbling internal demand, or to pump rates up to defend the currency given the level of exposure to foreign currency loans. There are already signs that just this development may now be taking place. The leu has been under almost continuous downward pressure since last August (see chart below) and JPMorgan Chase are now predicting that by the end of the second quarter the central bank will need to raise its Monetary Policy Rate by at least 1 percentage point to 10 percent simply to keep the leu from dropping to the "never mind the quality feel the pain" level of 4 per euro. This point was made by Miroslav Plojhar, an emerging-market economist with JP Morgan in London in a client note earlier this week.

"Problems in the financial markets can cause banks, mainly in Central Europe, to cut credit lines causing problems in financing the current-account deficit and sparking a sell-off in the leu....The fuse needed for it keeps getting shorter" Plojhar said.

I would add to the problems in financial markets the issue of fears about levels of exposure as tthe overheating turns into its opposite, and the currency exposure of Romanian clients starts to mount. Certainly few would want to repeat the experience the Swedish banks appear to be starting to have as a result of the lending practices of their subsidiaries in the Baltics.

Conclusion. Romania is overheating strongly, not far from a "correction", and needs watching carefully from now on.

References

More details about Romanian background demography can be found in my Romanian Demongraphy at a Glance post,

more details on the argument about catch up growth, overheating and demographics can be found in Claus Vistesen's Catch Up Growth and Demographics post,

and some more elaboration of the central argument in this post can be found in my Alarm Bells Ringing in Romania post.

Romania Inflation January 2008

2008-02-12T06:39:00.000-08:00

Romanian inflation accelerated in January to the fastest pace in 20 months as the weakening leu increased the cost of local services, including rent and phone bills, many of which are priced in euros. The annual rate rose to 7.3 percent, the highest since May 2006, from 6.6 percent in December, according to data released by the Bucharest-based National Statistics Institute earlier today. Consumer prices rose 0.9 percent month on month, compared with a gain of 0.6 percent from November to December.

The National Bank of Romania, raised its main interest rate 1 percentage point to 9 percent only last week, and is becoming increasingly concerned the inflation rate may rise to over 8 percent in the coming months because of the weakening leu, wage increases, a consumer lending boom and increased government spending.

The leu has droped almost 13 percent against the euro since last August, and this has made goods and services indexed in foreign currencies more expensive. In Romania, telephone bills, gas, rent and other items are quoted in euros and paid in lei.

The price of services, the area most sensitive to leu fluctuations, increased an annual 9.7 percent in January, the institute said. Food prices also rose an annual 9.7 percent because of a drought that destroyed a third of Romania's harvest last year. The cost of non-food goods increased 4.2 percent.

In January, rents rose an average of 1 percent from December and phone bills increased 4.4 percent, the INSSE said.

The central bank, which has now raised its main interest rate at three consecutive meetings, is likely to continue raising the rate in the future, and some economists are even forecasting that they may continue until it reaches 10 percent. The central bank's next interest rate meeting is on March 26.

Central bank Governor Mugur Isarescu raised his end-year inflation prediction on Feb. 7 to 5.9 percent from an earlier estimate of 4.3 percent. This forecast is above the 2008 end-year inflation target of 3.8 percent, plus or minus a percentage point. The central bank also missed the end-year 2007 target of 4 percent, plus or minus one point, as inflation rose an annual 6.6 percent in December.

One of the difficulties is that policymakers are treating this problem as if it is merely cyclical, whereas I fear it is structural, and that getting 6 percent inflation-free annual growth rates may be near impossible now in Romania due to the severe problems of lack of labour.

Of course, predictably the leu rose on the news, climbing to 3.6232 against the euro by 3:54 p.m. in Bucharest, from 3.6513 yesterday. If the currency movement was the main inflation issue, then this would provide a kind of automatic stabiliser mechanism raising the leu and damping inflation. Unfortunately, as I keep saying, my own view is that the problem is much deeper, and the real difficulty is that what is happening now is a kind of lock-in risk premium, whereby it may well prove very much more difficult for the central bank to subsequently lower rates than it is now proving to raise them, in which case the Romanian economy could soon find itself set on the course on whicb the Hungarian one has already embarked.

Romania Trade Deficit December 2007

2008-02-11T04:25:00.000-08:00

At last some (slightly) good news. Romania's trade deficit was smaller in December 2007 than in December 2006, recording the first such drop since October 2004 as the weaker currency and rising industrial capacity boosted exports and discouraged imports to some extent.

The deficit in December was 2.07 billion euros ($3.2 billion), compared with 2.1 billion euros in December last year, the National Statistics Institute said in preliminary data released today. This compares with a revised 2.2 billion euro deficit recorded in November.

Romania's leu has depreciated almost 14 percent against the euro since August as international investors have grown increasingly wary of areas seen as high risk amid mounting concern over the U.S. and global economy. The leu had been among the world's top- performing currencies in the previous two years, making imports cheaper for Romanians.

Imports in December rose an annual 6.5 percent to 4.3 billion euros, while exports increased 15 percent to 2.3 billion euros. Imports from other EU countries rose 7.63 percent as exports to the region increased 17.6 percent. So what is most pronounced about the reduction in the December deficit is not so much the continuing rise in exports, but the sudden drop in imports. It is too soon to say what lies behind this - is, for example domestic demand faltering for some reason - as it seems to be to sudden to be a simple question of the currency movement alone. However we will have to wait for more data before we can really see anything clearly here.

In the full year, the deficit widened to 21.5 billion euros from 14.9 billion euros in 2006 as imports rose 24.9 percent and exports increased 13.7 percent

The trade deficit is the main component of Romania's current- account gap, which widened in the first 11 months of last year to a record 15.29 billion euros. Fitch Ratings and Standard & Poor's have lowered their outlooks on Romania's credit rating in recent months, citing the growing current-account gap.

Romania Central Bank Raises Policy Rate To 9%

2008-02-04T03:59:00.000-08:00

Romania's central bank unexpectedly raised its benchmark interest rate a full point, the third consecutive increase, as inflation threatens to accelerate and the local currency weakens. The central bank increased its Monetary Policy Rate to 9 percent, the highest since 2005, from the 8 percent level set on 7 January 2008. This is now a very strong monetary tightening process.

The bank will ``continue to pursue a form of management of money-market liquidity'' and adopt ``higher provisioning for foreign exchange-denominated credits extended to unhedged borrowers,'' it said in a note about the decision.

Net monthly wages rose an annual 23.5 percent in November and private debt increased an annual 60 percent in December, most of it in euros.

More to the point on the debt front, household borrowing in foreign exchange denominated debt (largely euros) rose at an annual rate of 134.4% in December.

Central Bank governor Mugur Isarescu has repeatedly warned that rapid increases in euro-denominated loans pose risks to borrowers as a weaker local currency could increase their borrowing costs. Basically this situation places a limit on the central banks own monetary policy to put a break on credit expansion, especially if at some point the ECB starts to reduce rates.

Surprisingly this news of central bank rate increases due to strong inflation is pushing the leu upwards, and the currency advanced to a more than three-week high against the euro this morning on speculation the central bank will increase interest rates by half a percentage point to 8.5 percent later today.

The leu rose to 3.6429, the strongest level since Jan. 10, and traded at 3.6449 at 9:02 a.m. in Bucharest, from 3.6703 on Feb. 1.

This effect is very counter productive, since it raises a real excahnge rate which is already being pushed up by the inflation itself, only serving to deteriorate further and already battered trade deficit as exports become more expensive and imports cheaper. We could call all of this the perverse consequence of traditional monetary policy in the current environment.

Inflation and the Leu

2008-02-04T02:16:00.000-08:00

The Romanian government authorised an increase in the price of natural gas by 8.5 percent as of 1 February 2008. According to an article today in the Romanian newspaper Ziarul Financiar this could push up food prices significantly, starting from as early as this month. Food prices, which have been one of the drivers of Romanian inflation since a drought destroyed crops last year, may rise by as much as 0.7 percent simply as a result of the gas price rise the newspaper said, citing unidentified Finance Ministry officials.

Surprisingly this news of possible increases in inflation is pushing the leu upwards and the currency advanced to a more than three-week high against the euro this morning on speculation the central bank will increase interest rates by half a percentage point to 8.5 percent later today.

The leu rose to 3.6429, the strongest level since Jan. 10, and traded at 3.6449 at 9:02 a.m. in Bucharest, from 3.6703 on Feb. 1.

This effect is very counter productive, since it raises a real excahnge rate which is already being pushed up by the inflation itself, only serving to deteriorate further and already battered trade deficit as exports become more expensive and imports cheaper. We could call all of this the perverse consequence of traditional monetary policy in the current environment.

The Ups and Downs of the Romanian Leu

2008-01-17T06:22:00.000-08:00

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

2008-01-14T06:22:00.000-08:00

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

2008-01-14T00:29:00.000-08:00

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

2008-01-11T06:12:00.000-08:00

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

2008-01-07T04:43:00.000-08:00

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.

Merry Xmas and A Happy New Year

2007-12-24T15:05:00.001-08:00

Well, a Merry Xmas and a Happy New Year to all my readers. Thank you for taking the time and trouble to pass-by. This blog will now - failing major and surprising new developments in the global economy - be offline till the end of the first week in January, or till after the festival of Los Reyes Magos in Spain (for those of you who know what this is all about). Come to think of it, maybe this is just what our ever hopeful central bankers are in need of even as I write - some surprise presents from the three wise men - but I fear that this year if these worthy gentlemen do somehow show at the next G7 meet, the star in the east which draws them will not be the one described in the traditional texts, but in all likelihood the rising star of India.

Credit crunch, did someone use the expression credit crunch?

Romania Trade Deficit October 2007

2007-12-11T13:05:00.000-08:00

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.

Labour Shortage in Romania?

2007-12-11T12:48:00.000-08:00

Well according to Labor Minister Paul Pacuraru, quoted in the newspaper Ziarul Financiar, Romania needs at least another 300,000 workers to meet current needs and will need more than 1 million within a decade.

The labor shortage, Pacuraru said, is caused partly by a migrating workforce and partly by a declining population, and is most acute in construction, and the textile, automobile and food processing industries.

Maybe he has been reading this blog (and here, and here).

Actually, according to the UK Daily Telegraph finance minister, Varujan Vosganian, aims even higher, saying Romania lacks half a million workers."We need more engineers, mechanics and bricklayers," he is quoted as saying "We have a labour deficit of 500,000 employees."

And he wasn't talking about the elites - doctors and IT programmers gone to make their fortune elsewhere, though that would be damaging enough. Romania needs its skilled labourers to return - the people who are going to build up the infrastructure that the country so severely lacks. But when we look at the wage differentials, this idea of a mass return would seem to be a forelorn hope to me, in Latvia, in Poland, in Ukraine or in Romania.

So the simple issue is, what is now the normal capacity neutral growth rate for Romania at this point (remember this will get less as the population continues to decline)? That is, what is the annual growth rate which Romania is capable of without seeting off the sort of inflation we are seeing at the moment? Noone really knows, but it is obviously well below the rate Romania is currently growing at.

Second question: when and how will the adjustment come?

Romania Inflation November 2007

2007-12-11T06:42:00.000-08:00

Well here it is, I wouldn't say it was exactly good news, but a drop in inflation to an annual 6.67% from an annual 6.84% isn't bad news at any rate, unless you thought inflation was going to suddenly go away it isn't.

On one level you might have thought that the rot had been stopped, but it's not that simple. The month on month rate is 0,93, which is down from last months 0,97. But if we look at the components, then food rose 1,17% month on month, while services rose 1,21 month on month. In October food was up 1.3% over September, while services where only up 0,98. So food seems to be slowing, but price increases in services are accelerating (pass through) and this is not good news.

The Leu Turns Down Again

2007-12-04T06:59:00.000-08:00

Romania's leu fell the most in almost two weeks against the euro today, apparently on investor concern inflation is making exports uncompetitive and the current account deficit unsustainable growth. The leu dropped today for a second day after INSEE (the Bucharest-based statistics office) said producer-price inflation accelerated in October by the most in six months. The cost of goods produced in Romanian factories and mines rose at an annual 8.2 percent rate in October, compared with 7 percent in September, according to the INSSE data. Month on month producer prices rose by 1.6 percent, up from 1.2 percent in September.

The rate of Romania's economy expansion slowed 5.7 percent in the third quarter, the second slowest pace since the end of 2005, while inflation picked up to 6.8 percent in October, the strongest rate since April 2006. The leu fell by as much as 0.9 percent today, which was the most since Nov. 22, to 3.5353 per euro at 2:30 p.m. in Bucharest, down from 3.5026 late yesterday.

Romania Q3 2007 GDP Growth

2007-11-30T05:23:00.000-08:00

Romania's economic expansion accelerated slightly again in the third quarter as a lending boom and rising wages spurred consumption, offsetting damage to agriculture from a drought. Gross domestic product grew an annual 5.7 percent, up from 5.6 percent in the first quarter, according to data released today by INSSE (the National Statistics Institute).

For a detailed examination and explanation of why such continuing rapid growth may be problematic see this post earlier in the week.

Romanian Demography At A Glance

2007-11-28T06:41:00.000-08:00

"...the fetus is the socialist property of the whole society. Giving birth is a patriotic duty, determining the fate of our whole country. Those who refuse to give birth are deserters."

Nicolae Ceausescu addressing a Communist Party congress in 1986

Well for those of our readers who thought I had said all that could be said about Romanian demography in this monster post here, I have a rather nasty surprise: there is more. Scratching my head about the spike I found in the Romanian natality and mortality data I started scratching around a little more, and what follows is what I came up with.

And before I go any further, here's one for your bookmarks, since browsing around for information on Romananian remittances I came across the very intersting "Romanian Migration to Spain - Motivation, Networks and Strategies" by Ana Bleahu, from which I have drawn the above reasonably graphic chart. Bleahu's article is a working paper (careful PDF) from the Institute for Quality of Life at the Romanian Academy, Bucharest. Despite some evident shortcomings, the document is a mine of information, and very readable for the insight the interviews it is based on offer as to the actual motivations of the out-migrants.

As the above diagram makes clear, Romanians are leaving, and in large numbers. The charts I present in this post here - based on data from Italy's ISTAT and Spain's INE - indicated that at this point there are at least a million Romanians (out of a total population of around 20 million) living and working in Spain and Italy alone. Whether this migration is temporary or permanent remains to be seen, and the answer depends in large part, I would suggest, on what happens next in Romania.

Too Much Money Chasing Too Few People?

Now one of the big arguments Claus and I are pushing at the moment - on this blog and elsewhere - is that the sudden acceleration in inflation which we are now witnessing across a whole swathe of emerging economies in Eastern and Central Europe is not simply accidental, or coincidental. Nor is it a simple by-product of collective poor institutional quality, bad government and/or endemic corruption. There are larger, and in historical terms grander, "big picture" processes at work here.

One of these processes is intimately related to the very specific and unusual demographic profile which most of Eastern Europe has inherited from its recent past. So one of my central arguments is that what we have here is a kind of mis-match. A mis-match between a basically third world. "developing-country" type, income level (for this reason they tend to be called "emerging economies") and a very-first-world-type age structure - in the sense that many of these societies have had below replacement fertility for several decades now, and that the key 25 to 49 age group is now peaking nearly everywhere as a proportion of the total population.

But even their demography is pretty unique, since you could say that many Eastern European societies have a mature society population age structure, but with the top of the pyramid effectively lopped off. Lopped-off in the sense that life expectancy - and especially male life expectancy - is normally considerably lower than it is in Western Europe, or other developed economies like Japan. The implications of this are - at this point in time - far from clear, what we have effectively is a research "work in process" in hand here, since we will only know what the implications are as and when we get to see them. In this sense Eastern Europe has become a living laboratory.

But one thing is becoming increasingly clear, and that is that this underlying life expectancy reality is making the raising of participation rates among the over 60 population - which is basically the Lisbon Process "remedy" for addressing the problem of declining working age populations and rising elderly dependency ratios - a far more difficult result to envisage. Rather than increased participation rates, what we are getting as the labour market tightens is accelerating inflation, and this would now seem to constitute some sort of empirical fact.

My argument then (roughly summarised) is that the current epidemic of dramatic "overheating" which is extending itself across the map (and to non-EU destinations like Russia or Ukraine as well) is a by-product of this very special and almost unique combination of demography and poverty (I say almost since you can find this sort of mix elsewhere, for example in the Southern Indian state of Kerala).

Combined and carefully shaken these two ingredients have produced the rather unstable cocktail mixture of a substantial out migration of workers in search of a better standard of life (the poverty effect) together with a shortage of young new labour market entrants (the demographic/low fertility) effect. The twin pincer consequence we have here seems to be a very combustible mixture as we are seeing.

As I say, part of all this is driven by a very structurally distorted underlying demography. As they say demography casts a long shadow, and just how long is very well illustrated by the long run impact of Ceausescu's crazed version of pro-natalism introduced in the late 1960s. The consequences of this policy are very much with us today in the form of Romania's very unusual age structure pyramid (see below). In the pretty unique world of Eastern European demography, Romania stands out as being even more unique.

Demography at a Glance

So, and without more ado, let's now take a rather closer look at this Romanian demography, and to get the ball nicely rolling why don't we start by taking a quick glance at Romanian fertility.

Despite the fact that we have a gap in the data during the late 1980s a number of things stand out clearly enough in the above chart. The first of these is that fertility in Romania was already making the transition to below replacement level by the early 1960s, and in fact dropped below replacement level in 1962. The second is that fertility suddenly shot up in 1967. This was the year the infamous Ceausescu pro-natality campaign was introduced (and you can read more about all this in this post here, but since all of this is such an important aspect of Romanian history, and since the historical memory of Romanian society seems to have a major lacuna here, I am taking the liberty of reproducing a short extract from this book (Ronald D. Bachman, ed. Romania: A Country Study. Washington: GPO for the Library of Congress, 1989. More References at the foot of the article) which gives some essential background.

With a political system in place that made long-range planning the cornerstone of economic growth, demographic trends took on particular significance. As development proceeded, so did disturbing demographic consequences. It soon became apparent that the country was approaching zero population growth, which carried alarming implications for future labor supplies for further industrialization. The government responded in 1966 with a decree that prohibited abortion on demand and introduced other pronatalist policies to increase birthrates. The decree stipulated that abortion would be allowed only when pregnancy endangered the life of a woman or was the result of rape or incest, or if the child was likely to have a congenital disease or deformity. Also an abortion could be performed if the woman was over forty-five years of age or had given birth to at least four children who remained under her care. Any abortion performed for any other reason became a criminal offense, and the penal code was revised to provide penalties for those who sought or performed illegal abortions.

Because contraceptives were not manufactured in Romania, and all legal importation of them had stopped, the sudden unavailability of abortion made birth control extremely difficult. Sex had traditionally been a taboo subject, and sex education, even in the 1980s, was practically nonexistent. Consequently the pronatalist policies had an immediate impact, with the number of live births rising from 273,687 in 1966 to 527,764 in 1967--an increase of 92.8 percent. Legal abortions fell just as dramatically with only 52,000 performed in 1967 as compared to more than 1 million in 1965. This success was due in part to the presence of police in hospitals to ensure that no illegal abortions would be performed. But the policy's initial success was marred by rising maternal and infant mortality rates closely associated with the restrictions on abortion.

The above described episode has had a clear, evident and lasting impact on the age structure of the Romanian population, and we can readily see this if we take a look at a breakdown of the 2006 population by age, since we can see an evident spike in the 37-39 age range.

Now if we come to think about the actual drivers of fertility, it would be really interesting to know why Romanian fertility was hitting such low levels during the early 1960s. As far as the drivers of low fertility go in the short term, the key indicator is normally the rate of birth postponement. Birth postponement is a process which normally revolves around the rising age at giving first birth of those women who decide to have children. It is thus a timing decision, and normally reflects growing investment of young women in their own education or career oportunities. In the Romanian case we do not have specific data for this age, but (again thanks to Eurostat) we do have data for mean age on childbirth, and since most Romanian mothers now have only one child this is not a bad indicator, since the number will be lower, but not that much lower (possibly between 1 and 2 years).

As we can see, the median age at childbirth has been rising slowly but steadily from the mid 1990s, and this process is, in part, behind the very low fertility readings which have been registered in Romania in recent years. But if we think about the current level which is still under 27 (and this is an average for ALL births and not just first births, so the first birth median age might be what, 25.5?) then this still significantly below the Western European norm, which is around the 30 mark. So more years of very low fertility are to be anticipated as postponement continues, and if Romania hits a major economic crisis in the meantime (which is, I am afraid, a very distinct possibility) then we may get stuck in exactly the kind of low fertility trap which the Austrian demographer Wolfgang Lutz has so ably identified.

What we don't know at this point though (since I have been unable to find any data on this interesting topic) is what the first birth age of women was in Romania in the late 1950s/early 1960s. Given the relative poverty and economic backwardness of the country at the time a modern postponement process would seem to be an unlikely candidate for the very low fertility which was being registered, and pressure to work combined with a very "free and easy" abortion system would seem to be a more promising candidate explanation.

However moving on now to the natural evolution of the Romanian population, I think it is worth taking a look at the live births' chart:

Apart from the obvious spike in births in the late 60s which we have already spoken about, it is also worth thinking about the sharp drop in the number of births which took place around the end of the 1980s. To put this in some perspective we might point out that in 1988 some 380,000 children were born, while in 1991 this number was down to 275,000. This is a drop of over 100,000 children a year in just 3 years (and of course the annual rate has subsequently only dropped further). So in 2009 there will be 100,000 young people of 18 years of age LESS than might otherwise have been the case, and the Romanian labour market is BOUND to notice this sharp adjustment, out-migration or no out-migration.

Also, if we come to look at the balance of births and deaths, we will again observe some strange details in the data, including the abrupt rise in the number of registered deaths after 1967, but also the fact that the natural rate of population increase, that is births minus deaths (ignoring migration effects) turned negative in 1991.

So if we look at the theoretical population position we will see this negative growth confirmed:

Turning to life expectancy at birth, we will see, despite a decline in the early 1990s (which may have been associated with high infant mortality) the headline number is now rising, but it is still low in comparison with Western Europe, and this is going to have important economic implications, not least because it places severe limitations on one of the favourite economic recipes for getting out of the kind of problems Romania is getting into, namely raising participation rates in the over 55 age group. Looking at all this data it may well be that the health of the older Romanian population is just not up to taking this kind of strain. I suspect we are going to hear a lot more of this kind of issue in the East European context in the months and years to come.

Finally, to complete our demographic round up, we could look at the median age of the Romanian population. This age is - at a current level of 36.9 - very young by modern standards, but it is hard to know what interpretation to put on this, since Romania is hardly a "young" population in the sense that Iceland or Ireland are, since the whole structural configuration of the demographic panorama is so uniquely skewed and distorted, and in part the comparatively young median age is a reflection of the comparatively low level of life expectancy.

Now what stands out here is just how comparatively young Romanian society is at this point. This could become clearer if we put Romanian median age up against Slovenian median age, since Slovenia is effectively the youngest member of the EU10 (although still significantly younger than the older West European societies like Germany or Italy).

Really at this point I am neither sure how to interpret this, nor of the significance of this difference in ages between these two societies. Normally this more youthful effect would be associated with a much later decline in fertility to below replacement (say Ireland or Iceland), but this is not the Romanian case and it undoubtedly has something to do with the specific weight of the ceaucescu cohorts within the population, but quite what this will mean I am not really sure at this point. I don't imagine anyone is, since we have never really been here before.

Again, this key age group exhibits strange behaviour in the Romanian case, since (despite the inevitable gaps in the data) we can see that this group is already dropping as a share of the population in the 1970s (which is most unusual) and then of course (after the "birth spurt") it starts to climb again, and now it seems to have peaked again. But it seems to have peaked at a very low share - 37 (while 38/39 would be more normal) and at a very low median age (36, while 40 would be much more usual, again, if only we knew how to interpret all this). And then you have the million or so people who are there (in the official numbers), but aren't (insofar as they are out of the country). How will they affect things? I wish I knew the answer to all of this, but one thing is sure, we will find out soon enough, although unfortunately by that time it may well be too late to do anything constructive.

Population Pyramids

Finally lets have a look at some population pyramids, which, in the Romanian case aren't any more re-assuring. I have chosen here to make a comparison with Ireland, since Ireland has had a more or less normal (if somewhat delayed) demographic transition, and has been fully able to leverage this to get the full blast of her "demographic dividend". If we look at the pyramids for the early 1990s we can see that this is when Romania in principle was best positioned to get the rapid catch up growth, and this is, of course, when Ireland was doing exactly that.

If we look at the transitions through the pyramids, we can see that Ireland's path is a lot more stable than Romania's, and especially when we bear in mind that Ireland has, since the end of the 1990s been a strong net receiver of inward migration, while Romania's has been exactly the opposite case.

But really the most striking contrast is in the 2020 pyramids, since we can see that while Ireland's population is ageing, and the elderly dependency rate is rising, this is happening much more slowly than it is in Romania, and the whole pyramid is a lot more stable and sustainable, the bottom section is a lot thinker if you will. As I say, I wish I new exactly how to interpret all this, but one thing is for sure, the difference between Ireland and Romania's demographic evolution is not in Romania's favour.

By Way of Conclusion

Well returning to our point of departure and the crazed policies of Nicolae Ceausescu, perhaps it isn't necessary to say this at this point (after all the posting it shouldn't be!), but those of us on this blog who are advocating pro-natalist policies to help offset the more dramatic effects of population ageing, normally think in terms of an approach which is more along the lines of the Swedish or French ones, and we would obviously wish to completely dissociate ourselves from the type of coercive pro-natalism which was advocated and implemented by the likes of Ceausescu and his ilk. What we are arguing for is a collective effort on the part of the whole of society (organized inevitably via the state) to transfer resources to those women who would like to have children (Adam Smiths "hidden hand" seems to have gone "missing" at just this point, in the sense that societies and economies do not seem able to guarantee their own reproduction, which is at the end of the day a necessary prerequisite for economic growth as we now know it, so this is precisely the kind of case the old founder of libertarian economics would have had in mind as a justification for state intervention). What is being advocated by modern pro natalists then is a policy to support choice, one based on the secure knowledge that our collective interest as societies lies in the direction of doing this, and of reproducing our populations (even if in decline) across a stable trajectory. Our future lies in this direction since otherwise.... well, unfortunately we are more than likely just about to find out what the otherwise alternative is in the present Romanian case.

Unfortunately, however, maybe at the end of the day Ceausescu was right about one thing, maybe the rate of childbirth does determine the whole future of a society, and for many decades to come. His authoritarian attempt at social engineering however has very definitely become part of the problem legacy, and not part of the solution.

Bibliography and Appendix

Extract from Estimating the Consequences of Unintended Fertility for Child Health and Education in Romania: An Analysis Using Twins Data, by Peter J Glick, Alessandra Marini and David E Sahn.

Among the hardships faced by Romania’s population under Ceausescu was an almost uniquely harsh population policy. When Ceausescu came to power in 1965, Romania’s birth rate (15.6 per 1,000 population) was 44% lower than in 1950, in large part due to an exceptionally liberal abortion policy (Baban and David, 1996). With the aim of reversing this downward trend in fertility, the government in October 1966 made family planning and abortion illegal with only rare exceptions.

As a consequence of this law as well as restrictions on access to modern contraception and a range of other pronatalist policies (including divorce restrictions as well as financial incentives to bear children), the birth rate tripled from 13 to 40 per 1,000 in less than one year (Streatfield, 2001). Additional and even harsher measures were enacted in 1985, including among other practices compulsory regular pregnancy tests of women in their twenties (David, 1990). Public health consequences of these policies were severe, including extremely high rates of maternal mortality as women resorted to unsafe illegal abortions (Baban and David, 1996) and the placement of large numbers of unwanted children in overcrowded orphanages.

With the 1989 revolution, policy reversed again: the pronatalist policies were revoked and abortion and contraception were legalized. The rate of legal abortion quickly reached the highest level in the world, with about 200 abortions per 100,000 women aged 15-44 in 1990 (Serbanescu et al, 1995). Access to modern contraceptives improved but they remained generally unavailable (RAPHHM 1999; Baban 1999) and contraceptives knowledge was poor, in large part due to misinformation spread by the Ceausescu regime. There were modest declines in infant mortality and larger reductions in maternal mortality (Serbanescu et al., 1995; Mureşan and Rotariu, 2000) but these ratios were still the highest in Europe a half decade after the revolution.

Baban, A. (1999). ‘Romania’, Chapter 10, in David, H.P. (ed), From Abortion to Contraception, Greenwood Press, Westport, Connecticut.

Baban, A. and David, H. (1996). ‘The Impact of Body Politics on Women’s Body, Women and Men in East-European Transition Project’, Lectures held at the summer University in Cluj, Romania, July, 1996.

Mureşan, C. and Rotariu, T. (2000). ‘Recent Demographic Development in Romania’, in Kucera T., Kucerová O. V., Opara, O.B. and Schaich, E. (eds), New Demographic Faces of Europe, Springer-Verlag, Heidelberg, , pp.267-285.

Serbanescu, F., Morris, L., Stupp, P., and Stanescu, A. (1995). ‘The Impact of Recent Policy Changes on Fertility, Abortion, and Contraceptive Use in Romania’, Studies in Family Planning, Vol. 26, pp.76-87

Romanian Association of Public Health and Health Management (RAPHHM) (1999). Reproductive Health Survey, Romania, 1999: Final Report, Romanian Association of Public Health and Health Management, Bucharest

Trebici Vladimir (1991) – Genocid si demografie (Genocide and Demography) – Editura Humanitas, Bucuresti

According to Manuela Lataianu in "The 1966 Law Concerning Prohibition of Abortion in Romania and its Consequences. The Fate of One Generation":

All women were forced to go for a gynaecological control every month, this monthly health control representing the requirement for receiving medical care8. The pregnancies detected were monitored until term. In this way, the possibilities to provoke an empirical abortion were almost totally annihilated. The law was extremely severe, numerous gynaecologists as well as women who resorted to this method paying with years of prison their trial to avoid it. At the same time the law punished the sale of modern contraceptive means which, as a result, disappeared from the specialised shops. All persons over 25 years old who did not have children (excepting those who had valid medical infertility problems) were punished for celibate, paying 30 per cent tax on income.

The generations 1967 and 1968 are the largest in Romanian history, the children born during this period being informally called “ceausei” (Ceausescu’s babies).

Consequences of the Decree no. 770/1966 concerning prohibition of abortion

However, on long run the consequences of applying this law were not at all favourable to Romania. Firstly, the rate of maternal mortality – and especially that of maternal mortality caused by abortion – reached in Romania the highest position in Europe. As it could be noticed into the table 2, in 1980 in Czechoslovakia this index was 9.2. This value is the lowest in comparison with Romania, were this index reached the level of 132.1. After almost 10 years, in 1989 it can be noticed that generally, the woman’s situation – at least from this point of view – knew a substantial improvement in this part of Europe, excepting Romania, which registered a substantial increasing of it (169.4), maintaining the top position.

Another consequence of this law was a high increasing of the infant mortality rate. Between 1967–1989 there were born almost 10 millions children. 340,000 of them died before reaching the age of 1 year. Demographers estimate that 20 per cent of children born in this period were under-weight or with congenital malformations, this fact affecting negatively the biological quality of population.