BLACK SEA BLOG: Romania's currency, economy won't face "crisis" until 2009 at earliest

By bne IntelliNews January 31, 2008

Bogdan Preda in Bucharest -

How bad are Romania's finances and how much worse could they get? Is the country facing a crisis? Is the global slowdown to blame for pushing down the value of the Romanian currency - until a year ago one of the best performers both against the euro and the dollar - or is it the country's own deteriorating economic situation? Is it perhaps a combination of both? And what are the chances the slide will continue?

These are the questions currently being asked in Romania these days, as the Romanian leu fell against the euro to as low as 3.77 in January, its worst level in almost three years.

Some pundits point out the leu has seen worse days; in 2003, the currency constantly traded at more than 4 lei against the euro (or at more than 40,000 old lei). However, others argue the country's inflation rate was at that time much higher and Romania wasn't a member of the EU. Besides, a weaker leu made exporters happy, because for every euro they cashed in, there was more local currency to get back.

Since then, Romania joined the EU and enjoyed an accompanying foreign investment boom, which, coupled with the central bank's push for a stronger currency amid falling inflation, made the leu stronger. Given this, one shouldn't be surprised that economists and leu fans alike are starting to worry when the country's currency loses as much as 17% in just the six months since the end of June.

The question now is whether the worsening global economic situation will cause the leu to fall further. The answer is "no," it probably won't, though there are two conditions attached to that and they are linked. First, the government has to do a much better job of preventing the country's main economic indicators from deteriorating further; second, it must allow more room for the central bank to put its monetary polices to work so that Romanians and foreigners alike don't lose their trust in the leu.

Plenty of growth to come

Romania still has a lot of room to develop and for this it needs a lot of foreign investment. A good part of that, about €30bn, should pour in over the next three years or so from the EU.

In 2007, the total net profit for the 40 banks in Romania amounted to a record high €825m, about a third more than the previous year. Banks, especially the subsidiaries of foreign lenders operating in the country, are enjoying good profits from the relatively high interest rates on loans than in neighbouring countries.

How come? Such good business occurred mainly due to a lending boom fuelled by lower taxes and lower inflation, which brought down interest rates from the very high rates seen in previous years, but remained much higher than in neighbouring countries. Boom plus comparatively high interest rates meant more loans and more money for the banks.

With the annual inflation rate accelerating to 6.6% at the end of 2007 from 4.9% in December 2006 due to a severe drought and rising oil prices, the chances are inflation will continue to rise for at least the first two quarters of this year. Such a situation, along with a drop in the value of the leu against the euro, have "justified" recent moves by banks to raise their interest rates. Those rates will stay high even if inflation falls, and that's when good profits are made.

There is also the construction boom, which isn't happening for purely speculative reasons, but is also down to a serious need for new homes. The value of Romania's real estate market is predicted to grow to €23bn this year from €18bn in 2007, based on calculations by the country's Public Notaries Union, which administers taxes on real estate transactions. Higher interest rates and a weaker leu will probably cut into the appetite of some real estate investors and home buyers, while also eventually pushing down prices for land and building in some areas. But they definitely won't cause a crisis - or at least not this year.

Real risks seen for 2009

A real crisis, however, could occur in 2009 if politicians fail to address the country's worsening economics, namely the record current account deficit, public spending and rising inflation. National Bank of Romania Governor Mugur Isarescu warned in January of an inflationary "spiral effect" if the government caves in to pressure from workers for higher wages.

The ingredients for an explosive mix in 2009 are all there, unfortunately, despite the central bank's best efforts to keep prices in check by increasing its benchmark interest 50 basis points to 8% on January 9. Romania has to go through legislative elections in the last quarter of this year, with parties, politicians and special interests divided more than ever since the country broke with communism in 1989.

If it's to avoid a serious economic crisis in 2009, the current government must abstain from taking populist measures this year, and the next government must focus solely on improving the country's economic situation in 2009, including putting in place the necessary programmes that will bring in the EU money targeted for large infrastructure projects.

Unfortunately, politicians' dismal track record means one shouldn't expect sound economic policies, a situation that will clearly make the central bank's job more and more difficult.

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BLACK SEA BLOG: Romania's currency, economy won't face

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