Romania’s national currency strengthened on April 29 to its highest nominal rate against the euro in the past 16 months, or more precisely since January 4, 2012, according to the central bank’s mid-day quotations. The strengthening is consistent with the visible increase of inflows of portfolio investments, encouraged by a series of statements from key influential entities and backed by robust public sector fundamentals.

Nonetheless, inflows of direct investments – supposedly less volatile and in principle more supportive to sustainable growth, remain weak – down 15% y/y to EUR 163mn [0.12% of GDP] in Jan-Feb.

The currency’s strengthening in the recent period is, however, debatably impressive [2.4% ytd] and unlikely to accelerate. In fact, the currency has weakened in Jan-Mar this year in real terms after it had strengthened indeed substantially in Q4 last year and in January 2013 following the political tensions accumulated during the summer of 2012.

The nominal exchange rate dynamics reflects shorter-term developments such as speculative inflows that are corrected at a later moment in line with the fundamentals. In this regard, the country’s currency is likely to strengthen in real terms on medium term – but only if the expectations for direct investments and EU funds absorption materialises.

Later in the year, foreign investors will most likely maintain their interest in government papers since the country’s macroeconomic fundamentals will predictably show further public sector consolidation. Nonetheless, the fiscal consolidation apart from strengthening the investor confidence also acts as a stabiliser for the forex inflows in the sense that less public debt will be issued as a result of smaller public deficits. The Treasury already reduced the aggregate size of the issues planned for May to under EUR 3.8bn after draining RON 5bn in April.

Jan-Feb detailed BoP data explain the nominal and real strengthening of the local currency. The net inflows of portfolio investments [the liabilities side] increased by 90% to EUR 3.43bn in the period. The official reserves of the central bank consistently increased by EUR 1.1bn, compared to a EUR 589mn rise in Jan-Feb last year.

On the downside, net inflow of FDI shrank 15% y/y to EUR 163mn. The same diverging pattern was seen in 2012 versus 2011. While the net portfolio investments surged 132% to EUR 3.98bn, the inflow of FDI dropped 4% y/y to EUR 1.75bn.