Thursday, May 31, 2007

Romania Central Bank Gov Not Comfortable With Leu Appreciation

Dow Jones Newswires

Ongoing disinflation in Romania has allowed Romania's central bank to cut its main policy interest rate sharply this year, with 150 basis points of cuts since February. That has taken the benchmark rate down to 7.25% from 8.75% at the beginning of the year.

Earlier this week, the International Monetary Fund called those rate cuts premature.

But Isarescu noted that the IMF's outlook on the prospects for inflation in Romania are more pessimistic than the central bank's own projections. At the same time, the IMF is more comfortable with the leu's appreciating trend than the central bank, he said.

"I'm not" so comfortable, Isarescu said. The strong leu poses a challenge in terms of the competitiveness of Romanian companies as well as the sustainable financing of the country's double-digit current account deficit, he noted.

But his real concern, he added, is "this appreciation is inducing huge temptation from banks and their clients to lend and borrow in forex."

Increasingly, Romanian households are taking out mortgages in euros to take advantage of lower interest rates than those available in the local currency. Companies are doing the same.

"Forex credits for unhedged borrowers in my view (are) a clear risk for financial stability," he said.

He said he expects inflation to remain around target. That could be achieved even with a moderate uptick in current inflation rates.

Risks to that outcome are present and due to local conditions, Isarescu acknowledged.

Recent wage deals, especially in the public sector, have far outstripped productivity gains and actual inflation rates, and are likely to spur increasingly high demands in the private sector.

"Wage growth trends are a worry," Isarescu said.

So is the government's apparent willingness to run a higher budget deficit.

"Fiscal conditions should remain prudent," the central bank governor said.

Romania's government has committed to keeping its budget deficit below 3.0% of gross domestic product. But that is almost twice the scale of the deficit in 2006, which also marked an increase from the year before.

With the economy growing robustly, loosening fiscal policy now could lead to overheating of the economy and eventually trigger higher inflation, analysts say.

"They are playing with fire," Ciprian Dascalu, an economist for ING in Bucharest, said of the government's policy. He noted that administered price hikes are being end-loaded into 2008, suggesting price stability is effectively being paid for with tomorrow's inflation.

Any depreciation of the leu would "immediately be seen in the current inflation figures," Dascalu added.

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