Tuesday, September 18, 2007

Romania: RON under pressure, more to come

Lars Christensen, Senior Analyst, Danske Bank

The weakening of the Romanian leu (RON) continues and the leu seems to have become the “proxy” for Central and Eastern European imbalances. On September 5, we recommended buying EUR/RON (See EM Strategy: Romania: Buy EUR/RON) We maintain this recommendation as we clearly expect more RON weakness. The rise in global risk aversion over the last 24 hours is likely to put further pressure on RON.

Furthermore, we reiterate the reasons for further RON weakness:

• The Romanian economy is among the most imbalanced economies in the Emerging Markets universe, with overheating asset markets, excessive credit growth and a large current account deficit. We place Romania in the same “group” of countries in CEE as the Baltic States and Bulgaria – in terms of heightened risk of a hard landing in the economy and financial distress. However, while there are currency pegs in the Baltic States and Bulgaria, there is a floating exchange rate in Romania. Hence, the leu is the easiest case to trade if one wants to trade the case of overheating in CEE.

• Fiscal policy is strongly pro-cyclical and hence contributes to increasing imbalances in the economy. The political situation remains uncertain.

• After the recent rise in FX volatilities the key policy rate in Romania of 7.0% does not give any real protection in terms of carry-to-risk.

• The large Romanian funding needs – due to the high external imbalances – make the Romanian markets and economy sensitive to a global credit crunch.

• Romanian households to a large extent have funded real estate investments in foreign currency (mostly EUR and CHF) and that makes them very exposed to currency risk.

• The leu is the most overvalued currency in our entire Emerging Markets universe. Some of our models indicate that RON could be overvalued by more than 30% on a fundamental basis.

• Technically, we have broken the nearly three-year downtrend in EUR/RON and a new uptrend has been established. According to our technical analysts, EUR/RON will meet resistance around 3.40. If this resistance is broken then the next resistance level is around 3.55.

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