Tuesday, April 15, 2008

Rising Costs Show Risks

April 14, 2008; Page A11

Inflation in Romania and Turkey is rising faster than elsewhere in Europe, underscoring how second-round effects from high food and oil prices spread more rapidly in emerging economies with high reliance on debt, while raising the risk of hard landings for the economy.

Net wages in Romania jumped 21% year to year in February, ensuring that March's consumer inflation, due out Monday, will rise above February's 8% pace, already twice the central bank's target. In Turkey, March inflation has also sped up, reaching 9.2% with a new survey showing expectations are worsening.

Inflation has been a global theme because of soaring commodity prices, but the upward trend in prices is broader and more insidious on Europe's easternmost frontier. While Central European countries such as Poland can combat inflationary pressures with a rising currency, it's an expensive strategy for Turkey and Romania, which rely heavily on financing from abroad. Policy makers in both countries face a dilemma, and market volatility has grown intense, pointing to the risk of a plunge in currency and asset prices.

The mix of vulnerable currencies, high foreign debt, lofty inflation rates and darkening export prospects set the stage for a "stagflationary scenario," said Lars Christensen, chief emerging-market analyst at Danske Bank. "In such an environment, it truly becomes more challenging for policy makers to make the 'right decisions,'" he said.

Growth already is slowing sharply in Turkey, and Romania may soon lurch as well.

National Bank of Romania Gov. Mugur Isarescu has frequently lamented the pace of wage gains in Romania, where the government runs a loose fiscal policy and has pushed through large raises for public-sector workers.

Wage demands may deter the foreign direct investment that Romania urgently needs to fund its current account deficit, which is currently 14% of gross domestic product and rising.

Meanwhile, in Turkey, the last central-bank-expectations survey forecast year-end inflation above 8%, a sharp rise from 7.2% two months ago. Gov. Durmus Yilmaz has shelved plans to cut Turkish interest rates from 15.25%, the highest rate in the world until Iceland's central bank raised rates to 15.5% last week.

While domestic demand has ground almost to a halt, easing inflationary pressures, Mr. Yilmaz has taken pains to point out that the risk premium -- the extra charge foreign investors demand to loan -- has jumped and that market-volatility measures are now more intense than in May 2006, when the Turkish lira lost 30% against the dollar.

A weaker currency would force energy imports to push inflation higher, leaving the central bank with the unwelcome prospect of raising rates even as economic growth sputters at its slowest pace in six years.

"Getting control of inflation is key to everything else" said Kristin Lindow, a credit officer covering Turkey for Moody's Investors Service in New York.

Such a scenario would be particularly harsh for Turkey, where the corporate sector has gone on a hard-currency borrowing spree, meaning that a weaker lira would raise debt-servicing costs.

Write to Christopher Emsden at chris.emsden@dowjones.com

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