Monday, April 21, 2008

Romania: Inflation Climbs Again

Oxford Business Group Latest Briefing

Romania's inflation hit another high in March, as global and domestic factors dragged prices upwards. As last year, the country seems likely to overshoot its inflation target by some way. As a consequence, the central bank has been increasing interest rates rapidly. While pressures from food prices and liquidity may ease over the year, the aim of bringing the price index down to 3% by 2010 is now looking problematic.

Annual consumer price inflation reached 8.63% in the year to the end of March, up from 7.97% in February, according to the statistics released by the National Institute of Statistics (NIS). Romania has been hit by higher than expected inflation of late, with the end-2007 figure reaching 6.57%, well above the 3-5% target band set by the central bank, the National Bank of Romania (BNR). Inflation in 2006 was 4.87%, so last year's results confounded hopes on disinflation.

The BNR expects inflation to cool a little over the year, but still come in significantly above its target of 3.8%; in February, it revised its forecast for 2008 to 5.9% from 4.3%. The International Monetary Fund (IMF) has a more pessimistic estimate of almost 7%.

Inflation in March was 0.67% overall, compared to 0.1% in the same month last year. Services saw the largest price increases - 0.92% - followed by non-food goods (0.67%) and foodstuffs (0.55%). A breakdown of monthly inflation statistics reveals that price rises were driven by increases in the costs of several key goods and services. Food oil prices, for example, rose 3.44%, while post and telecommunication services gained 1.4%; milk and other dairy products increased 1.21%. Perhaps most importantly, fuel prices climbed 2.31%.

Food prices, which rose 10.82% in the year to end-March, have been driven upwards by a number of factors on the supply side. Domestically, last year's drought damaged crops, cutting harvests. On an international level, many food-producing countries have been hit by climatic issues, from the lack of rainfall to flooding, which bedevilled Romania's neighbour Bulgaria. Crop growing trends have also tended to move away from cereal crops that form the staple of many countries (in Romania, bread and therefore wheat). A shift towards lucrative biofuels in the US, and now the EU, has seen farmers switch from basic cereals. The same has happened as meat consumption in the developing world, particularly in Asia, has increased, encouraging livestock farming at the expense of wheat and rice.

Fuel prices, which increase transportation costs and company overheads, have been a root cause of some of the inflation across the board. Instability in the Middle East and increasing demand from the growing economies of Asia and Africa have contributed to pushing oil above $100 a barrel. Demand from countries such as China has also driven up the cost of commodities and construction materials.

These factors, of course, have been affecting other European countries as well. The EU-wide price index has risen 5.9% in the past 12 months, despite a slowdown in some of the larger economies in Western Europe. Nonetheless, there are also important domestic contributors to price rises.

The weakening of Romania's currency, the leu, has made imports significantly more expensive, while in the run-up to elections slated for this autumn, a battening down of the fiscal hatches seems unlikely (though the budget deficit is being reduced, to widespread praise). Having said this, the leu's slip will help ease perhaps Romania's biggest economic problem, the current account deficit, by cheapening exports and reducing demand for imports.

Wages have also been galloping ahead of growth, increasing 21% in the year to February against around 6% for gross domestic product in 2007. While monthly statistics for February show a slight wage drop, the trend is still towards higher pay. Where wages have not been seen to keep pace, protests have occasionally occurred, for example the 19-day strike at the large Dacia car plant, which was called off on April 11 after a pay rise was negotiated.

Furthermore, inflation is an extremely important issue in Romania, as the country must bring its rate down significantly in order to join the eurozone. Current requirements stipulate the candidate countries for the European Single Currency must have inflation to no more than 1.5% above that of the three EU countries with the lowest rates, for two years. Romania would therefore have to aim for around 3% on present performance. In early April, BNR deputy governor Cristian Popa said that it is the BNR's aim to lower inflation to 3% or even lower, by 2010. The governor, Mugur Isarescu, had warned in February that Romania's slated adoption of the euro in 2014 would be unobtainable if inflation does not fall in a sustainable way in 2008 and 2009.

Therefore, in response to the growing price pressures, the NBR has hiked up rates considerably[MSOffice5]. In March, it increased its main rate half a point to a 31-month high of 9.5%, the fourth consecutive rise. Isarescu has affirmed the bank's commitment to pure inflation targeting, saying that it will not intervene to secure the leu's exchange rate.

Combined with the NBR's actions, other factors may also lead to a medium-term easing of inflationary pressures. A slowdown in the global economy and a reeling in of loans due to the international credit crunch and cyclical factors may help reduce the amount of liquidity pouring onto the Romanian market. Meanwhile, a concerted backlash already underway against biofuels and improved harvests may contribute to bringing food prices down. And if the next government has a strong mandate, it may feel more able to apply this fiscal brakes where necessary. As the effects of the current administration's low and flat tax income are felt in the pockets of workers, wage pressures may also decrease.

However, all these will take time to work their way through into prices - agricultural changes in particular - while the jury is still out on the effects of the flat tax.

The authorities will hope that disinflationary factors will come together to bring inflation within target in the next two and a half years. The past few months suggest that this may be harder than they imagined.

No comments: