Monday, April 11, 2011

FT: Romania: lurking stagflation

April 11, 2011

Stagflation is not as far away as you may think. The Dracula of economic threats is alive and well inside the European Union – in Romania. Bucharest on Monday announced a jump in annual inflation to 8 per cent in an economy which was in recession last year and will struggle to pull out of negative territory in 2011.

The country’s challenges lack the immediacy of the debt crises facing Greece, Ireland and Portugal, but it faces deep-rooted difficulties which won’t fade in six or 12 months. And as a EU member, it can hardly be ignored in Brussels.

Romania’s inflation rate rose in March to 8 percent, the highest since August 2008, from 7.6 percent in February, the National Statistics Institute reported. The increase was driven by rising food prices, particularly for fruit and vegetables, which are in short supply locally following last year’s poor harvests. Rising oil prices also had an effect, driving up the costs of fuels and petrochemical products.

While the whole world is vulnerable to global commodity price hikes, Romania is particularly exposed among EU members because food accounts for an especially high percentage of the consumer price basket (33 per cent, compared with just 17 per cent in neighbouring Bulgaria).

Economists expect the inflation rate to moderate once this summer’s harvest is collected (assuming it is not another poor year on the farm) and last summer’s VAT hike is no longer in the numbers.

But inflation won’t drop nearly enough to meet the central bank’s (recently increased) year-end targets of 3 per cent. Economists have published forecasts as high as 6 per cent. And next year won’t necessarily be much better: under the terms of its support agreement with the International Monetary Fund and the EU, Bucharest has pledged to cut heating fuel subsidies which are among the EU’s highest. The move will boost inflation by around 1 percentage point in the year that it’s implemented.

Nicolaie Alexandru-Chidesciuc, Romania chief economist at ING, says the central bank now has little chance of reducing interest rates from the current 6.25 per cent a level that has not been changed since the 2008-9 crisis. Citigroup also says that the bank is likely to keep rates on hold: it might cut if food price inflation moderates but it might have to tighten if the government runs a bigger fiscal deficit than the 4.4 per cent of GDP envisaged by the IMF/EU programme.

After two years of recession, compounded by biting public spending cuts to tame borrowing, Romania’s leaders are keen to see some economic growth to give Romanians a bit more money in their pockets and allow the government a little more wiggle-room on deficit management. After implementing one IMF-EU programme, they last month agreed another, supported by a €5bn loan package.

The government has forecast a 1.5 per cent increase in GDP for 2011 – a figure which gives little margin for avoiding another year in negative territory if events turn out even slightly worse than expected.

ING’s Alexandru-Chidesciuc says: “Yes you can describe it as stagflation. There is some recovery but it’s very very fragile. And it comes with high inflation.”

Romania deserves credit for stabilising its economy following the 2008-9 crisis with a severe austerity programme which included a 25 per cent cut in public sector pay. But without mastering inflation that stabilisation is incomplete.

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