Thursday, November 3, 2011

FT: Romania: a risky rate cut

November 2, 2011 
by Stefan Wagstyl

Romania on Wednesday became the first European Union country to cut interest rates in response to the Greek crisis and the consequent deterioration in the economic outlook.

Faced with the risk of renewed recession, the central bank surprised the markets by reducing its benchmark rate by 25 basis points to 6 per cent – despite clear risks of a run on the currency. Investors have so far taken the news in their stride, with the leu holding steady against the euro. But Romania’s close ties to Greece leave it vulnerable.

Neil Shearing of Capital Economics, told beyondbrics: “This is a surprise move. I don’t expect it to be the start of a cycle of aggressive rate-cutting. And there is a risk of an about-turn if the crisis in the eurozone gets worse.”

After the announcement, the leu erased earlier gains to trade flat against the euro around mid-day. Other currencies in the region were generally up against the euro, with the Polish zloty, for example, rising 0.6 per cent.

The pressure for a cut in Romania was particularly strong with the country facing one of the worst declines in economic prospects in the region. In its latest economic forecast, published last month, the European Bank for Reconstruction and Development cut its GDP growth prediction for Romania for 2012 by 2.7 percentage points to 1.1 per cent, the biggest cut for any country in the region bar Slovakia (-3.0 percentage points).

With only 1.5 per cent growth now forecast for 2011, Romania could be set for a prolonged slowdown if not outright recession.

Meanwhile, links with Greece are close, with Greek banks particularly prominent in Romania. Capital Economics calculates that Greek parents have extended credits of around $5bn to Romanian subsidiaires – credits which would, in extremis, be called in.

Fortunately for the central bank, Romania also has some advantages. First, it has in place a €5bn ($6.8bn) precautionary facility from the International Monetary Fund – useful ammunition should it come under attack in currency markets. An IMF mission is currently in Romania conducting a review.

Next, unlike other free-floating east European currencies, the leu has held its own against the euro this year, falling only by about 1.5 per cent. The zloty, by contrast, is down nearly 10 per cent.

Also, inflation – a longstanding challenge for Bucharest – slowed to 3.5 per cent in September and came inside the central bank’s target range.

That doesn’t mean Romania is safe. With nearly two thirds of credit denominated in foreign currencies, the country could face the same foreign exchange loans problems that have hit Hungary and Poland.

Capital Economics said in a note:

Admittedly, the leu has held up fairly well during the recent market turmoil… But even so, Romania’s fragile banks and close financial ties to the euro-zone’s southern periphery (especially Greece) mean that the leu is likely to come under further pressure as the euro-crisis intensifies.

As elsewhere in the region – and around the globe – all eyes are on Athens.

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