Friday, March 30, 2012

FT: Romanian rate cuts: running out road

Romania’s central bank cut interest rates on Thursday for the fourth time in as many policy meetings, taking rates down to a record low of 5.25 per cent.

The whole 1-percentage-point reduction has been achieved with a barely a twitch in the leu, which has moved little from the 4.35 level against the euro where it when the central bank swung into action in early November.

But this has been achieved against the global rally in emerging market currencies this year. Life will be much harder for the Romanian National Bank if there’s another sudden sell-off, as there was last spring.

The bank said in a short statement:

The NBR will continue to closely monitor domestic and global economic developments in order to, by accordingly adjusting its available instruments, to ensure the fulfilment of its objectives of achieving price stability, as well as financial stability.

Romania, which saw GDP plunge 7 per cent in 2009, is struggling to recover from that crisis. The central bank faces the challenge of encouraging growth in an economy expected to grow by just 1.5-2 per cent this year without jeopardising the inflation target or the currency.

With consumer prices rising by just 2.6 per cent in February, inflation isn’t a big worry right now. But the currency is. While it’s only fallen by around 1 per cent against the euro since early November, it is at 4.37 close to the top of its post-2008 range.

Mugur Isarescu, central bank governor, told reporters aftetr the policy meeting that the leu was in an “equilibrium zone,” which moved when fundamentals changed.

The centre-right government of new prime minister Mihai Razvan Ungureanu is trying to keep the public finances stable in the hope of an economic recovery that would boost employment, tax revenues, and its own political support.

An International Monetary Fund precautionary programme is in place as a backstop, allowing the central bank to cut rates without scaring investors (in contrast to neighbouring Hungary).

Economists expect perhaps one further cut. But they warn that Romania is getting close to the limit in taking risks with the currency. As Capital Economics said in a report on Thursday:

We expect one further cut this year, but the threat of financial contagion from the euro-crisis is a formidable barrier to more aggressive easing. …With around two-thirds of household debt and one-third of corporate debt denominated in FX, Romania is extremely vulnerable to swings in the leu.

As such, the IMF programme acts as a backstop, shoring up investor
confidence – this allowed Romania to escape last year’s emerging market sell-off relatively unscathed.

The IMF programme is still there. But would it pass the test again if it came under pressure from investors in 2012?

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