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Wednesday, September 5, 2007

Romanian Leu on the Slide

Romania's leu fell for a seventh straight day today - to its lowest level in four months against the euro. The leu fell 0.4 percent this morning to trade at 3.3245 per euro - at 12:25 p.m. in Bucharest - its lowest since May 1. The currency gained 8.5 percent against the euro between January and June, and since that time it has been the second worst performer among the 26 emerging market currencies which are tracked by Bloomberg, losing 6.25 percentover the period. To get a taste of things, here's the latest 24 hour chart on the euro-leu cross. Since the charts presented here are a measure of how many leu it takes to buy one euro, movements upwards indicate a decline in the value of the leu.

Now today's decline has been attributed to any number of factors, ranging from a fall in the benchmark NTX Index of 30 large companies in Central and Eastern Europe - the index declined about 0.2 percent today - to comments from Japanese bank regulator Yoshimi Watanabe about Asian exposure to US sub prime mortgage issues, but the fact of the matter is that Romania's economy is seen as being increasingly vulnerable given the global decline in risk appetite and the developing credit crunch.

Here is a two year euro-leu cross chart, where the turnround from the end of June is quite apparent:

and here's the chart for the last month where the steady deterioration in the situation is again most clear:

Analyst Lars Christensen at Danske Bank has also picked up on what has been happening to the leu, and has published a research note which I reproduce below and the substance of which I basically agree with at the analysis level, although I am not, of course, recommending anyone to buy or sell anything.

Since the beginning of July, the Romanian leu (RON) has weakened significantly. However, we see room for significantly more weakness in RON and therefore recommend to Buy EUR/RON spot.

We give the following reasons for more RON weakness:

• The Romanian economy is among the most imbalanced economies in the Emerging Markets universe, with overheating asset markets, excessive credit growth and a large current account deficit. We place Romania in the same “group” of countries in CEE as the Baltic states and Bulgaria in terms of heightened risk of a hard landing in the economy and financial distress. However, while there are currency pegs in the Baltic states and Bulgaria, there is a floating exchange rate in Romania. Hence, the leu is the easiest case to trade if one wants to trade the case of overheating in CEE.

• Fiscal policy is strongly pro-cyclical and hence contributes to increasing imbalances in the economy. The political situation remains uncertain.

• After the recent rise in FX volatilities the key policy rate in Romania of 7.0% does not give any real protection in terms of carry-to-risk.

• The large Romanian funding needs – due to the high external imbalances – make the Romanian markets and economy sensitive to a global credit crunch.

• Romanian households to a large extent have funded real estate investments in foreign currency (mostly EUR and CHF) and that makes them very exposed to currency risk.

• The leu is the most overvalued currency in our entire Emerging Markets universe. Some of our models indicate that RON could be overvalued by more than 30% on a fundamental basis.

• Technically, we have broken the nearly three-year downtrend in EUR/RON and a new uptrend has been established. According to our technical analysts, EUR/RON will meet resistance around 3.40.
If this resistance is broken then the next resistance level is around 3.55.

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