At the last monetary policy board meeting on Oct. 31, the central bank raised its main interest rate to 7.5 percent from 7 percent after cutting it four times earlier in the year. The benchmark rate was 8.75 percent when Romania joined the EU in January, the highest among the 27 members. The bank cut the rate at the first of its four monetary policy meetings in 2007, citing slowing inflation - which fell to a 17-year low of 3.7 percent in March - and a strengthening leu.
``The short-term inflation outlook has worsened in the context of heightened macroeconomic risks, especially those related to the income policy and higher public spending in the run-up to forthcoming elections,'' The bank also cited ``a possible significant deterioration of inflation expectations.''
Central Bank Statement
The Bucharest-based National Bank of Romania had already accepted that it would miss its year-end 2007 inflation target of 4 percent, plus or minus 1 percentage point, as the leu continued to weaken and the Romanian government boosted spending on infrastructure and social programs after joineding the European Union a year ago.
The central bank board also left its minimum reserve requirements on commercial bank deposits at 40 percent for foreign-exchange deposits and 20 percent for deposits in lei.
Inflation was an annual 6.7 percent in November as food prices increased after a drought destroyed a third of Romania's crops, and depreciation of the leu raised the cost of imports and many local goods and services.
The central bank has indicated that government spending is a threat to its inflation target, and that to reduce the overgheating in the Romanian economy fiscal policy needs to be tightened considerably. However, at least in the short term one can imagine that government spending will more than likely increase as the country prepares for next November's parliamentary elections.
The leu, after appreciating throughout 2006 and the first seven months of 2007depreciated almost 13 percent against the euro between the outbreak of the sub-prime bust in August and the end of the year. The leu's drop increases inflation by making items indexed in euros and paid in lei more expensive for Romanian citizens. In Romania, rent, gasoline, phone bills and other goods and services are habitually quoted in euros and paid in lei.
The central bank also indicated that its decision to raise the rate today was influenced by the fact that consumption is at an "unsustainable level in the context of rapid expansion of credit to the private sector, especially of foreign currency loans."
Private debt in Romania increased an annual 55.1 percent in November to 141 billion lei ($58 billion) as individuals and companies took out more loans in foreign currencies, the central bank said on Dec. 28. Total outstanding loans in foreign currencies, mostly euros, increased an annual 74 percent while leu-denominated loans gained 38 percent.
The central bank also said net wage growth, which accelerated to an annual 25.2 percent in October, was further pressuring inflation and outstripping productivity gains, emphasizing the `"risks of deteriorating external competitiveness".
The current account gap in the first 10 months of 2007 widened to 13.35 billion euros ($19.7 billion) from 7.75 billion euros a year earlier. Much of the deficit was created by a surge in imports as the leu's gain made goods cheaper for Romanians and the country eliminated import barriers as it joined the EU.
Romania's trade deficit has steadily deepened during the first ten months of this year, and has already reached over 17.2 billion euro, an increase of over 6 billion euro when compared with the same period of 2006, according to data this week from the National Statistics Institute. The overall trade deficit for the whole of 2006 amounted to "just" some 14.8 billion euro.
Over the same period, the total value of exports grew by 13.2%, rising to 24.2 billion euro, while imports advanced 27.2% to 41.4 billion euro.
In October this year, exports exceeded 2.7 billion euro, a 17.2% increase as compared to the similar month last year. On the other side, imports reached in October the total value of 4.9 billion euro.
The leu has been steadily depreciating as the current account deficit widened and international investors grew more and more wary of investing in countries perceived as higher risk amid the U.S. subprime crisis.
Well, the central bank are now trying to react, but in todays conditions I do fear that this is a question of too little too late.