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Tuesday, April 22, 2008

IMF Calls For Interest Rate Hikes in Romania

Romania's central bank should raise interest rates further to curb inflation as the economy continues to ``boom'' this year, the International Monetary Fund has said.

``Inflation is now quite high,'' IMF country Mission Head Albert Jaeger said, speaking to reporters today in Bucharest. ``The booming economy is increasingly becoming a driver of inflation. More monetary policy tightening may be needed, principally in interest rates.''

Banca Nationala a Romaniei lifted its monetary policy rate half a percentage point to 9.5 percent last month as the inflation rate to an annual 8.6 percent. The bank, which makes its next interest rate decision on May 6, has raised the key rate at all four meetings since October, when it was 7 percent.



The bank missed its 2007 inflation target of 4 percent, plus or minus one percentage point, as consumer prices surged an annual 6.6 percent. The IMF said in a news release today that inflation will end this year at an annual 6 percent, above the central bank's target of between 3 percent and 5 percent.

Romanian inflation accelerated in March to the fastest pace in more than two years as a weaker leu boosted the cost of services and imports and rising wages and lending spurred consumption.



Romania must cut the inflation rate to 3 percent by the end of 2010 or risk missing its target of adopting the euro in 2014, central bank Governor Mugur Isarescu has said.


Jaeger predicted the economy will grow 6 percent this year, the same rate as last year. He said growth will probably slow to 4.7 percent in 2009 as richer countries import less and international investors grow wary of higher-risk investment.

``The slowdown in 2009 could be much sharper,'' Jaeger said. ``Global financial turmoil will spill over to Romania. External financing, which has been cheap in the past, will become more expensive.''


He also urged the government to refrain from increasing spending or lowering taxes in the near future, particularly in the lead-up to November 2009 parliamentary elections. The government targets a budget deficit this year of about 2.2 percent of gross domestic product although Jaeger said the government ``overestimates'' revenue for this year.

Jaeger said Romania's current-account deficit, which widened in the first two months of this year to 2.19 billion euros ($3.5 billion) from 2.08 billion euros a year earlier, is ``unsustainable.'' Fitch Ratings and Standard & Poor's have both lowered their outlooks on Romania's credit rating, citing the continuing current account shortfall as justification.



IMF Hard Landing Warning

The latest IMF Global Financial Stability report (published last week), warns thata number of Eastern European countires now face a continuing and growing risk of experiencing a "hard landing" as the global financial crisis continues to spread. The fund also drew attention to the possibility of serious of spillover problems arising for the Scandinavian, Italian and Austria banks that have lent heavily in the region, and this warning will not be taken lightly by these banks (whose benevolence and cooperation was, it will be remembered, thought to be the principal lifeline for the Romanian and Baltic economies in times of distress).

At the heart of the IMF's concerns are the large current account deficits being run in certain CEE countries, deficits which have now reached extreme levels in some cases, running to the tune of 22.9pc in Latvia, 21.4pc in Bulgaria, 16.5pc in Serbia, 16pc in Estonia, 14.5pc in Romania and 13.3pc in Lithuania.



"Eastern Europe has a cluster of countries with current account deficits financed by private debt or portfolio flows, where domestic credit has grown rapidly. A global slowdown, or a sharp drop in capital flows to emerging markets, could force a painful adjustment,"


The IMF said lenders in Eastern Europe had built up "large negative net foreign positions" during the boom, especially in the Baltic states. "Liquidity for these banks has all but dried up and [interest] spreads have widened 500 basis points."

Many of these countries concerned rely on credit from branches of West European and Nordic banks, but these foreign lenders are now themselves having difficulty raising money in the wholesale capital markets.



"A soft landing for the Baltics and south-eastern Europe could be jeopardised if external financing conditions force parent banks to contract credit to the region. Swedish banks, the main suppliers of external funding to the Baltics, could come under pressure,"


As the IMF note in their report, awareness of higher risks in the CEE countries has been rising in recent months, and this rising awareness has been been reflected in the performance of bank stocks exposed to the region, in Credit Default Swap spreads, and in the performance of the Romanian leu (see chart below) given that the leu is the only floating currency with a liquid forward market among the group of eastern European countries with large external imbalances. As we have seen it has depreciated substantially since July 2007, as investors have been expressing their negative views on the region as whole The stocks of Swedish banks exposed to the Baltics have underperformed other Nordic bank shares (and here) partly owing to significant short-selling and CDS spreads on sovereign debt have surged since August 2007, as investor demand for credit protection has pushed up prices. The interesting point to observe is how this is now all moving in tandem.


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