Economic Overview - June 2010

19 Iulie 2010

RAIFFEISEN BANK S.A.

 

Highlights

In order to reduce the budget deficit, the government had to take radical measures. An austerity program was applied starting July 1st. The key measures refer to: a cut by 25% in wages in public sector, an increase in value added tax (VAT) from 19% to 24%, a cut in social transfers (excluding pensions) by 15%, a tax of 16% on interest on deposits and luncheon tickets, a cut in current expenses with goods and services in the public sector, and lay-offs in public sector. Initially, the government planned to reduce pensions by 15% but the measure was rejected by the Constitutional Court and it was replaced by the hike in VAT.

The large increase in VAT would push up inflation rate starting with July. The pass-trough from the increase in VAT to the increase in final consumer prices is expected to be high, but below the maximum arithmetical impact of 4.2%. Also, recent heavy rains and floods suggest additional upward pressures on food prices in the following months. Cut in subsidies for thermal heating are expected to put additional pressures on prices in the ending months of the year. Given these circumstances, we adjusted upward the end-year inflation forecast to 8.5% from 4% previously.

At the last monetary policy meeting on 30 June, the NBR hold unchanged the key interest rates at 6.25%. Expected increase in the inflation rate would not allow the central bank to cut further the monetary policy rate. Moreover, if there will be second round effects on inflation from the hike in VAT and inflationary expectations will increase, we don't exclude even a hike in the key interest rates by the end of the year.

Dynamics of short-term indicators (industrial output, retail sales, turnover in market services for population) came on the positive side in March-May. It suggests that economic activity has most likely improved in the second quarter as compared with the first quarter. We are looking for a quarterly GDP growth rate close to 0% qoq in Q2, while a slightly positive figure should not be excluded. However, the austerity measures should have a negative impact on real disposable income and consumption in Q3 and Q4. Heavy rains and floods would most likely have a negative impact on agricultural output. Given these circumstances, we revised downward the GDP projection for 2010 and we are looking now for a contraction of 3% this year.

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