Economic Outlook: A Booming Economy - What Next?
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VLAD MUSCALU
Economist
ING BANK N.V. AMSTERDAM - BUCHAREST BRANCH
A booming economy - what next?
We revised upward our GDP growth forecast from 6.6% (6% market consensus) to 7.8% (7% market consensus) based on the view that strong domestic demand will remain the main driver, while net exports’ negative contribution should decrease since data so far point for an improvement in exports dynamics. We had previously been positive on 2008 economic growth contrary to the prevailing view of foreign analysts based on our forecast for a very tight labour market – which persists as unemployment rate is at 3.8% in June – with strong impact on wage and credit dynamics and the fact that 2008 is an election year. It is important to point out that a very good agricultural year might push GDP growth even above 8.5%, which was the highest growth rate recorded by Romania in 2004.
At the same time, we still see 2009 as the year that will bring the required macroeconomic adjustment (growth expected at 4.8% against previous 5.1%). Mainly, we look for deceleration in credit growth and wage dynamics – largely due to tight monetary policy – coupled with slowdown in Eurozone that will ultimately affect Romanian exports.
Regarding inflation, we expect end-2008 inflation at 6.5% (market consensus at 6.5% and we had 5.4% in February Directional). The reasons for upward adjustment are the sizeable negative supply shocks – very strong increases in crude prices and hikes in energy prices – that forced us to revise the peak in inflation from March to July. Now we expect a peak of 9.3% in July, but substantial disinflation afterward based on less strain from food prices and a positive base effect. Nevertheless, the NBR will still miss its 2008 inflation target (3.8% with a ±1pp band) and there are considerable risks that even 2009 target might be missed (4.4% is our forecast vs. the 3.5% target with a ±1pp band). Still, a record crop in 2008 could have a strong impact on food prices and year-end inflation could be below 6.5%.
In our view, RON will not suffer from another strong correction in coming months even though macroeconomic disequilibria (large C/A deficit, loose fiscal policy and overheated economy) persists as its equilibrium level against EUR is estimated to be between 3.50 and 3.60. We look for a lot of RON volatility in the 3.40-3.70 range mainly driven by international investor sentiment. However, due to increased carry attractiveness, EUR/RON is likely to fall below the 3.50 level in the following months. Because the NBR has suggested that it finds a band of RON 3.50-3.70/EUR sustainable, we think that any breach of the 3.50 level will force the NBR to Romania step into the FX market to defend the 3.40 level. Although the RON may appreciate until end-September, we see risk of RON weakness if the NBR fails to deliver the hikes that foreign players expect. We forecast EUR/RON around 3.65 at the end of 2008 (consensus is at 3.55).
We believe the central bank is likely to continue the tightening cycle disregarding the improved inflation outlook and the appreciating exchange rate as it shifted the focus on fiscal and wage policies. Thus, the key policy rate is likely to reach 10.50 in the next months with upside risks, as consistent risks linger. However, declining headline inflation would automatically lead to increased restrictiveness in monetary policy. Because of this and slowdown in growth, interest rate cuts are likely at the beginning of 2009, in our view.
The budget deficit raises the most significant risk for the Romanian economy, as it is possible that it will breach the Maastricht threshold of 3% of GDP as fiscal policy so far was looser than that during pevious year and we look for more loosening in an election year. Furthermore, political arena remains shaky as there is no clear political majority. An eventual surpass of the 3% limit might trigger a rating downgrade to below investment grade with negative impact on domestic currency and the stock exchange.
Political outlook
Romania’s incoherent politics pose a threat to economic prospects and might hinder euro adoption prospects and the convergence process. The ruling party – PNL, liberal party – has less than 20% seats in the Parliament and has to rely on PSD (leftist) support for most important legislation packages. In the run-up for votes is likely that the pro-cyclical policies will be boosted.
Romania had local elections on 1 and 15 June (first and second rounds) and the parliamentary elections are scheduled for the last quarter of 2008, though the date is not yet set and a delay into 1Q 09 is plausible. The local election results gave a similar picture to recent polls, indicating that there is no party that could win a majority in the parliamentary elections which makes coalition building unavoidable. Moreover, when it comes to coalitions, the outcome is foggy. At the moment it seems that the PD-L (centre-right, supported by President Basescu) could win the elections, closely followed by the PSD (leftist) and PNL (liberal party) on the third place. Nevertheless, it is unclear what party either could ally with as both the PSD and PNL are unwelcome.
