Current Economic Contraction Could Lead to a Correction of the Macroeconomic Imbalances Accumulated during the Last Years

Octombrie 2009

LUCIAN ANGHEL - Chief Economist BANCA COMERCIALĂ ROMÂNĂ S.A.

Increasing negative effects of the international crisis upon domestic economy

Annual economic growth turned negative in 2009 as the effects of the global crisis upon the domestic economy grew larger. Aggregate demand contracted on both the consumer and investment side. Households final consumption fell as people financial resources diminished - retail loans slowed down sharply, unemployment began to rise while the prospects for future wage growth became highly pessimistic. Gross fixed capital formation decreased only slightly in early-2009 but the next quarters could bring a larger contraction as construction activity entered the negative territory beginning with March and the outlook remains negative both on the residential and the infrastructure elements. The contribution of the net exports to the economic growth might be positive in 2009 in line with a sharper decline in imports as compared to exports.

As some countries like USA, China or Germany might see the end of recession this year, Romania could witness a clear improvement of the economic conditions no sooner than 2H 2010. Current data suggest that economic recovery will be slow, with real GDP below the potential over the next years.

• The contribution of net exports to real GDP might turn positive in 2009 (percentage points)

Source: NIS, BCR Research

Sharp adjustment of the C/A deficit in 2009

The correction of the external imbalance began in 2008 and continued throughout 2009, with an estimated C/A deficit below 6% of GDP at the end of December, strongly down from 12.3% last year. This contraction reflects the strong decline in aggregate demand (both households consumption and investments of the private companies) and was triggered by the second wave of the international financial crisis, namely Lehman Brothers bankruptcy in September 2008.

The good news is that external funding needs might be lower than initially estimated, with FDI covering a large part of the C/A deficit. FDI structure will improve, non-debt-creating inflows playing a dominant role now as some companies are transforming inter-company loans into equity participations.

Romania will remain an attractive business destination for strategic investors who will find profitable business areas like agriculture, infrastructure investments through public private partnerships, renewable energy, IT&C even in the midst of the strong economic contraction.

In the long run, central bank's decision of cutting to zero the minimum reserve requirement for FX liabilities with residual maturity above two years creates an incentive for local banks to replace the short-term external funding lines with long liabilities. As a result, the short-term external debt will decline further removing thus at least partially one of the major concerns of the rating agencies about Romania's ability to withstand the economic crisis.

The agreements from Vienna and Brussels between the largest foreign banks incorporated in Romania, IMF and European Commission on maintaining banks' overall exposure to the country and increasing the capital of their subsidiaries if needed is crucial in securing Romania's macroeconomic stability during these turbulent times.

• 2009- closing the macroeconomic imbalances

Source: NBR, BCR Research

The disinflation process might continue in the short run

After two consecutive years in which inflation rate stood above the target due to an inadequate mix of macroeconomic policies with a strong monetary policy but loose fiscal and income policies, 2009 might bring an inflation rate inside the target. The second quarter brought a slow disinflation process supported by the contraction of the aggregate demand and a more stable RON after the agreement with the IMF and EU.

Despite this, the disinflation process remains surrounded by important risks in the long run and Romanian economy still has to improve the supply side for a low and stable inflation rate. The dependence of the economy upon imports especially on the consumer goods side creates particular problems through the exchange rate risk, the low investments in agriculture left this sector at the mercy of nature and the persistence of rigidities in the price-setting mechanism could make the disinflation process more difficult in the long run. The high share of the food products in the CPI basket (37.6%), considerably above European standards, highlights the importance of agriculture.

1

2

The tricky lag LUCIAN CROITORU Adviser to the Governor - BANCA NAŢIONALĂ A ROMÂNIEI Lucian Croitoru, Adviser on monetary policy issues to the National Bank of Romania Governor, talks about the NBR’s next moves and explains why the decrease ofthe policy rate hasn’t been reflected into lower interest rates on bank loans. mai mult... The turnaround CRISTIAN SPORIS Secretar de Stat - MINISTERUL ECONOMIEI ŞI FINANŢELOR Cristian Sporis, Secretary of State at the Ministry of Public Finance, in charge with the national treasury and public debt, explains how the state managed to borrow money at the lowest costs in the last seven years and how it turned from a clear market taker into a player with a strong position on the market. mai mult...