Romania Central Bank Statement

Author: | Published: 19 Oct 2018
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Romania's annual CPI inflation rate swiftly re-entered the variation band around the 2.5% flat target, spiking above 5% due to supply-side factors and pressure from fundamental drivers coupled with some statistical base effects. The upswing, in contrast with the tepid pace in other EU states, is related to the global cycle, as international commodity prices have risen. However, Romania's inflation is set to moderate, also following less accommodative monetary conditions, with year-end annual CPI forecast at 3.5% this year and 2.7% in 2019.

In 2017, Romania's economy ran further on the fast-track, with an annual GDP growth of 7% beating expectations, partly due to strong agriculture production. Economic activity is likely to temper this year, although GDP growth remains above potential amid persistent excess demand, public finance and labour market tensions and Romanian entrepreneurs struggling with issues related to structural competitiveness.

Despite progress on the real convergence path, the consumption-driven nature of Romania's growth is pressuring external balance, primarily the trade deficit, even though exports' advance continues. The current account deficit (CAD) widened mildly to 3.4% of GDP last year, being autonomously financed as both FDI and EU funds poured in. The budget deficit came just under 3% of GDP in 2017 – though its structural reading is placed well above the 1% medium-term objective. Public debt hovers now around 35% of GDP.

Financial stability stayed robust, with risk aversion and default for loans to the private sector among the main vulnerabilities. Financial intermediation, now at just 27% down from 40% a few years ago, remains a challenge as corporate credit should replace direct fiscal incentives as a driver of growth, if economic development is to be sustainable.

As regards the monetary policy, the NBR already hiked the annual rate three times this year to 2.5% (in May), after narrowing the corridor around the key rate last year. The steps towards policy normalisation were facilitated by favourable developments in the banking sector: the NPL ratio dived to 6% from above 20% in 2014 (the largest adjustment in the EU over the period) and the share of leu-denominated loans in the total credit grew from one third prior to the crisis to two thirds, reducing contagion risk and improving monetary transmission.

With the economy operating above capacity, further demand-side policies risk fuelling macro imbalances, potentially increasing inflationary pressures, weakening competitiveness and further widening the CAD. To safeguard stability and achieve sustainable growth, an adequate policy mix is needed. Given the pro-cyclical fiscal policies over the past few years and the persistent labour market strains, Romania needs a wise approach to ensure an appropriate dosage, magnitude and timing of any further moves in these areas, along with the implementation of structural reforms.

Going forward, as regards monetary policies, a gradual approach is warranted. I personally see normalisation as amounting ultimately to a return to real positive interest rates, in line with the overriding price stability objective and in the context of swings in global capital flows. Thus, striking the right balance in terms of the interest rate differential, especially in our emerging region, is of the essence. Future NBR actions hinge on how monetary policy normalisation will unfold in Europe. Currently, the mainrisks to price stability are related to domestic fiscal and income policies as well as uncertainties in the external environment.