Romania At A Glance - January 2008

The data being present here is both conventional and non conventional, and reflects our in house view that demographic components need to be taken alongside more conventional macro-economic ones to appreciate growth dynamics, and in particular in the Eastern Europe context. So, alongside charts for the exchange rate and consumer debt, you will also find charts for Romanian male life expectancy, live births and fertility, out migration to Italy and Spain (based on data from ISTAT and INE) as well as quarterly GDP growth, retail sales, inflation, as well as for the trade and current account balances. Basically we hope you will find this background data useful in assessing the argument which we are presenting on this blog, namely that Romania's demography,as proxied in long term fertility and out-migration rates (there are over a million people missing from the potential labour force due to out migration alone), means that current growth rates, or anything near them, cannot be sustained without provoking continuous inflation, and loss of export competitiveness, the combination of which may well lead to severe macroeconomic consequences. Please click on thumbnails for better viewing.

In the first place we show the recent decline in the Romanian leu vis-a-vis the euro, together with a chart indicating the growing non-leu indebtedness of the Romanian population (which of course, makes the risk from a correction in the currency even more significant.

To give an indication of the rate at which this problem is growing, according to data from the Romanian central bank, in October 2007 the nominal value of non-government credit advanced year-on-year by 51.4%, with a 40.5% growth in RON-denominated loans and a 63.3% rise in foreign currency-denominated loans when expressed in RON (expressed in EUR, forex loans expanded by 72.4 percent).

Next on the left there is a chart for quarterly GDP growth The Romanian economy has been growing strongly, although not excessively, in recent quarters, but what is driving this growth? On the right you can see the rapid acceleration in retail sales since the middle of this year. This expansion in domestic consumption is in part produced by a strong inflow of remittances the large number of Romanians who are now living and working abroad.

On the left you can see the number of Romanians who have residence in Italy according to ISTAT, and on the right you can see the equivalent number for Spain according to the INE. Exact figures for the total numbers of Romanians abroad are impossible to come by (which makes it impossible to calibrate anything resembling a NAIRU for Romania) for the simple reason the the Romanian authorities do not attempt to obtain an accurate measure as can be seen from the official migration statistics included in the chart on the right.

Next on the left we have a chart where you can see the recent acceleration in Romanian inflation while on the right we can see the upward movement in wages and salaries.As strong growth continues and labour capacity constraints are hit, due to the declining quantity and quality of labour which remains, a critical point is reached when wages and retail prices start to rise rapidly.

Here you can see on the left the consequences of this dynamic for the Romanian trade balance and on the right the correlate of this for the current account deficit. As domestic prices rise, imports become cheaper and get sucked in in ever larger quantities while exports get more expensive and export growth slows.

On the left are the annual numbers of live births - which is really what matters from a labour supply point of view. This has been dropping since the late 60s.Then you can see Romanian male life expectancy, which is compartively low, and this is a big complicating factor in raising participation rates among older workers to replace those who have either left or simply not been born.

2008 Forecasts:Consenus Economics are forecasting economic growth in Romania of 6.3% for 2007, and a slightly slower 5.7% for 2008. The number for 2007 seems about right, although the final reading may even be slightly higher given the governent fiscal stimulus during the second half of the year, while the number for 2008 may be rather on the high side, depending on the pace and extent of the slowdown. Really everything here hinges on whether Romania has a soft or hard landing, and when. My own feeling is that the landing will be a hard one, but the timing is very hard to foresee, and it is the timing which will have the greatest influence on the final outcome. As long as things continue as is, then the consensus forecast looks about right, but will things continue as is? The IMF in their October World Economic Outlook came in with a similar figure of 6.3% for 2007 and 6% for 2008, the Economist Intelligence Unit is forecasting growth in the 5 to 5.5% range for 2008, while the EU Commission put the figure at 5.9% in its November forecast.More interestingly the Commission sugest that this rate is achieveable without producing any significant reduction in the unemployment rate (currently officially around 7% on ILO methodology), which suggests they feel it can mainly be achieved by increasing participation rates, and redeploying labour from non productive to more productive sectors. But - as in Poland, where a large number of citizens are also known to be working abroad - it is very hard to know what credence to give the official unemployment data. Certainly a number of Romanian ministers have been very vocal in recent weeks stating that Romania has an urgent need for anywhere between 500,000 and 1 million workers.

My own view is rather more downside than all of this. A lot really depends on factors outside Romania's control, and internally the party can obviously continue for as long as it is allowed to. One limit point may well be the ability of Romanian citizens to continue contracting debt at this rate. It is noteable that despite the strong inflow of remittances and the inflow of bank funds for credit purposes the leu has been sliding. Should the appetite for credit inside Romania start to dry up, or should changed credit rules force it to, then pressure on the leu may become very strong indeed. Another limit obviously exists on the labour supply front. The IMF put Romania's growth rate at between 5 and 6% in their 2006 annual staff report, and they did this, interestingly enough, by attributing a negative (-0,2%) component to labour supply in a growth accounting study. So they are expecting the growth to come from an injection of capital and TFP. But this is where macroeconomics gets to be a funny business, since much of the growth which actually takes place in modern economies is quite labour intensive, and without that labour relative prices get out of line, and the impact of this mis-alignment is a brake on growth. So basically I would say here that the proof of the pudding is going to be in the eating. If Romania had the labour force to complement its aspirations, then I would say 6% growth would not necesssarily constitute overheating, but under the circumstances it may well do

Sunday, December 30, 2007

Alarm Bells Ringing in Romania?

by Edward Hugh, Barcelona

According to the Financial Times, in this article, it was just 5 years ago that Raiffeisen International, the Austrian-based bank with the greatest involvement in Eastern Europe, bought Casa Agricola, a struggling state-owned Romanian bank, for $45m and invested about $250m in its modernisation. Today, analysts estimate the bank could be sold for $2.5bn (€1.68bn, £1.22bn). The rise in value is attributed to Raiffeisen’s success in overhauling Casa Agricola as well as to Romania’s soaring economic growth, rapid credit expansion and spiralling asset appreciation. Many business people in Bucharest see the case of Casa Agricola as exemplary, and argue that similar success stories are developing across the board.

Not everyone, however, sees things like this. The International Monetary Fund, for example, (and of course yours truly the blogger here) takes a rather different point of view. Concerned about the continuing impact of the global credit market turmoil, the IMF has been consistently warning (and here) about the dangers of economic overheating in Romania, citing in particular the yawning current-account deficit and the financing problem that this could pose should there be a sudden and sharp reversal in investor risk appetite.

In addition inflation, which had been falling steadily in recent years, jumped to 6.8 per cent October after climbing steadily from a low around 4 per cent in the January-July period.

Rising world energy and food prices, compounded by a drought inside Romania itself, are playing their part. But so is rapidly rising local pay (fuelled in part by labour shortages which are caused by massive outmigration - the consequences of which the Romanian authorities are effectively in denial about - and years and years of below replacement fertility). Wages seem set to rise this year by about 25 per cent in money terms (or about 20 per cent in real terms) year on year.

Far from running a fiscal surplus to try and cool the economy - as advised by the IMF to drain excess liquidity from the system - government spending is being increased, with a 43 per cent increase in pensions currently being implemented, and a further 30 per cent rise having already been approved for early 2009.

A steady and increasing flow of remittances from Romanians working abroad is also helping to fuel a credit surge, particularly in home loans. In fact the IMF is not the only entity drawing attention to this situation. The National Bank of Romania published data earlier this week - in its Monetary indicators October 2007 press release - which shows that private debt in Romania increased an annual 51.4 percent in October as individuals and companies took out more loans in foreign currencies. Debt rose to 133.3 billion lei ($55 billion) as of Oct. 31.

And the combination of all these factors means that GDP goes charging forward at what may well be an unsustainable pace. According to data just released from INSSE (the National Statistics Office) GDP in Q3 2007 again accelerated again (slightly) to an annual 5.7 %, up from 5.6% in Q2.

Now according to the Romanian National Bank:

In October, non-government credit went up 3.3 percent (2.3 percent in real terms) from September 2007 to RON 133,319.6 million. RON-denominated loans picked up 3.3 percent (2.3 percent in real terms), while foreign currency-denominated loans increased by 4.0 percent when expressed in EUR and by 3.3 percent when expressed in RON. At end-October 2007, non-government credit advanced year on year by 51.4 percent (41.7 percent in real terms) on the back of the 40.5 percent growth in RON-denominated loans (31.5 percent in real terms) and the 63.3 percent rise in foreign currency-denominated loans expressed in RON (when expressed in EUR, forex loans expanded by 72.4 percent).

The IMF has warned that borrowers might be assuming too much risk, especially as an increasing share of the loans are either in foreign currency, mainly euros, or indexed to foreign currency.

And of course all this increase in credit is financing soaring increases in imports, boosting this year’s likely current account deficit to 14-15 per cent of GDP – a level the IMF considers dangerous. Last year the €10bn deficit was largely financed by privatisation-boosted FDI of €9bn. But this year’s forecast FDI of €7bn will fall far short of the likely €17bn deficit – leaving banks to finance the gap with credit, much of it short-term.

The IMF take the view that this is unsustainable, particularly with global conditions worsening. But Bucharest-based bankers argue much of the credit is quasi-investment as it is provided in-house by multinational banks to their Romanian subsidiaries.

Of course one of the areas where all this extra economic heating is most directly noticed is in construction, and Romania recorded in August (the latest month for which comparative data are available from Eurostat) the highest annual pace of construction growth (37.5%) of any country in the European Union. According to data supplied to Eurostat, Romania is way out in front here, followed by Great Britain with a 7.7% year on year rate and Slovenia with a 4.6% one. Even the Baltic countries have no dropped out of this particular race.

Meanwhile the Romanian leu continues its downward course, falling again early in the week for the third straight week against the euro as investors became increasingly concerned about the widening current-account deficit and accelerating inflation. The leu has been the world's worst-performer against the euro in recent weeks, falling the most since August 2005, as investors trended away from higher-yielding emerging-market assets amid a sell-off in Romanian stocks.

As can be seen above, in the few days the fall seems to have been brought to at least a temporary halt after central bank Governor Mugur Isarescu said sharp swings in the exchange rate can harm the country's economy and indicated the possibity of a further tightening of monetary policy to address the inflation problem.

The National Bank of Romania raised its key interest rate to 7.5 percent from 7 percent at the end of October following the rise in the inflation rate to a one-year high of 6% in September and 6.8% in October. But Isarescu has also warned about the sharp rise in indebtedness and the limits to conventional monetary policy in the current environment.

"In the last four or five months, credit in foreign currencies exploded...When we raise rates, foreign currency loans rise because they look cheaper. We have reached a limit of monetary policy.''
Romanian Central bank Governor Mugur Isarescu

Now although Romania nominally has a relatively high unemployment rate - some 7% using ILO methodology - it is impossible to know just how realistic this figure is, since we do not really know how many Romanians are actually in the country and ready and available for work, or indeed the quality of the unemployed labour force that actually are. One measure of the situation though can be found in the recent statement by economy and finance minister Varujan Vosganian that Romania has a current labor shortage of about 500,000 workers, especially in construction, heavy industry and car manufacturing.

"We need more engineers, mechanics and bricklayers........We have a labor deficit of about 500,000 employees," he admitted at the opening of a conference on professional and technical education recently.

One of the really difficult problems which comes into operation in a situation like that which Romania is currently experiencing, and where a strong level of euro indexing of prices and a significant number of households and companies are paying loans which are in or indexed-to euros (or other foreign currencies), is that exchange rate and monetary policy become effectively impotent (this is what Mugur Isarescu means when he talks about the limits of monetary policy) to correct growing competitiveness problems - since given the indebtedness it is just not practical to encourage any substantial downward correction the exchange rate, while increasing the interest rate only puts upward pressure on the currency and attracts additional funds in search of yield, and these only serve to make the excess demand problem even worse. Thus the only real arm left in the government policy arsenal is the fiscal policy one, whereby the government attempts, by running a fiscal surplus, to "drain domestic demand" from the system, and thus work to effect some form of price deflation (for a fuller discussion of this complex topic in the Latvian context see this post). And this, of course, is exactly the policy that the IMF economists tirelessly advocate that the Romanian government practices, but unfortunately the message seems to be falling on deaf ears.

Now, evidently, running a deficit stimulates demand, which increases economic growth, and this extra growth does, of course, bring in increased revenue which can help pay for extra spending, but if the economy is already running up against its capacity limits then this extra growth is rather artificial, and such attempts at growth really only has one result, that of pushing up wages and prices, and thus increasing inflation, and given the difficulties associated with implementing a strong downward correction in the currency this inflation means only one thing, a loss of export competitiveness, and this, of course, is what we are seeing happening in the Romanian case.

And on top of this we have the issue of remittances coming back home, stimulating even more demand, demand which would lead to the employment of those workers who have migrated, only they are now no longer there. Undoubtedly this flow of remittances (around 4.3% of GDP in 2006 according to the World Bank) carries some of the responsibility for the escalating home demand, and rush to borrow, since you don't have to be an economic wizard to see that the money can be initially used to accumulate the deposit to purchase a new family home, and then subsequently as a stream of income to help make the mortgage repayments.

So more than having the alarm bells ringing, the writing is now on the wall I would say. Even Central bank Governor Mugur Isarescu warned on Nov. 1 he was concerned that foreign-currency lending ``exploded'' in recent months, increasing the risk associated with any depreciation of the local currency, and the national currency the leu was the world's worst-performer against the euro last week, falling the most since August 2005, as investors shunned higher yielding emerging-market assets amid a sell-off in Romanian stocks. So take note of the old adage, caveat emptor.