With an eye to more expansive fiscal policy and potential external risks, the National Bank of Romania has kept its monetary policy rate at 1.75% despite the decline in average consumer prices over the 12-month period ending in November and a value-added tax cut this year.
IHS perspective | |
Significance | The National Bank of Romania (NBR) continues to hold firm on its policy rate given risks that balance against positive developments to date in the Romanian economy. |
Implications | The monetary authorities remain attuned to offsetting the relaxation of the fiscal stance in the run-up to the parliamentary election. |
Outlook | With inflation likely to remain below the top of the bank's target range for some time to come, the NBR will work to spur lending through the downward adjustment of reserve requirements, but should hold the line on interest rates. |
At a regularly scheduled meeting on yesterday (7 January), the board of the National Bank of Romania (NBR) opted to keep its monetary policy interest rate unchanged at 1.75%, a historic low, but decided to lower the reserve requirement for foreign-currency-denominated liabilities of Romanian banks. The decision did not come as a surprise in light of earlier statements by NBR governor Mugur Isarescu that although the board regarded the current rate as appropriately balancing risks to the economy and risks to macroeconomic stability, the bank could proceed to encourage lending by lowering reserve requirements in the coming months.
The NBR press release indicates that the board regards the trajectory of consumer prices to be relatively on target. The bank maintains a target band of 1 percentage point around 2.5%. In November, the latest data available at this time, the year-on-year (y/y) change in the consumer price level was a decline of 1.1% and the average rate of change in the 12 months ending in November 2015 was -0.4%. However, the board attributes this to the movement in fuel prices and the broadening of the coverage of the reduced rate of value-added tax (VAT) to include most food items in June 2015. The board judges that if the effect of the VAT change were excluded, the rate of y/y inflation would have been running at around 2%, squarely within the target range.
The economy is judged to be in quite good shape. GDP grew at 3.6% y/y in the third quarter. The NBR believes that if the agricultural results in the third quarter had not been as disappointing as they were, the economy might have grown by as much as 5% y/y. The main driver of economic growth has been private consumption and the bank considers that this reflected rising nominal incomes, lower indirect tax burden, a re-expansion of domestic lending, and renewed consumer confidence. The revival of lending has been accommodated by recent monetary policy actions and has solely characterised leu-denominated lending. Foreign-currency-denominated debts have been converted to leu-denominated debts so that the domestic currency share of total bank claims has risen to 50.9% from a low point in May 2012 of 35.6%.
The NBR sees these favourable developments in the Romanian economy as essentially offset by two kinds of risks, thus arguing for the status quo in terms of monetary policy. First of all, the NBR continues to carefully monitor fiscal policy developments in an effort to ensure a balanced policy mix for the economy. The bank views with some concern the recent acceleration of fiscal expenditure contemporaneous with the run-up to the parliamentary election scheduled for late 2016. This is combined with yet another cut in the tax burden effective at the outset of January as the rate of VAT was reduced from 24% to 20%. Although the leu has stayed within a relatively narrow band against the euro in the past year, going forward the NBR sees risks connected to the leu because of uncertainty around the fragile growth of the world economy as well as an expanded budget deficit to be posted by the Romanian government.
Outlook and implications
The NBR believes that in view of the reduction of the broad VAT rate, the rate of inflation will remain in negative territory in the near term. However, once the effect of the June 2015 VAT change drops out of the calculation, the y/y inflation rate will move into the positive range again. At the same time, the fiscal deficit will be expanding and nominal labour costs will be rising. Along with potential risks to the exchange rate from external developments and a possibly less favorable view on the part of international investors, this motivates the NBR to keep its policy rate unchanged. However, in view of the reduced pace of foreign-currency lending and in order to harmonise NBR policies with those of the European Central Bank and other EU central banks, the NBR has opted to cut the minimum reserve requirement on foreign-currency-denominated liabilities to 12% from 14% while leaving the requirement on leu-denominated liabilities at 8% as of 24 January. It is likely that further steps in this direction will be taken in the months ahead, with the bank holding fast on the monetary policy rate. The board will meet again on 5 February.