This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 03 BUCHAREST 003446 
 
SIPDIS 
 
SENSITIVE 
 
STATE FOR EUR/NCE - WSILKWORTH, EB/IFD 
STATE PASS USTR - LISA ERRION 
TREASURY FOR STUART 
USDOC FOR 4232/ITA/MAC/EUR/OEERIS/CEEB/BURGESS/KIMBALL 
STATE PASS USAID 
 
E.O. 12958: N/A 
TAGS: ECON ETRD EIND EFIN RO
SUBJECT: The Lion in Winter: Romania's Foreign Exchange 
Policy Changes 
 
 
This cable is Sensitive but Unclassified.  Not for Internet 
distribution. 
 
¶1. (SBU) Summary:  The National Bank of Romania (BNR), the 
country's central bank, has recently shifted from its long- 
standing policy of closely managing the Romanian Leu (ROL) 
foreign exchange (forex) rate to an infrequently managed 
free float.  The BNR now limits its interventions on the 
forex market and refrains from announcing when they will 
occur in advance. The Leu (Romanian for "lion") is gaining 
strength, causing anxiety for exporters and prompting more 
interest in tools to hedge currency risk. End Summary. 
 
Increasing Unpredictability in Foreign Exchange 
--------------------------------------------- --- 
¶2. (U) The National Bank of Romania (BNR), on October 29, 
switched to an infrequently managed float of the ROL on the 
foreign exchange market.  Since then, the ROL has 
appreciated 6.3 percent against the Euro and 11.4 percent 
against the USD, causing a boom for importers and increasing 
concern among local exporters.  The BNR's decision to cease 
almost daily interventions in the currency market is based 
primarily on its increasing forex reserves that have grown 
more than $4.2 billion from the beginning of 2004, now 
exceeding $14 billion.  This amount is well within the IMF- 
recommended range of reserves equivalent to four to six 
months of imports.  These robust reserves, coupled with a 
surplus of currency in the forex market originating from 
foreign remittances, foreign direct investment, and interest 
income on the BNR's reserves increased the Bank's comfort 
level with a freer float. 
 
Handling Hot Money 
------------------- 
 
¶3. (U) The BNR has defended its choice of allowing the ROL 
to float wider and more often as discouraging inflows of 
speculative or "hot" money.  Although Romania officially has 
always discouraged speculative foreign investments, they 
were not seriously considered a threat until recently. 
Historically, this so-called "hot" money naturally avoided 
Romania due to high investment risk.  Today, in spite of 
incomplete liberalization of the capital account, 
speculative foreign investment is dramatically increasing 
due to growing signs of an improved investment environment 
climate, including: 
-Fitch, the international credit rating agency, recently 
upgraded Romania to investment grade; 
-Macro-economic indicators, including inflation, 
unemployment and the budget deficits continue to stabilize; 
-The IMF precautionary standby agreement allows Romania to 
borrow up to approximately US$367 million if needed and 
authorized; 
-European Union membership is expected in 2007; and 
-Foreign investors have enthusiastically invested in 
Romanian Eurobonds, which, according to the central bank, 
may reach Euro one billion by the end of the year. 
 
¶4. (U) Improved economic conditions set the stage for 
increased hot money in the Romanian economy.  BNR Governor 
Mugur Isarescu predicts that speculative investments will 
total approximately Euro one billion by the end of 2004. 
Speculative investors have been particularly eager to 
exploit the high interest rates offered on ROL accounts 
through local banks.  Investors can easily benefit from the 
11.6 percent annual interest rate on ROL accounts by working 
through middlemen, a positive spread of 7 to 8.5 percent 
above Euro-denominated accounts.  Speculators exchange hard 
currency for ROL, invest in interest-bearing ROL accounts 
controlled by local brokers, then withdraw the money with 
the intention of quickly exchanging it for hard currency and 
then exporting the profits.  While exchange rates were 
stable due to central bank intervention, this positive 
spread was assured.  Today, with increasing exchange rate 
volatility, long-term bank investments, particularly those 
exceeding six months, may become less attractive for 
speculators if the ROL reverses its climb.  Investments with 
short-term maturities become more desirable; investors gain 
both higher interest and benefit from the current ROL 
appreciation trend. 
 
¶5. (U) Foreigners resident in Romania will also soon be able 
to join the group of potential speculators.  Currently 
prohibited from opening ROL accounts on their own, 
foreigners will be able to open local currency accounts in 
¶2005. 
¶6. (U) The BNR decided to discourage speculative investment 
by opting for a freer ROL float, rather than choosing to 
place restrictions on local banks, such as mandatory 
investment terms, interest-free short term accounts or early 
withdrawal penalties.  Although decreasing the spread 
between high interest rates on ROL accounts and low rates on 
hard currency accounts would also mitigate speculative 
investments, large cuts are unfeasible at this time due to 
relatively high Romanian inflation rates.  Nevertheless, the 
BNR has begun a process of lowering interest rates, which 
now stands at 18.25 percent for commercial banks deposits, a 
7.15 percentage point spread compared to the 11.1 percent 
inflation rate.  However, recalcitrant local commercial 
banks have avoided following the BNR's lead to cut their own 
interest rates on loans, due to a dearth of competition and 
risk associated with the domestic lending market. 
 
Keeping Inflation at Bay 
------------------------ 
¶7. (U) In addition to a desire to discourage speculative 
investment, the timing for the BNR's decision may also be 
linked to a desire to apply downward pressure on the 2004 
inflation rate, targeted for nine percent.  At the nine- 
month mark, the inflation rate stood at 6.6 percent, and, 
anticipating the need to purchase fuel for heating for the 
impending winter, the GOR recognized that maintaining the 
nine percent goal in the face of significant fuel imports 
was unlikely.  A rapidly strengthening ROL has served to 
keep inflation under control by making imports cheaper. 
 
Exporters Concerned about Impact... 
----------------------------------- 
¶8. (U) Not everyone is happy about the new managed float. 
Foreign imports are becoming cheaper for the Romanian 
population and Romanian export goods are becoming more 
expensive on foreign markets, hurting local manufacturers. 
The National Association of Exporters and Importers (ANEIR) 
recently declared that Romanian exporters lost seven to ten 
percent of revenue within one month as a direct result of 
the switch. Bank analysts are taking a more conservative 
stance, preferring to wait for two to three months of data 
to analyze to what degree the new forex policy affects 
exporters.  ANEIR is calling for dramatic cuts in interest 
rates to slow ROL purchases from speculative investors, 
which are a major factor in the currency's appreciation. 
 
¶9. (U) In addition, Romanian businesses are becoming 
increasingly interested in currency hedging strategies, 
although this is mainly coming from more sophisticated, 
medium- and large-sized firms.  This growing interest is 
apparent on the Sibiu commodities exchange where ROL-Euro 
futures contracts have increased from ten in June, 2004 to 
almost 1300 during the month of November.  ROL-USD contracts 
have also increased from 19 to 194.  Exporters who deal 
mainly in Euros, importing Euro-denominated inputs, and 
selling finished products priced in Euros, are virtually 
immune from the switch, although salaries and local 
utilities continue to be paid in ROL, which will have a 
negative effect on profits. 
 
¶10. (U) Romania's Minister Delegate for Foreign Trade 
recently defended the BNR's policy to let the ROL 
appreciate, in spite of criticism from exporters.  He has 
called on Romanian exporters to better prepare export 
strategies and examine ways to become more competitive.  He 
has also has insisted that lower inflation resulting from 
the new policy will greatly benefit Romanian businesses in 
the long term.  The BNR agrees with this assessment and has 
described the earlier ROL depreciation against major 
currencies as an implicit subsidy for uncompetitive Romanian 
exporters that could not continue. 
 
...But Consumers are Happy 
--------------------------- 
¶11. (U) While exports decline, imports are surging as 
Romanians eagerly purchase cheaper products from abroad, 
including machinery, textiles, minerals and automobiles. 
Embassy's discussions with a major U.S. car manufacturer and 
importer located in Romania found increasing first-time 
customer interest in U.S. vehicles and increasing sales 
overall on European imports.  Low cost imports are also 
benefiting Romanian businesses by allowing them to purchase 
tools and raw materials for lower capital costs, which will 
spur growth.  However, as imports increase and exports fall, 
the trade deficit is widening.  ANEIR believes that given 
the current ROL appreciation Romania may attain a record- 
high trade deficit by the end of the year. 
 
What the Future Holds 
---------------------- 
¶12. (U) Capital account liberalization will advance in April 
2005, with the anticipated availability of ROL denominated 
bank accounts for foreigners.  This will allow foreigners to 
benefit from high interest without requiring the services of 
a middleman.  This move may unleash a renewed ROL buying 
frenzy as speculators move into these accounts.  Soon 
afterwards, The Romanian government will create a secondary 
monetary market in which domestic T-bills, certificates of 
deposit and mortgages will be traded and which will likely 
also be open to foreign residents.  This market may also 
boost confidence in the ROL, perhaps again raising its 
value. 
 
¶13. (U) The BNR hopes that an additional important 
psychological boost for the public perception of the Leu as 
a serious and stable currency will occur next year when it 
introduces the "new" Leu to replace the old currency unit. 
The BNR, between July 2005 and December 2006, will divide 
all current denominations by 10,000, effectively removing 
four zeros from the bills.  The official currency trading 
designation of the Leu will change from ROL to RON 
("Romanian New").  The BNR hopes that this denomination 
process will assist disinflation through a psychological 
effect, similar to the results that followed Poland's 
currency redomination.  In the long term, as Romania 
approaches European Union membership and eventual adoption 
of the Euro, possibly in late 2014, the BNR believes 
volatility between the two currencies will diminish. 
However, where the rate will stand at that time is 
impossible to predict, all the more so as a new president 
with center-right leanings and somewhat undefined policy 
preferences has just unexpectedly been elected. 
 
Comment 
------- 
¶14. (SBU) Recent foreign exchange policy has shown that 
Romania has subordinated exchange rate price stability to 
inflation targeting, a move that is consistent with 
international standards and best practices.  However, this 
move makes business difficult for those Romanian exporters 
that may be unprepared for increased international 
competition as their goods and services become more 
expensive.  This situation is a good test for the more 
competitive environment that Romania will face in the future 
as it approaches EU accession.  In the short term the ROL 
will likely continue to appreciate, absent significant 
interference from the BNR.  In the longer term, if Romania's 
taste for cheap imports continues, and the trade deficit 
expands, demand for hard currency should slow and reverse 
current Leu appreication. 
 
Crouch