VZCZCXRO3197
PP RUEHAG RUEHAST RUEHDA RUEHDBU RUEHDF RUEHFL RUEHIK RUEHKW RUEHLA
RUEHLN RUEHLZ RUEHPOD RUEHROV RUEHSR RUEHVK RUEHYG
DE RUEHBM #1272/01 3131629
ZNR UUUUU ZZH
P 091629Z NOV 07
FM AMEMBASSY BUCHAREST
TO RUEHC/SECSTATE WASHDC PRIORITY 7599
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/USDOC WASHDC

UNCLAS SECTION 01 OF 02 BUCHAREST 001272 
 
SIPDIS 
 
STATE FOR EUR/NCE - AJENSEN, EB/IFD 
TREASURY FOR LKOHLER 
USDOC FOR KNAJDI 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: EFIN ECON ETRD PGOV RO
SUBJECT:  ROMANIAN CENTRAL BANK HIKES INTEREST RATES IN FACE OF 
GROWING INFLATION FEARS 
 
 
Sensitive But Unclassified - please handle accordingly. 
 
SUMMARY 
------- 
 
¶1. (SBU) Faced with growing inflationary pressures in the economy, 
the National Bank of Romania (BNR) raised its benchmark interest 
rate a half point, from 7.0% to 7.5%, at its October 31 Board of 
Directors meeting.  The hike marked a reversal of the looser 
monetary policy BNR had pursued since the beginning of the year, and 
comes in response to mounting signs that inflation this year will 
exceed the Bank's annual target by perhaps a full percentage point. 
Markets had anticipated the move, along with the Bank's decision not 
to change existing minimum reserve requirements for credit 
institutions.  Outside analysts, including the IMF, see the move as 
reassurance of the central bank's policy independence, but worry 
that yellow caution signals concerning Romania's growing economic 
imbalances are beginning to flash a bit more urgently.  End summary. 
 
 
Central Bank Reverses Course 
---------------------------- 
¶2. (U) Local market analysts had anticipated the BNR's October 31 
decision to raise its benchmark interest rate by half a point, to 
7.5%.  The real surprise was that, in the face of rising 
inflationary pressures, the Bank waited this long to reverse its 
monetary relaxation policy.  BNR had progressively cut rates since 
February from 8.75% to 7.0%, encouraged by lower inflation in 2006 
through early 2007 in connection with the appreciation of the leu 
against the euro.  However, as early as mid-summer it was becoming 
evident that the Bank would have trouble keeping inflation within 
the annual target band of 4% plus/minus one percent, particularly as 
domestic agricultural production suffered from a serious drought. 
Inflation zoomed to an annualized rate of 6.03% in September, led by 
steeply rising food and energy prices, very strong domestic wage 
growth, and an end to the leu's exchange rate gains against the 
euro. 
 
¶3. (U) In explaining the rate hike, the Bank also cited rising 
prices of imported food commodities generally and the adverse impact 
of the exchange rate on Romania's ballooning current account 
deficit, particularly when viewed against the background of recent 
turmoil in world financial markets.  The Bank also took the unusual 
step recently of issuing a public call for the GOR to hold spending 
in check.  While analysts say BNR policy has been prudent and 
credible, and that BNR has been understandably reluctant to fuel 
more speculative capital inflows by raising interest rates, market 
conditions forced its hand.  By attempting to apply the brakes, BNR 
also clearly has its eye on persistently strong household 
consumption, projected increases in public spending towards the end 
of the year, and further uncertainty over the leu's rate movements - 
all of which together will make it impossible to confine inflation 
within the 5% upper band ceiling. 
 
Darker Clouds on the Economic Horizon? 
-------------------------------------- 
¶4. (SBU) From a purely political perspective, outside analysts 
including the IMF were encouraged by the rate hike, as it 
demonstrates that the BNR is asserting its policy independence at a 
time when Romania's political cycle would have argued against a 
monetary tightening.  With the country now entering an extended 
electoral period, beginning with European Parliament elections, 
politicians would clearly prefer the BNR take no action that could 
put a damper on economic growth.  Still, how much leverage BNR 
really has over the broader economy - much less GOR fiscal policy - 
is open to question.  That uncertainty is fueling concerns that 
Romania's economic fundamentals may not be as sound as they appear. 
Rising inflation, the huge and growing external deficit, and rapidly 
increasing wages in excess of labor productivity gains are 
cautionary signals that Romania's recent economic exuberance is 
becoming unsustainable. 
 
¶5. (SBU) An IMF mission to Romania in late September stressed the 
heightened vulnerability of Romania's economy and currency to 
external shocks.  The IMF is increasingly concerned about government 
spending and the lack of a solid medium-term framework for fiscal 
policy at the Ministry of Economy and Finance.  As a result, the IMF 
is warning that the current account deficit could exceed 15% of GDP 
by year's end, and recommends the GOR reign in demand by holding the 
consolidated budget deficit to 2% of GDP in 2007 and 1% in 2008. 
The GOR may come close in 2007, but no one is expecting it will meet 
the 2008 recommendation. 
 
¶6. (SBU) Other analysts are similarly expressing caution about 
Romanian prospects.  Standard & Poors cut Romania's outlook this 
 
BUCHAREST 00001272  002 OF 002 
 
 
week to "negative" from "stable" on the basis of BNR's warnings. 
ABN AMRO predicts that inflation will run above the BNR target into 
2008, with further interest rate hikes a real possibility.  While 
higher interest rates would normally be expected to prop up the leu 
by inviting speculative investment flows, ABN AMRO believes rising 
investor concerns over exchange rate risk will still push the 
currency down vis-`-vis the euro in the coming months. 
 
Comment 
------- 
¶7. (SBU) While by all outward appearances Romania's economic boom 
continues unabated, the BNR rate hike and rising unease on the part 
of ratings agencies and the IMF are warning signals that the country 
may be in for a correction.  BNR's action has reinforced perceptions 
that the Bank is serious about trying to hold inflation in check, 
and if the leu declines against the euro as analysts are predicting, 
that would ease the pressure on the current account deficit.  Higher 
interest rates pose other risks, however, and BNR clearly wants the 
Government to restrain spending so as not to force the Bank into 
raising rates too much.  Romania's ability to weather an external 
shock is looking rather more precarious, and it may not take much to 
upset the apple cart. 
Taubman