What did the NBR really say yesterday?

On Tuesday I wrote a post showing that NBR’s policy has been too tight in the last three years relative to the economic conditions. I was advocating for an aggressive loosening of broad monetary conditions which includes an aggressive cut in interest rates. A day later the NBR cut the key rate by 0.25% to 6%. I see this as a no-change and so did the market. But few newspaper want to tell you that there is more to this cut than meets the eye.

Then does really anyone think, even the NBR, that a 0.25% cut will lower lending rates? Not me and I am sure not the NBR either.

For example, here is how ZF sells the story (highlights are my own):”BNR Cuts Key Rate To Boost Lending yesterday, 12:10

Romania’s central bank Wednesday lowered its main interest rate by a quarter of a point to 6% a year, the first cut in the last year and a half, in a move to boost bank lending and energize economic recovery.”

I do not have a subscription to the paper but I can guess what is following.

However, I heard the idea from more than one paper and that made me curious. I went back to the source for more evidence:  NBR statement following the decision .

Well, it is one of the most interesting I have seen from them in a while. The first paragraphs give you the impression that the cut in the key rate is justified by their view that inflation will fall further:”For the months ahead, disinflation is envisaged to consolidate, along with the downward adjustment of inflation expectations”.

But then it starts to get interesting.

“…the revival of loans to the private sector is still modest, also as a result of banks’ pro-cyclical behaviour reflecting uncertainties and risks related to the sovereign debt crisis in the euro zone and the mixed signals on world economy recovery.”

In plain language the NBR puts the blame of poor lending in the last three years on banks. Still, it does acknowledge that lending behavior is influenced by developments in global and local economy.

And then very very interesting.

“The judicious adjustment of the central bank’s stance is aimed at steadily ensuring adequate real broad monetary conditions so as to secure a lasting maintenance of inflation inside the variation band around the targets as well as financial stability – these elements, alongside the implementation of commitments on strengthening fiscal consolidation and structural reforms undertaken by the Romanian authorities under the multilateral external financing arrangements signed with international institutions, are essential for a sustainable recovery of the Romanian economy.

The gradual adjustment of real broad monetary conditions is expected to be reflected in banks’ lending rates. At the same time, the NBR Board reiterates the importance of fostering domestic saving, also by an appropriate remuneration of bank deposits in order to ensure a sustainable external deficit and a progressive reduction in relative terms of the degree of dependency of Romania’s economy on external financing.”

And there it is in black and white: adjustment of real broad monetary conditions. I am amazed they specifically mention the broad monetary conditions in two paragraphs. I will not flatter myself that this is an answer to my preliminary conclusions posted here a day before the decision but I can congratulate myself on the timing of the post.

Now, I want to go back to one specific sentence in the statement: “The gradual adjustment of real broad monetary conditions is expected to be reflected in banks’ lending rates”. This must mean more than just cutting rates. This is why in my view.

NBR’s own research says that the process of adjusting deposits or lending rates is slow. It finds two interesting characteristics: dominant position of banks in the financial sector (i.e. lack of funding alternatives) and the substitution of RON loans with EUR loans. Both very valid and I could not agree more with them. Even more interesting are the estimates from the research paper.

Below are the pass-through effect to lending rates for households and companies from a permanent one percent increase in the key policy rate. As you can see the immediate effect is an increase in the lending rates for households with 0.36% while for companies 0.51%. The effect of the increase in the key policy rate will be larger with time.


3 m













Source: NBR, Caiet de studii nr.28/2010

But, and this is a very big BUT, the paper talks about a change in key rate understood by the market as permanent. In the same time it talks about an increase in the key rate and one that is 4 times higher than the change in the key rate delivered by NBR yesterday. Regarding the magnitude the table above tells you how much theoretically one should expect lending rates for new credit in RON to fall in the current months . If the response would be symmetric, i.e. an increase is passed to the economy in the same way as a decrease. But there is still one big problem: ASYMMETRY. This is present in central bank’s decisions – they like to lower rates faster than to increase them-  and in commercial banks. What is this? It is a very simple fact. Banks will pass faster an increase in costs, i.e. interest rates, to the consumer than a decrease. In other words an increase in the key rate represents a cost while a decrease represents a profit.

Back to the sentence in the statement which implies that adjustment of broad monetary conditions will be reflected in the lending rates. As you can see the own NBR research shows that you should not expect much even when the change is bigger and permanent. Thus my view is that you should not expect anything when the change in the key rate is small, not seen as permanent and it represents an immediate profit to banks, i.e. a decrease.

And there is something else. Broad monetary conditions include more than the key rate developments. The other very important channel is the exchange rate. In the current state of the economy an injection of liquidity in the system via currency depreciation will do much more for lending rates than the key rate. It will increase the cost of euro loans, new and old, via depreciation and provide liquidity for the new RON loans to be less expensive.

One more element to be added here: reserve requirements. A lowering of the reserve ratio will increased the broad monetary base and contributes to lower RON rates for new loans.

I hope that this long post shows that the statement from the NBR cannot only refer to the credit channel as the only channel to influence the real monetary conditions. In order to deliver lower RON lending rates NBR has to consider the other elements: the exchange rate and the reserve ratio. It is sending the clear signal that that is what is expecting but they must know that without depreciation and lower reserve ratios it cannot be done.  Until they mention that  I am glad that the central bank is looking at broad monetary conditions because my research shows that before the fiscal mistakes of 2009, 2010, 2011, the negative monetary policy shock of 2008 had very lasting effects for the Romanian economy.




16 thoughts on “What did the NBR really say yesterday?

  1. I don’t think they will be very happy about a depreciation :). I saw on a TV band something written, like: A. Vasilescu said the NBR will conduct market operations in order to determine the banks to decrease the rates. Something alike.

    I Don’t quite trust him, I don’t see on statistics the NBR using such a thing :DDDD, but it’s what I saw :). And, anyway, is 6%, quite like the robors these days. And I think it’s freak to have a 6% rate and to use market operations to keep the markets rates at … 5% :)). May be you can understand this one better than I did :).

    1. Unless they force banks at gun point I am certain that a 0.25% will not do anything. Market operations??? Money market rates have been below the key policy rate for the last 4 quarters at least. See my post on Tuesday. The margin that bans charge over the cost of funds is a function of economic environment, volatility of funding costs, solvency of clients and few others. In this environment the biggest immportance is assigned to market risks (i.e. probability of recession) and cost of funds risks (i.e. the risk that you might have to borrow at 10% from the NBR). Market operations alone will be more of the same, and that has not done a very good job for us lately.

      1. I thought I am freak or something :)) And I can’t even understand what sort of market operation can you make while you’re higher than them … 🙂 I thought is the reverse, you need to go lower than them and then try to bring them down. Do you think it’s possible that Mr Vasilescu signaled further, eventually visible, decreases?

  2. “the substitution of RON loans with EUR loans”.
    “The other very important channel is the exchange rate”

    I’m not sure the exchange rate chanel works that well since as you stated the Romanian economy has witnessed in the past year a substitution of RON loans with EUR loans. I would even go further and say that in Romania most of the assets are tied to the EUR exchange rate. A large part of the food we buy in supermarkets are imported and the purchase contracts behind them are also negociated in EUR. Unfortunatelly salaries not and therefore a depreciation of the EUR exchange rate could induce a lot of damage on the household consumption side. There is also a lot of pressure on Romanian households and SME’s which have euro denominated loans and cannot refinance them.

    The reserve ratio will most likely be lowered in 2012, when I expect the NBR to bring out the big guns.

    1. @ddr

      If we want to keep the actual model, with lot of imported consumption and less production inside, keeping the exchange rate artificial at certain levels may look like a solution in the short run. Although is not, because most probably after the consumption will start to improve, and also the imports, we will see a natural devaluation of the ron, as probably the level of FDI and loans to romanian banking system will not be that high, and, mostly, will not put the same pressure, as volumes, on the exchange rate, as in the period before and following the eu accession, which was a special period. And I don;t know to what extent the central bank will still be able to keep the artificial levels, if the interbank market continues to grow, plus the imports, plus a more and more addiction of the romanian people to euro, as you advertise. So thinking that you could keep this model for years, may be unrealistic :). In the most happy (or unhappy, I don’t know) scenario you will see sudden jumps to the next level, just like after 2008, if you don ‘t allow it to fluctuate naturally meanwhile, and you will end up in the same place.

      Plus, this is why currency risk exists, to bring back the equilibrium, not to encourage people to remain irational forever. One day the imports will get really expensive, the consumption will drop, and this will stimulate the internal production. May be is time for us to start to produce our own food and stop protecting the imports. People will still need to buy things, so most probably they will start to search for cheaper, eventually romanian, goods, which will encourage more production and more competition inside our border. And is the same with the guyz with a euro denominated loan. Again, we shouldn’t encourage an irational model forever, just because in the very short run it sounds better. Little by little we should allow the natural exchange rate risk to rebalance some mistakes, because this is why it exists, and it shouldn’t be eliminated artificially :).

      Even if the NBR will not depreciate it itself, the market will do it for them, it wouldn’t be the first time :).

      1. The NBR has a managed exchange rate. They do not have the necessary funds to maintain the exchange rate at an “artificial level” but what they can and actually do is manage the extend to which the exchange rate fluctuates in a given period. They cannot change the trend, but they can make it more smooth in the short term.

        The exchange rate you see know is not artificial.

      2. @ddr
        I agree with you that they cannot change the trend. But they can really control the levels by making the market very small and without derivative products.Actually, if Romania would have had a normal secondary market for gov. bonds the exchange rate volatility would have been harder to control.

        And I am sorry, but I cannot agree with your last point. The current level is as artificial as you can get. just look at the lower reserve from last month, that should tell you how much it cost the NBR to keep it around here.

  3. This is true that they have a managed regime, but as you acknowledge,and as we all can see, they can’t influence this too much in the long run. The exchange rate already got to another level, although in the beginning the NBR didn’t agree :). Plus, I can’t see a reason for this smoothing, is against our medium and long term interest. 🙂

    So the exchange rate could also help in reestablishing some balances, and also in the fight against euro loans, which are now a problem, and seam to continue to amplify if nothing is done about this. Of course I wouldn’t expect from them a deserved devaluation of our ron, as even nowadays is overvalued, so I wouldn’t expect the rate to get to 5 next year :). But this doesn’t mean that we can’t see a 4.5 as an average level in 2013 :).

    On my opinion, everything that is managed, targeted, and mostly in a direct way, is artificial. Including the eurron. Is not like this price is freely set in the market, at the meeting of the demand and supply. But is like from time to time the central bank intervenes in the natural course of the process :). This means an artificial price, it doesn’t fully reflect the view and the transactions of the free market. Of course it is not totally artificial, but is artificial. And also overvalued, together with the interest rates. 🙂

    Of course, this is only my view.

    1. 1. If I am not mistaking, the RON has undeperformed its CEE peers since the start of the crisis. So, basically, I would argue that the C-Bank has not exaggerated with its manged regime.
      2. The Pandora’s box for EUR loans has been opened 5-6 years ago and only banning it could stop it (with the economic headwinds ahead, not desirable). So this is the status quo and we can only accept it as it is and what the NBR can only do is to try to gradually change the balance smoothly towards RON lending. As such, with almost every household having borrowed euros to buys a vacuum cleaner, car or whatever, and with a recession unfolding, it did make a great deal of sense for the C-Bank to smooth the EURRON dynamics.
      3. If C-Banks in Poland, Turkey etc have stepped in lately to curb LC depreciation, I guess we could “forgive” our own C-Bank for doing …well, the exact same thing.
      4. I agree that “artificial support” is not good, but I would say that sometimes it is a necessity in order to give TIME to other more important imbalances to be worked through.

      1. 1. I think this is quite short sighted 🙂 Who are the peers, to what extent structurally we look the same, to what extent we bear the same monetary policy, and so on? This is not a reason to conclude the NBR didn’t exaggerate :). The guys in the banks prefer it, because is easier to compare things, you only need a graph. No offense >:D:D<.

        And, btw, I find this addiction to always choose the neighbours as a reference to be questionable. I'd ask you: do you feel like Romania has much to do with Turkey or Poland, both in terms of bop or monetary policy?

      2. Investment decisions are always based on comparables. And those crazy-investors who contribute to our bop do care about those simple graphs.
        I always prefer a “short sighted” view if it brings me money. You call it short sighted, I call it “the K I S S rule”.

  4. @Florin Citu

    Let’s say that BNR lets the RON float.(They don’t intervene at all.) And the romanian state allows at least the USD, EURO and RON as legal tender.

    Basically, people will be able to make their own mind on which currency they use for paying at the supermarket, their taxes and so on. And the Romanian New Leu will no longer be that important. So they wouldn’t have to spend all those taxpayer money to artificially maintain the exchange rate.

    People should be allowed to choose. I don’t think that free market concept reffers only to products and services. I can easily reffer to currencies as well.

    1. (spell checked version:)
      @Florin Citu

      Let’s say that NBR lets the RON float.(They don’t intervene at all.) And the Romanian state allows at least the USD, EURO and RON as legal tender.

      Basically, people will be able to make their own mind on which currency they use to pay at the supermarket or to pay their taxes. And the Romanian New Leu will no longer be that important. So NBR wouldn’t have to spend all those taxpayer money to artificially maintain the exchange rate.

      People should be allowed to choose. I don’t think that the free market concept refers only to products and services. It can easily refer to currencies as well.

      1. @adrian t.
        very good point. this is what is all about:free choice. Actually, if you look at what has happened in Romania you will find that people and firms were allowed to enter contracts in any currency they wanted. Just that taxes had to be paid in RON. So, good money drove bad money out of contracts in the private part of the economy and the illegal part of the state-owned economy. Even today, we not dealing with the problem properly. You either allow all currencies to be used in the economy for all purposes or you just make one the real legal tender. Half ways will get you in trouble every time.
        thanks for the comment.

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