Last week I looked in detail at the NBR statement after the decision to cut the key policy rate by 25 basis points. To refresh, my conclusions there were that due to a badly damaged credit channel to relax monetary conditions NBR will have to depreciate the currency in nominal terms or lower the minimum reserve requirements (MRR) for RON and EUR.
Last night Deputy Governor Cristian Popa was on TV and among other topics he mentioned the monetary conditions. His talk confirms my estimate that the only way to relax monetary conditions is by depreciating the RON.
Just here me out.
First, let’s look at the credit channel again, but very briefly. Let’s assume I am totally wrong. And that the post I wrote few days ago about the NBR statement is just total non-sense. I will give the benefit of the doubt to anyone and let’s assume the people at NBR know better and are closer to the real world than I am. Let’s assume that a 0.25% cut in the key policy rate is enough to lower lending rates in Romania. Let’s assume NBR is right and I am dead wrong and the credit channel works. Even better, it works faster than research at NBR shows. In the best scenario let’s assume that the whole 25 basis points cut get instantaneously transferred to lending rates. Does anyone honestly believe that a 25 basis point cut can increase demand for credit while real income has fallen by 2.9% until August this year relative to the same period last year? I do not.
Second, let’s look at the minimum reserve requirements (MRR) – implicitly a tax imposed by NBR on banks’ liabilities to control credit growth. Last night Mr. Popa provided new information regarding the evolution of this tax. In his view MRR for both EUR and RON will remain unchanged due mainly to fear of capital flight. Thus, Mr. Popa confirms what I have been saying all along – two days after I said it was also mentioned by one CEO of a branch of a Dutch bank in Romania – that currently there are no barriers to capital into or out of Romania.
Third, a tricky central bank can push money in the economy via the budget deficit. I have not mentioned this channel in my previous analysis but it is an important one these days and in almost market economies. This is how it would work. Surprise budget deficits need to be finance via local banks. Local banks will finance it and then use the t-bonds/bills to get cash from the central banks two or three days later at the same price or even a discount. This will not be your normal primary market deal but a deal done via few preferred banks. Banks will go to the NBR to cash the bonds and this is how money get pushed in the economy, i.e. money supply growth. But Mr. President Basescu, the IMF and the NBR assured us of a small budget deficit in 2012. Thus at least in theory this channel is also eliminated.
To me these are the three main ways through which the central bank can currently inject cash in the Romanian economy. Unless there is another way by which the central bank can push money in the economy by process of elimination we are left with RON depreciation, even orderly if that makes the NBR comfortable, but depreciation nonetheless. This does not mean that RON will fly into the sky tomorrow. It does mean, however, that if central bank is serious about relaxing monetary conditions will have to leave with RON rates against EUR constantly higher on average. The depreciation should continue until Romanian economic growth will be above potential for some time. Also, should any of the other channels show signs of recovery then depreciation of RON could take the back seat. Until then there is no way to avoid a weaker RON.
P.S.: I am not sure why everyone is so afraid of depreciation. I had to buy some EURO today from my RON account at ING Bank. The exchange rate used was 4.41 RON/EUR. In the real economy we are already there. All we need is for the “official” rate to close the gap.