In 2012 invest in Romania like it is an election year

In 2012 the Romanian government will be in the RON denominated market like a bull in a china store. It is big and clumsy and with every move can knock off entire parts of the store, i.e. the economy.  What is worse, our “bull” is blinded by its political goggles as 2012 happens to be an election year in Romania. Nevertheless, this could be a great year for investing in Romanian denominated assets, you just need to understand a bit of local politics.

Until this year the surge in public debt which started in 2009 did not create a real problem for the money market or for the economy. The government borrowed short term and in RON while the real economy borrowed long term and in EURO (see the graph below).

Things have changed, however, and EURO is now needed elsewhere to support balance sheets that support ballooning government debts. This in turn means two things for Romanian lending/banking/financial market: increased costs and in the best case scenario maintaining the current nominal value of the funding lines. Bluntly put, lending in EURO is stopped by a shortage of euro for the local market.

Therefore, banks and any other institution extending credit will have to find ways to do it in RON. In the same time the Romanian government will have to roll-over its short term debt but also to fund the increasing expenditures for 2012 (forget about the deficit, the revenues are manipulated to give the low deficit).

Basically we will witness a real competition for RON funding between the government and the real economy. Do not be so quick to think that the government will be the clear winner. The battle will be fierce.

For example, it is normal to assume that if the NBR keeps the current liquidity in the money market slowly but surely we should see strong upward pressure on money market rates. It will not happen overnight because banks need time to sell the RON story to their clients. It will happen, nevertheless.  Therefore, higher money market interest rates will make the cost of borrowing for the government more expensive. With an NBR always looking to lower the cost of borrowing for the government (I do not know why -you can speculate about it yourselves- but they do it) one would be entitled to expect short term rates to remain low.  WRONG! The NBR cares a lot about the exchange rate. In fact it cares more about exchange r ate deviations from an target known only to them than it cares about the inflation.(see graph below and analysis on monetary policy). In this environment it will have a real problem to lower rates as this could push the exchange rate too high for their own liking. In an election year this would be seen as a big, big faux pas from the NBR.

Where does this leave then interest rates, the exchange rate and the real economy in 2012? To understand it you have to put your political glasses on. As long as you will think like a politician you will be fine and might make some return on your investments in 2012. What do Romanian politicians need in 2012? Growth and higher nominal wages. What is it that they do not need? RON depreciation.  It is almost impossible to deliver growth in 2012 but very easy to increase nominal wages and stop RON depreciation.

Thus the conclusion for me is that in 2012 we should expect: interest rates to remain high, government borrowing costs to increase along with public debt and RON to depreciate just a bit.

All of this it will have a cost which we will see starting 2013: no economic growth and higher taxes.


9 thoughts on “In 2012 invest in Romania like it is an election year

    1. @Bogdan
      If you are overly optimistic with your revenues. It can be done by assuming a very optimistic scenario for growth. Or by assuming an optimistic scenario for collection. Or by assuming that you will in one year receive from the EU funds that you were not able to receive in the last 5 years.
      These are just few ways. 🙂 I will stop here otherwise I will give them ideas.

  1. EUR funding is becoming more expensive and the NBR has a 6% policy interest rate. Inter-bank interest rates are high as well. I am really curios how would have things worked out if the Gov. hadn’t increased the VAT offering the “inflation is too damn high” excuse to the NBR not to lower rates. Taking in to account the fact that before the VAT surge we had disinflation, and afterwards disinflation kicked in again, it would be interesting to see what the NBR will offer as an excuse for not lowering rates in 2012 (and no, a 0.25% decrease is not enough)

    On the other hand, If I am not mistaking, high interest rates were the IMF’s prescription during the asian crysis to countries facing similar challenges as Romania. They said these rates were necessary in order to insure foreign capital does not leave the country. It turned out to be a bad move then so I’m really curios why it should work now.

    1. @ddr
      The current monetary policy stance is consistent with an exchange rate targeting regime. The NBR knows the economy is euroized and that fiddling with the RON rate does not help.

      1. My thoughts exactly, rents, assets prices, wages, even aspects of fiscal legislation are euro denominated, but this keeps us in a tight spot when it comes to monetary policy. If the NBR targets the exchange rate then it will have little or no other means of offering stimulus to the economy given the current circumstances. Fiscal stimulus is out of the question, and from what I understand so is monetary stimulus.
        So what now? Do we wait for a monetary or fiscal miracol?

      2. I am not sure about the fiscal part.A combination of aggressive expenditure cuts together with much lower taxes might do the trick. Regarding monetary policy the only way out is to bite the bullet and depreciate the currency. Not to gain competitive advantage internationally. WE need it to increase the monetary base and lower long term rates. This combination should create an incentive for banks to push RON loans. Also, we need to force those selling contracts denominated in foreign currencies to sell in the same time protection. People should have the option to protect themselves. Somehow we need to eliminate the information asymmetry between lenders and borrowers.
        Finally, we need to accept some losses within the economy. This way we will release resources that are now tied in bad investments.

  2. Fiscal cuts are out of the question. The Gov. does not even consider talking about measures to lower taxes, and this has happened since 2009. None of the recent fiscal measures imply lowering taxes or diminishing the taxation basis. Lowering the VAT would not help in any way consumption, profit tax is irelevant at this point for companies while social contributions have a very low pass through effect (if you lower social contribution, at this point, given political and economical uncertainty, the money will go to company reserves or employees savings account, and not to expenditure in the real economy). The monetary measures you brought up would probably be more usefull but would inflict a lot of pain to the population (please read eligible voters) in 2012.

    If a radical change does not take place (perhaps in the EU), 2012 may be a lost year for Romania, in which nothing notable from a macro point of view will happen

    1. @ddr As I said in the post, I expect higher nominal wages this year and higher public debt. Everything else will be kept simmering up to December 2012. Then will see how the built up pressures will be relieved. I have my money on higher taxes in 2013.
      Growth will not return to Romania until the EU will grow again at 2%.

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