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.