Romanian economy shows more and more like a developed economy. Unfortunately we are talking about the crisis symptoms. Nominal GDP growth stabilized since 2010 at an average of 4% per year. Inflation has fallen and it has surprised on the downside over the same period. The output gap (an imperfect estimation of demand deficit) has remain high over this period also.
Unfortunately the latest data confirms the continuation of this picture. The National Bank of Romania has revised its measure of output gap throughout 2014 every time showing a bigger gap – higher demand deficit
On top of everything the key policy rate is just 25bp above the inflation target while inflation remains 100bp below target. It is estimated by the NBR to return to target by 2016. However, if it lingers close to zero and key policy rate is reduced below the target we might need to talk about negative interest rates to bring the inflation to current target. Of course NBR could lower the target but this is a dangerous proposition this close to zero.
Luckly for the NBR there is a solution: currency depreciation. NBR needs to allow the RON to depreciate. In fact it needs to make it clear that it will allow the currency to float freely. Any interventions in the FX market should be sterilized. Considering the current global economic environment the risks of a prolonged appreciation are much smaller than those of a prolonged depreciation. Finally to help things the NBR should release long term liquidity into the money market. Both these will reassure banks interested to lend long term in RON that there will not be a sudden liquidity shortage after a period of RON depreciation. Also, more liquidity will attract more players to both FX and money markets. Some of that effervesce will spill over to the rest of the economy.
Sources: NBR and FCA own estimates