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Cablegate: Romanian Central Bank Hikes Interest Rates in Face Of

VZCZCXRO3197
PP RUEHAG RUEHAST RUEHDA RUEHDBU RUEHDF RUEHFL RUEHIK RUEHKW RUEHLA
RUEHLN RUEHLZ RUEHPOD RUEHROV RUEHSR RUEHVK RUEHYG
DE RUEHBM #1272/01 3131629
ZNR UUUUU ZZH
P 091629Z NOV 07
FM AMEMBASSY BUCHAREST
TO RUEHC/SECSTATE WASHDC PRIORITY 7599
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/USDOC WASHDC

UNCLAS SECTION 01 OF 02 BUCHAREST 001272

SIPDIS

STATE FOR EUR/NCE - AJENSEN, EB/IFD
TREASURY FOR LKOHLER
USDOC FOR KNAJDI

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: EFIN ECON ETRD PGOV RO
SUBJECT: ROMANIAN CENTRAL BANK HIKES INTEREST RATES IN FACE OF
GROWING INFLATION FEARS


Sensitive But Unclassified - please handle accordingly.

SUMMARY
-------

1. (SBU) Faced with growing inflationary pressures in the economy,
the National Bank of Romania (BNR) raised its benchmark interest
rate a half point, from 7.0% to 7.5%, at its October 31 Board of
Directors meeting. The hike marked a reversal of the looser
monetary policy BNR had pursued since the beginning of the year, and
comes in response to mounting signs that inflation this year will
exceed the Bank's annual target by perhaps a full percentage point.
Markets had anticipated the move, along with the Bank's decision not
to change existing minimum reserve requirements for credit
institutions. Outside analysts, including the IMF, see the move as
reassurance of the central bank's policy independence, but worry
that yellow caution signals concerning Romania's growing economic
imbalances are beginning to flash a bit more urgently. End summary.


Central Bank Reverses Course
----------------------------
2. (U) Local market analysts had anticipated the BNR's October 31
decision to raise its benchmark interest rate by half a point, to
7.5%. The real surprise was that, in the face of rising
inflationary pressures, the Bank waited this long to reverse its
monetary relaxation policy. BNR had progressively cut rates since
February from 8.75% to 7.0%, encouraged by lower inflation in 2006
through early 2007 in connection with the appreciation of the leu
against the euro. However, as early as mid-summer it was becoming
evident that the Bank would have trouble keeping inflation within
the annual target band of 4% plus/minus one percent, particularly as
domestic agricultural production suffered from a serious drought.
Inflation zoomed to an annualized rate of 6.03% in September, led by
steeply rising food and energy prices, very strong domestic wage
growth, and an end to the leu's exchange rate gains against the
euro.

3. (U) In explaining the rate hike, the Bank also cited rising
prices of imported food commodities generally and the adverse impact
of the exchange rate on Romania's ballooning current account
deficit, particularly when viewed against the background of recent
turmoil in world financial markets. The Bank also took the unusual
step recently of issuing a public call for the GOR to hold spending
in check. While analysts say BNR policy has been prudent and
credible, and that BNR has been understandably reluctant to fuel
more speculative capital inflows by raising interest rates, market
conditions forced its hand. By attempting to apply the brakes, BNR
also clearly has its eye on persistently strong household
consumption, projected increases in public spending towards the end
of the year, and further uncertainty over the leu's rate movements -
all of which together will make it impossible to confine inflation
within the 5% upper band ceiling.

Darker Clouds on the Economic Horizon?
--------------------------------------
4. (SBU) From a purely political perspective, outside analysts
including the IMF were encouraged by the rate hike, as it
demonstrates that the BNR is asserting its policy independence at a
time when Romania's political cycle would have argued against a
monetary tightening. With the country now entering an extended
electoral period, beginning with European Parliament elections,
politicians would clearly prefer the BNR take no action that could
put a damper on economic growth. Still, how much leverage BNR
really has over the broader economy - much less GOR fiscal policy -
is open to question. That uncertainty is fueling concerns that
Romania's economic fundamentals may not be as sound as they appear.
Rising inflation, the huge and growing external deficit, and rapidly
increasing wages in excess of labor productivity gains are
cautionary signals that Romania's recent economic exuberance is
becoming unsustainable.

5. (SBU) An IMF mission to Romania in late September stressed the
heightened vulnerability of Romania's economy and currency to
external shocks. The IMF is increasingly concerned about government
spending and the lack of a solid medium-term framework for fiscal
policy at the Ministry of Economy and Finance. As a result, the IMF
is warning that the current account deficit could exceed 15% of GDP
by year's end, and recommends the GOR reign in demand by holding the
consolidated budget deficit to 2% of GDP in 2007 and 1% in 2008.
The GOR may come close in 2007, but no one is expecting it will meet
the 2008 recommendation.

6. (SBU) Other analysts are similarly expressing caution about
Romanian prospects. Standard & Poors cut Romania's outlook this

BUCHAREST 00001272 002 OF 002


week to "negative" from "stable" on the basis of BNR's warnings.
ABN AMRO predicts that inflation will run above the BNR target into
2008, with further interest rate hikes a real possibility. While
higher interest rates would normally be expected to prop up the leu
by inviting speculative investment flows, ABN AMRO believes rising
investor concerns over exchange rate risk will still push the
currency down vis-`-vis the euro in the coming months.

Comment
-------
7. (SBU) While by all outward appearances Romania's economic boom
continues unabated, the BNR rate hike and rising unease on the part
of ratings agencies and the IMF are warning signals that the country
may be in for a correction. BNR's action has reinforced perceptions
that the Bank is serious about trying to hold inflation in check,
and if the leu declines against the euro as analysts are predicting,
that would ease the pressure on the current account deficit. Higher
interest rates pose other risks, however, and BNR clearly wants the
Government to restrain spending so as not to force the Bank into
raising rates too much. Romania's ability to weather an external
shock is looking rather more precarious, and it may not take much to
upset the apple cart.
Taubman

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