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Cablegate: Romania: Strong Growth Continues, but at an Inflationary

VZCZCXRO0124
PP RUEHAG RUEHAST RUEHDA RUEHDF RUEHFL RUEHIK RUEHKW RUEHLA RUEHLN
RUEHLZ RUEHPOD RUEHROV RUEHSR RUEHVK RUEHYG
DE RUEHBM #0739/01 2660925
ZNR UUUUU ZZH
P 220925Z SEP 08 ZDK ALL CTG NUM SVCS
FM AMEMBASSY BUCHAREST
TO RUEHC/SECSTATE WASHDC PRIORITY 8715
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE
RUEATRS/DEPT OF TREASURY WASH DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC

UNCLAS SECTION 01 OF 02 BUCHAREST 000739

STATE FOR EUR/CE: ASCHIEBE AND EEB/IFD

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ECON ETRD EIND EFIN RO
SUBJECT: ROMANIA: STRONG GROWTH CONTINUES, BUT AT AN INFLATIONARY
COST

BUCHAREST 00000739 001.4 OF 002


Sensitive but Unclassified, Not for Internet Distribution.

1. (U) Summary. Romania's economy posted higher-than-expected
growth in the first half of 2008, prompting renewed worries of
over-heating in the near future. The construction, services,
industrial and retail sectors drove the growth rate to 8.8% over the
same period last year. However, the impressive growth was
accompanied by surging inflation, which at an annualized rate in
June of 8.6% is still well above the Central Bank's target. This
has prompted the Central Bank to continue its policy of monetary
tightening. End summary.


2. (U) Romania's real GDP growth rate accelerated during the second
quarter of the year to 9.3%, on top of 8.2% in the first quarter,
reaching an average 8.8% growth rate over the first half (H1) of
2008. This was the best H1 growth performance in 18 years. The
growth was driven by a surge in construction, up a staggering 33.3%
over the same period in 2007; services, up 7.6%; followed by
industry, up 5.8%. Agriculture improved from last year's
disappointing season, when the severe drought impacted growth; H1
production this year rose by 2.6% despite floods in some parts of
the country. Overall, services have risen to account for nearly
half (49.5%) of GDP, while manufacturing accounts for 26.5%,
construction 8.1%, and agriculture 3.6%. Statistics show robust
economic expansion across the board, with household consumption
increasing 11% compared to the same period in 2007. The growth in
the formation of fixed capital was 7.8%. In nominal terms,
Romania's H1 2008 GDP amounted to the equivalent of USD 81.9
billion.

3. (U) This strong growth trend has, not surprisingly, been
accompanied by rapidly rising prices. Given the June-thru-June
annualized 8.6% inflation rate, analysts now expect a final 2008
annual rate of between 7.5% and 8%. This would be more than double
the Central Bank's target of 3.8% plus or minus 1% and a
substantially worse performance than the 2007 rate of 6.6%. In H1,
service sector inflation posted the highest increase at 3.78%,
chiefly due to rising public utility costs. Food prices followed
closely behind, up 3.68%. Only non-food items were below the
average, up 3.37%. Despite several consecutive hikes of the
benchmark interest rate, and high minimum reserve requirements, the
Central Bank has not yet succeeded in taming inflation. Main
factors in the inflation surge were higher international fuel
prices, which have had a direct impact on transportation costs;
persistent consumer demand, due to rising incomes; and residual
tensions in the agricultural market as a result of several years of
poor yields. Because one factor keeping inflation from rising even
faster has been the leu's previous appreciation against the euro,
worries remain with regard to the future forex rate trend. The
practice of denominating (and borrowing for) big ticket purchases in
euros could drive further inflation if the leu were to markedly
depreciate and the price of these goods were to rise commensurately.


4. (U) Despite higher-than expected inflation in the first half of
2008, initial reports for July and August indicate that a slight
deceleration may have begun. Prices actually declined in August by
0.09%, prompting the August-thru-August annualized inflation rate to
drop to 8.0%. Still, the main challenges for controlling inflation
in the second half of the year will include real salary gains
compared to labor productivity, expected growth in public sector
spending during the election cycle, uncertainties related to
international fuel prices, and the upward trend in
government-controlled prices (i.e. utilities, transport, and social
insurance expenditures). Robust economic growth and labor
emigration continue to push domestic incomes higher, which in turn
should continue to support retail consumption at today's high
levels. However, unpredictable fuel prices will likely have the
most pronounced effect on the final inflation rate for 2008.

5. (SBU) Comment. Despite the high inflation headlines and, in some
respects, the appearance of a bubble economy, the underlying
economic trends appear to be setting Romania up for a slowdown,
rather than a spectacular crash. The high growth in the first half
of 2008 revived old worries of a "hard landing" for the Romanian
economy. However, post believes a more likely scenario is a modest
slowdown in growth from the currently unsustainable 8.8% to around
5-6% in 2009. Inflation appears to have already slowed somewhat in
July and August, while Romanian exports have been growing at higher
rates than imports. Moreover, foreign investors' appetite for
exposure to the Romanian economy remains steady, with an increasing
share of the current account deficit being financed by foreign
direct investment despite world financial market turmoil.
Additionally, reports of layoffs, especially in the construction
sector, in the weakening economies of Western Europe may evenually
offer some wage relief in Romania. Large numbers of Romanian

BUCHAREST 00000739 002.2 OF 002


expatriates are employed in Spain and Italy, and if deteriorating
conditions there prompt even some of these workers to return home,
this would help to further moderate wage inflation. It would also
assist in keeping foreign investors, who are on the lookout for
investment opportunities far away from Wall Street's financial
turmoil, interested in Romania. End Comment.

Taubman

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