Cablegate: Romania: Policymakers Attuned to Inflation As Election

VZCZCXYZ0003
PP RUEHWEB

DE RUEHBM #0574/01 2030848
ZNR UUUUU ZZH
P 210848Z JUL 08
FM AMEMBASSY BUCHAREST
TO RUEHC/SECSTATE WASHDC PRIORITY 8496
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC PRIORITY
RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY

UNCLAS BUCHAREST 000574

STATE FOR EUR/NCE KSOLERA, EB/IFD
TREASURY FOR LKOHLER
COMMERCE FOR KNAJDI

SIPDIS
SENSITIVE

E.O. 12958: N/A
TAGS: EFIN ETRD ECON PGOV RO
SUBJECT: ROMANIA: POLICYMAKERS ATTUNED TO INFLATION AS ELECTION
SEASON APPROACHES

REF: A) Bucharest 562

Sensitive but Unclassified; not for Internet distribution.

1. (SBU) Summary: Rising inflation is capturing the attention of
Romanian policymakers and is likely to play a significant role in
the upcoming election season. Annualized inflation (June 2007 to
June 2008) is up to 8.61 percent, with price increases in consumer
staples acutely affecting consumers across the board. As is the
case elsewhere in the world, energy and food prices are outpacing
increases in other sectors and helping to drive up the overall
inflation rate. The openness of the Romanian economy to world
market forces has limited the tools available to the Government of
Romania (GOR) to respond effectively to these increases. At the
same time, pre-election politics appear to be keeping the GOR from
exercising the few fiscal policy levers it does have to control
inflation. The National Bank of Romania's (BNR) efforts to rein in
prices through tighter monetary policy have so far met with little
success. End Summary.

2. (U) In the last 12 months (June 2007 to June 2008), foodstuffs
in Romania have shown dramatic price increases, rising at an
annualized rate of 11.77 percent. Last year's poor, drought-damaged
harvest, combined with rising domestic consumption and global
commodity price increases, are to blame. Further increases are
expected later in the year, with some business leaders forecasting a
10 percent rise in the price of bread, 10 to 15 percent in sugar,
and 3 to 4 percent in dairy products just by September. The hope is
that a good agricultural season this year will mitigate some of the
price increases, especially in the productive summer months, but
high energy prices will likely act as a brake on any significant
price reductions. (Comment: Market survey data on agricultural
output and prices for June and July are not yet available, but local
seasonal produce is currently plentiful and reasonably priced in
Bucharest. This is likely a temporary effect, and prices should
start to tick back up again in the fall as local produce goes out of
season. End Comment.)

3. (U) Increasing energy prices are also of major concern, even
though Romania produces a substantial portion of the natural gas and
oil consumed domestically. The natural gas distribution companies
have lobbied the government for significant price increases to cover
higher production costs, and although the GOR regulator only just
approved a 12.5 percent increase in gas prices as of July 1,
pressure is building for another round of rate increases later this
year. Electricity rates show a similar trend, with the regulated
price rising 4.4 percent on July 1. The present national average
price for gasoline of approximately 4.58 Lei per liter (the
equivalent of USD 7.95 per gallon at current exchange rates), up 12
percent so far this year, is a further drain on the Romanian
consumer. Diesel fuel is up 17 percent, which in turn makes all
manner of goods and services much more expensive.

4. (SBU) The policy responses on the part of the Government and the
BNR have been mixed. The BNR recently raised the Romanian Lei
benchmark nominal interest rate to 10 percent in an effort to curb
inflation. However, as reported reftel, other factors limit the
BNR's flexibility to boost rates further. (It is also worth noting
that, with inflation at over 8.6 percent, the real interest rate is
only about 1.4 percent, making the actual dampening effect minimal.)
This places additional burdens on the GOR to avoid aggravating
inflation through expansionary fiscal policies, tough to do in an
election year. So far the only significant efforts in this regard
have been to postpone until October 1 the scheduled increase in the
monthly minimum wage (from 500 to 540 Lei), and to hold the line on
some public sector wage increases. On the other hand, the GOR just
announced a budget "rectification" of over 600 million euros in
additional spending, mostly for infrastructure projects.

5. (SBU) In addition to these limited fiscal restraints, the GOR
has announced several initiatives aimed at mitigating the effects of
higher prices. These include lobbying the European Commission for a
reduction in the recently increased tax on diesel fuel for
agriculture; increasing (modestly) the amount spent on bread and
dairy subsidies for primary school students; providing a heating
subsidy for low-income households; cutting employee payroll taxes;
and putting together a "solidarity fund" to distribute 160 million
Romanian Lei (approximately USD 71 million) to households earning
less than 615 Lei (approximately USD 275) per month.

6. (SBU) Comment. The approaching national election season, not
economic fundamentals, appears to be driving the political response
to inflation this time around. Rather than focusing on tightening
its belt, the GOR is instead trying to treat the symptoms by
lessening the pain of higher prices. Despite the BNR's assertion

that its maneuvering room for further interest rate hikes is
limited, the lack of tighter fiscal policies will put additional
pressure on the Bank to continue raising rates before higher
inflationary expectations become more firmly entrenched. If high
inflation continues, not only will it dampen economic growth, in
part by removing the Romanian competitive advantage of inexpensive
skilled labor, but it will also make Romania's long-term goal of
entering the Euro zone an increasingly distant one. End Comment.

TAUBMAN

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