Cablegate: Romania: By Tapping On the Brakes, the Central Bank Keeps

VZCZCXRO2206
PP RUEHAG RUEHAST RUEHDA RUEHDF RUEHFL RUEHIK RUEHKW RUEHLA RUEHLN
RUEHLZ RUEHPOD RUEHROV RUEHSR RUEHVK RUEHYG
DE RUEHBM #0812/01 2970929
ZNR UUUUU ZZH
P 230929Z OCT 08
FM AMEMBASSY BUCHAREST
TO RUEHC/SECSTATE WASHDC PRIORITY 8795
RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC PRIORITY

UNCLAS SECTION 01 OF 02 BUCHAREST 000812

STATE FOR EUR/CE: ASCHIEBE
ALSO FOR EUR/ERA: BROCKWELL, JKESSLER
AND EEB/IFD
TREASURY FOR: LKOHLER

SIPDIS
SENSITIVE

E.O. 12958: N/A
TAGS: EFIN ECON ETRD EIND RO
SUBJECT: ROMANIA: BY TAPPING ON THE BRAKES, THE CENTRAL BANK KEEPS
THE FINANCIAL CRISIS UNDER CONTROL

REF: A) BUCHAREST 789 B) OCT 21 KESSLER EMAIL

Sensitive but Unclassified, Not for Internet Distribution.
1. (SBU) Summary. Several factors particular to the Romanian
economy have reduced the local impact of the global financial
crisis. Overall, Romania's financial and banking system has
sufficient liquidity and is not expected to experience any negative
short-term repercussions from the current crisis. However,
Romania's macro-economic picture is fragile, largely due to poor
government budget discipline at a particularly sensitive time. In
all likelihood, Romania will experience a slow down in economic
growth rates in the medium term. Of continuing concern is a future
depreciation of the Leu against the Euro, which would have negative
implications for inflation and future credit growth, even as it
positively affects the current account deficit. According to the
Romanian Central Bank (BNR) the current high rates on overnight
inter-bank loans are chiefly a result of an unsuccessful speculative
attack against the Leu. End summary.

2. (SBU) The DCM and EconOffs met with Shamir Khaliq, the President
of Citibank Romania, on October 17. Khaliq mentioned that he had
just returned from an emergency conference involving the President
of Romania, the Central Bank, and the commercial banking community.
He indicated that his perception, reinforced by the emergency
meeting, is that sufficient liquidity exists in Romania to weather
the global financial crisis. Noting that he found the latest report
issued by Goldman Sachs on Romania unfair, he laid out some of the
differences present in the Romanian economy, which would mitigate
the fallout from the crisis. As opposed to Hungary, which was
highlighted in the same report, Romania has very low debt to GDP
ratios, low public debt to total debt ratios, high loan provisioning
requirements for banks, and high minimum reserves requirements. On
the liquidity question, he pointed out that local banks are required
to hold minimum reserves equivalent to 20 percent of their local
currency balance sheet, and 40 percent for books denominated in
foreign currencies. This means that 9 billion Euros out of a 60
billion Euro banking market are immediately available to the BNR if
it ever has to inject emergency liquidity into the system. These
reserves are almost three times larger than the entire overnight
interbank market. Acknowledging the very high interest rates on the
overnight market, he said that the small overall size of this market
made it possible for the BNR to act as a counterparty, if it so
chooses, to transactions if the market were to completely shut down.

3. (SBU) At the same time, foreign speculators tested the BNR's
resolve and began making large bets against the Leu last week,
expecting the BNR to abandon a defense of the currency. However,
the BNR cut off the attack by doing two things, temporarily selling
Euros to prop up the Leu, and then declining to provide extra
liquidity to the overnight market on October 17 as the speculators
scrambled to settle their positions. While this action temporarily
raised interest rates on overnight loans to 80 percent, and while
reverberations are still being felt in the commercial market this
week, the BNR is unrepentant, with Governor Isarescu announcing to
the press on the 20th: "Those who made mistakes in their betting
have received a lesson. Technically, all of their swaps couldn't be
re-financed, because the Leu had been pulled out of the market. It
is not glorious for a large bank to be unable to close its
position."

4. (SBU) The forex rate has remained volatile this week, with the
Leu reversing its recent depreciation and recovering five percent of
its value, perhaps as a result of the BNR's intervention. This
volatility presents concerns for individuals with large foreign
currency loans. In an October 10th meeting at the IMF, the regional
representative for Romania and Bulgaria, Juan Ferndanez-Ansola,
highlighted foreign currency lending as the major cause for concern
in the local environment. He pointed out that consumers earning
local currency wages have borrowed 14 billion Euros from banks in
Romania. So far this risk has been mitigated by rapidly rising
wages. As the growth rate begins its expected decleration next
year, the risk of defaults on these loans rises. This, coupled with
the recently implemented stricter provisioning requirements on new
foreign currency lending, should decrease demand and encourage
individuals to move to Leu-denominated fixed interest loans.
Unfortunately, the high overnight market rates are having the
opposite short-term effect, with interest rates on some variable
loans shooting up to 18 percent this week.

5. (SBU) Despite believing that the credit market will shrink in
the next year, the IMF is currently forecasting a 4.8% GDP growth
rate for Romania in 2009. While the local IMF has traditionally
held a bearish attitude about the Romanian economy, Fernandez-Ansola

BUCHAREST 00000812 002 OF 002

believes that the global financial crisis will only slow down
investment and marginally increase unemployment, but not stop growth
completely (Comment: Given the current upward pressure on wages, an
uptick in unemployment would be welcomed in some quarters. End
Comment.) A bigger concern for the IMF is the GOR's lack of fiscal
discipline in an election year. Highlighting the 50 percent raise
recently approved for teachers (ref A), Fernandez-Ansola remarked
that the GOR will need a net six billion Euros to meet obligations
before the end of this year, an amount which, especially given the
current situation, is impossible to finance on the international
market. The MEF is instead locked into the domestic market, and
correspondingly high interest rates, simply to meet existing
obligations, which will make future spending still more difficult.

4. (SBU) Another cushion for the Romanian market is that local
mortgage loans are typically extended for no more than 40 to 70
percent of the value of the property, most of which are
owner-occupied. The high individual equity, and relative novelty of
mortgage lending, means that foreclosures are still a rarity in
Romania, as the owners carrying loans are able to sell their
substantial equity stake in their homes and pay off the mortgage in
cases of financial distress. It is true that many of these
mortgages are denominated in Euros, which carry lower interest
rates, but bear a substantial exchange rate risk. A rapidly
depreciating Leu can be a double whammy for households, raising the
cost of the loan, while at the same time inflating the prices for
basic imported goods. One negative aspect of EU accession for
Romanian households is that imported food and higher quality
consumer goods have driven many local producers out of business.
Accordingly an exchange rate swing in Romania would have an
immediate and disproportionate impact on household consumption.

6. (SBU) Comment. Perversely, a reduction in the availability of
credit and a cooling of the global economy is precisely what Romania
needs in order to put itself on a more stable long-term growth
track. Instead of having a negative impact, slowing credit growth
is precisely the tap on the brakes that is needed to keep the
Romanian economy on its current growth trajectory. Credit
penetration is still low compared to the more developed EU
economies, with the average Romanian having little exposure to
financial markets and consumer debt. Some individuals and firms,
especially those overextended in foreign currencies, will be
impacted and certain sectors will slow. However, economic growth in
Romania is broadly based and reflects, more than anything else, a
belated catch-up with the rest of the EU. The long-term problems of
insufficient investment in infrastructure, education, and
healthcare, are very different from a short-term financial panic in
global markets. Rather, the crisis has hit precisely at the time
that Romania has been feeling the negative inflationary effects of
an expected eight percent annual GDP growth rate, a rate which the
GOR has been understandably unwilling to reduce in an election year.
A forced reduction in the availability of credit will limit the
impact of the Romanian Parliament's increasingly irresponsible
attitude towards fiscal discipline, as well as Parliament's scope
for future "presents" to the Romanian voter. End comment.

Taubman

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