ROMANIA’S CENTRAL BANK: INFLATION REPORT, November 2008

– SUMMARY –

Inflation rate evolution and its causes

In September 2008, the 12-month inflation rate stood at 7.30 percent, down by 1.31 percentage points against June, when the reading was 8.61 percent. This development confirms the previous projections of the National Bank of Romania (NBR) according to which disinflation would resume starting 2008 Q3.

Among supply-side factors, the rebound in agricultural output – in the wake of the adverse shock during 2007 – acted as the major determinant of the slowdown in inflation. This performance impacted in particular the volatile prices of some food items, with cheaper fruit and vegetables offsetting the opposite effects on inflation dynamics exerted by developments in administered prices and fuel prices.

The mismatch between payroll increases and productivity gains during June – August 2008 as compared to the first five months of 2008 led to further increases in unit labour cost, generating inflationary effects through both the pressure of higher wages on excess demand and cost-push pressures on producer prices.

The uptrend in annual CORE2 inflation, which had been manifest since August 2007, came to a halt in 2008 Q3. The effects of higher aggregate demand pressure on core inflation were countered by the significant slowdown in the growth rate of prices for processed foodstuffs included in the CORE2 basket, the favourable influence of a stronger domestic currency versus the euro on import prices and relatively lower inflation expectations. Against this background, CORE2 inflation dynamics in the third quarter of

2008 was slower than that of the overall CPI inflation, thus contributing to the latter’s deceleration.

In 2008 Q2, ongoing acceleration of economic growth (to 9.3 percent) fuelled inflationary pressures triggered by excess demand. Behind the GDP growth stood the surge, albeit slightly decelerating, in both investment and household consumption, underpinned by sizeable increases in the incomes of companies and loans to the private sector, as well as by the advance in public expenditures.

The slowdown in domestic demand dynamics was more than offset by the marked decrease in the negative contribution of net external demand to GDP growth. The gradual and significant narrowing of the trade deficit started in the final months of 2007. The consolidation of this trend led to exports growth outpacing imports in 2008 Q2 and Q3 (until August) for the first time since 2002 Q4.

Monetary policy since the release of the previous Inflation Report

On 31 July 2008, the National Bank of Romania Board decided to raise the monetary policy rate to 10.25 percent per annum. Subsequently, global and domestic macroeconomic developments sent diverging signals regarding the medium-term inflation outlook. As a confirmation of NBR projections, the annual inflation rate re-embarked on a downward trend after reaching a peak in July. The growth of credit to the private sector began slowing gradually, whereas the exchange rate of the domestic currency posted greater volatility and a trend reversal, from appreciation to depreciation, towards the end of 2008 Q3. Inflationary pressures exerted by aggregate demand increased due to the faster second-quarter economic growth while real wages continued to overtake productivity gains. In addition, while coming closer to the country’s general election date (Nov 30), the risk of looser fiscal and income policies became more relevant.

The deepening of the global financial crisis (especially starting September) led to a sizeable increase in uncertainties surrounding the world economic outlook, as well as concerning their implications on the Romanian economy. The broad-based global financial deleveraging process, resulting in increased risk aversion and a subsequent flight to quality of non-resident investors’ capital began to gradually, but ever more strongly affect emerging economies, entailing substantial volatility of local currencies.

To date, emerging market currencies have been mostly subject to downward pressure.

In this global context, the probability of a significant direct impact of financial deleveraging on the
Romanian economy appears to be remote, given the information available thus far. A contributor to this state of affairs is the still low financial intermediation in Romania* and the lack of significant exposure of the financial and banking system to the financial instruments lying at the root of the crisis (subprime mortgage-backed securities)**. Under such circumstances, the deepening of the international financial crisis is expected to affect domestic economic activity mostly indirectly, via the impact of the envisaged flagging aggregate demand in the euro area on Romania’s exports dynamics. This indirect influence is enhanced by the tightening of domestic lending conditions along with the rises in external financing costs and debt service of economic agents, especially those exposed to foreign currencydenominated debt. Amid growing uncertainties, both the magnitude and duration of these processes are difficult to assess.

In response to the domestic macroeconomic developments and the global environment affected by heightened uncertainty, the NBR Board decided to keep the monetary policy rate at 10.25 percent per annum in its meeting of 25 September. The decision was meant to strike a balance between the gradual tightening of real monetary conditions once inflation has resumed its forecasted downward trend, with the aim of fulfilling the medium-term disinflation objectives, and ensuring an adequately prudent policy stance is maintained when faced with the emergence of new risk sources at macroeconomic level.

Inflation outlook

The recent deepening of the global financial turmoil caused a marked rise in volatility on world markets, posing major difficulties to forecasting the nature, magnitude and duration of the effects of the crisis on the domestic economy. Therefore, the quantitative assessments in the baseline scenario of the current projection are afflicted by a higher than usual degree of uncertainty. Against this background, the baseline scenario describes, to a far greater extent than in the previous exercises, a possible trajectory of inflation strictly conditional upon the adopted assumptions and the information available upon preparing the forecast. Consequently, deviations from the projected inflation path are more likely to occur in both directions in the current forecasting round, the identified risks being more balanced as concerns their upside versus downside impact on inflation than in the previous rounds.

The baseline scenario of the current projection places the 12-month inflation rate at 6.7 percent for end-

2008, 0.1 percentage points above the figure published in the August 2008 Inflation Report. For end-2009, inflation is forecasted to stand 0.3 percentage points above the previously projected level (4.5 percent versus 4.2 percent), which places it at the upper bound of the variation band around the end-year target.

The new projection puts the inflation rate trajectory above that presented in the August 2008 Inflation Report until end-2009. Compared to the previous projection, the factors boosting forecasted inflation include: more pronounced pressures from CORE2 inflation, which could be associated with higher pressures exerted by aggregate demand, as reflected by faster GDP growth in Q2 and expectations of robust GDP increase in Q3; looser fiscal and income policies expected during the projection horizon; a less favourable evolution of import prices as well as the assumption of a somewhat slower decrease in inflation expectations in the first part of the forecast horizon; and the assumed more rapid increase in administered prices. Such unfavourable influences are mitigated throughout the forecast horizon by the more favourable scenario regarding fuel price inflation. Adding to these influences is the difficultto-precisely-assess effect of global financial turmoil on euro area economic activity, which may spill over quickly into the deceleration of domestic economic activity.

In light of the currently available data and taking into account the unusually high uncertainties, the baseline scenario of the projection assumes a noticeable slowdown in the growth rate of aggregate demand over 2009, given the combined pressures of successive monetary policy rate increases, the recent prudential measures taken by the NBR in order to curb lending growth, the temporary rise in the costs of both foreign borrowing and debt service of economic agents exposed to foreign-exchange denominated debt, as well as of the constraints on credit dynamics owing to the global financial turmoil. The envisaged deceleration in the pace of increase of euro area external demand for Romanian exports is seen as restricting the pace of domestic economic activity and, in turn, excess demand. Moreover, a slowdown in the dynamics of domestic absorption components, particularly private consumption, is projected, translating into a deceleration of import expansion. This development will pave the way for the controlled reduction of excess demand, with the projection foreseeing a temporary elimination of excess demand in 2009 Q2 and Q3, thus favouring disinflation.

Subsequently, the pace of economic growth is seen returning to somewhat higher levels, insofar as the constraints triggered by the global financial crisis diminish gradually.

The NBR will further channel its efforts to driving the inflation rate towards the established targets while striving to ensure the adequate functioning and stability of the financial system amid the adverse effects of the global financial crisis. To this end, the firm monetary policy stance will be retained throughout the projection horizon. This will help bring inflation back within the variation band around the central target in the latter part of the forecast horizon, conditional upon adequate support from the other macroeconomic policies and the absence of any significant slippages from the coordinates of the baseline scenario.

The major uncertainties surrounding the effects of the global financial turmoil on the world economy and on the national economy have serious consequences both on the layout of the baseline scenario of the current projection and on identifying and quantifying the effects of risk factors most likely to become manifest during the current forecasting round. Compared to the previous rounds, risk factors associated with global market developments become increasingly relevant for the current projection due to the recent surge in the global financial crisis and the expectation of its more persistent effects on domestic economic developments in the medium term. The current projection round is characterised by relatively balanced upside versus downside inflation risks, whereas the specific macroeconomic environment in the previous rounds had tilted the balance of risks mainly towards scenarios indicating upside risks were prevalent.

Thus, the risks accompanying the movements in oil and other commodity prices, administered prices and volatile food prices, as well as the risks associated with exchange rate dynamics are relatively symmetrically distributed against the projected trajectories. Special importance is also attached to asymmetric risks: on one hand, the risks of higher inflation due to real wage growth overtaking productivity gains and a more expansionary fiscal policy; on the other hand, the threat of lower inflation, which is likely to occur following a faster slowdown in economic growth than in the baseline scenario, under the impact of the global financial crisis.

Monetary policy in sight

Considering the new coordinates of the medium-term inflation forecast as well as the complexity associated with the numerous uncertainties, the NBR Board has decided in its meeting of 30 October 2008 to keep the monetary policy rate unchanged at 10.25 percent per annum. At the same time, the NBR Board has decided to lower the minimum reserve requirement ratio on RON-denominated liabilities of credit institutions to 18 percent, from 20 percent previously, starting with the 24 November – 23 December 2008 maintenance period. This decision is aimed at improving liquidity management given that the trend of gradual reduction in excess liquidity in the banking system and, implicitly, in the central bank’s net debtor position in its relation with credit institutions – as signaled by the NBR starting April 2008 – has become more pronounced of late. Moreover, the current 40 percent minimum reserve requirement ratio on foreign currency-denominated liabilities of credit institutions was left unchanged. By taking these measures, the central bank is acting in a proactive manner towards consolidating the traditional monetary policy transmission channels with a view to ensure sustainable financing of the economy amid the anticipated slower dynamics of foreignexchange loans as the effects of the global financial crisis continue to spread.

The NBR seeks to fulfil its medium-term objectives by pursuing sustainable disinflation which can only be achieved by avoiding the aggravation of macroeconomic disequilibria and by maintaining financial stability.

Against this background, the NBR Board has restated the need for the steady and sustained monetary policy efforts aimed at countering demand-pull inflationary pressures and anchoring inflation expectations to be supported by strengthening the other components of the macroeconomic policy mix and speeding up structural reforms.

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Notes:

*) The annual weight of non-government credit in GDP amounted to 38.9 percent in 2008 Q2, compared to an average of 48 percent in Poland, Hungary and the Czech Republic.

**) A limited direct impact of the financial crisis is also due to the measures taken over time by the National Bank of Romania to improve prudential supervision, increase policy efficacy and enhance financial stability. Special mention deserve the relatively high level of reserve requirements associated with foreign currency-denominated liabilities of credit institutions and also the recent prudential measures aimed at dampening credit expansion.

Source: National Bank of Romania (Nov 3, 2008)

Ford Europe: Crisis does not change our investment plans for Romania

"The financial crisis in Europe has not led to a change of plans for the plant in Craiova. The value of the investments remains the same - 675 million euros, and we have no intention of reducing the number of employees," said Hans Juergen Fuchs, manager communications for European Direct Markets at Ford Europe.

John Fleming, Ford Europe president, announced during the Auto Show in Moscow at the end of August that the first recruitment drive for the manufacturing centre in Oltenia would begin in 2010. The current staff at the plant in Craiova (3,900 employees) will cover, according to John Fleming, the current production needs of Ford, which is approximately 30,000 Ford Transit Connect units in 2009.

"Ford's plans concerning the establishment of a National Sales Company in Romania on August 1, 2010, are not influenced by the current market conditions," Hans Juergen Fuchs said.

Ford Europe will manufacture three vehicle models in Craiova as of 2011. Beside the light utility vehicle Transit Connect and the future small class model, the American carmaker will also make a medium class utility vehicle, most likely the next generation Ford Transit, which will be aimed at the European market.

Transit Connect utility vehicles, currently made at the Kocaeli plant in Turkey, will start to be exported to the United States next summer. According to sources on the market, the small class car will be the first generation of B-Max that will replace the current Fusion.

The European car market fell 4.4% in the first eight months of this year compared with the same time last year, to a volume of 11.7 million cars, while the decline in the eurozone stood at 5%, and dropped to 10.5 million units.

The steepest declines in terms of volumes sold were registered on "traditional" markets like Spain (minus 22%), to merely 0.9 million units and Italy, minus 11% to 1.9 million cars.

"In response to the current conditions on the market that are affecting the automotive industry, especially 'traditional' markets in Western Europe and based on the current estimates, Ford will lower production at most plants in Europe in the remaining months of this year. This will be a marginal reduction compared with the previous year's output. Even before the financial crisis, most European carmakers, except Ford Europe had unused production capacities," Fuchs stated.

Ford Europe plants operated at a 100% or more capacity, following the introduction of an additional shift.

"We certainly need to take steps to make sure we maintain our production capacity at the same level as demand and this way we will retain our competitive edge," Fuchs added.

Going against the current trend, Ford will rehire 1,000 workers in the United States, at a plant in Michigan, in January, as it anticipates rising demand for the new pick-up model.

The number of jobs at Ford Craiova will be increased to a figure of between 7,000 and 9,000 until 2012, which could lead to a total number of up to 36,000 jobs, while the total investment is expected to reach 675 million euros.

Source: zf.ro

DHS Signs Visa Waiver Program Interim Declaration with Romania

Release Date: November 3, 2008 (U.S. Department of Homeland Security)

Washington, D.C.

U.S. Department of Homeland Security Secretary Michael Chertoff signed today a Visa Waiver Program (VWP) declaration with Romanian Ambassador Adrian Vierita. The security enhancements outlined in the declaration continues Romania's progress on the path toward visa-free travel to the U.S., and possible designation as a VWP member.

"I commend the Romanian government for its commitment to these security enhancements and our shared value of freedom," said Homeland Security Secretary Michael Chertoff. "This achievement builds on the strong relationship our nations share and brings us closer to the day when the citizens of Romania can travel without a visa."

The VWP has been authorized by U.S. law for over 20 years, with 27 current members from Asia and Europe. The U.S. Congress authorized DHS in August 2007 to reform the VWP and strengthen the security arrangements required of existing participant countries, as well as to expand the conditions for aspiring countries to join the program.

The security enhancements outlined in the interim declaration represent important progress toward meeting the requirements of the modernized VWP. They include, better information sharing about international travel and border screening, improvements in information exchange on known and suspected terrorists, timely and comprehensive reporting of lost and stolen passports, developing an air marshals program, and expanding operations for U.S. Federal Air Marshals.

Romania's Central Bank Governor Mugur Isarescu: The 2009 economic growth forecast drops below 5.5 percent

During a press conference on Monday, National Bank of Romania (NBR) Governor Mugur Isarescu made a briefing of the quarterly report. Thus, the governor stated that inflation rate decreased in the third quarter of the year -- mainly due to the country’s agricultural sector good outcome this summer.

Mr. Isarescu said that there is no clear projection yet regarding the policies to be implemented by the next government to cut spending. For the next year annual inflation, Romania’s central bank admits it has a poor estimation (due to the global volatility). Mr. Isarescu said that the 2009 yoy inflation could be anywhere from 1 percent up to more than 5 percent. The factors to influence inflation will be: the policies adopted by the future government, volatility of foods’ prices, and the exchange rate.

Earlier, this morning, Romaia’s central bank made public (on its website) the ‘NBR's International Reserves in October 2008’:

At end-October 2008, foreign exchange reserves of the National Bank of Romania stood at EUR 27,318 million, compared to 26,021 at end-September 2008.

The EUR 1,297 million increase recorded in the reported month owed to the following:

• EUR 4,402 million worth of inflows representing the change in the foreign-exchange reserve requirements of credit institutions, the funds deposited in the account of the European Commission, transactions in the interbank market, income from the management of foreign reserves, a.s.o.;
• EUR 3,105 million worth of outflows consisting in the change in foreign-exchange reserve requirements of credit institutions, transactions in the interbank market, principal repayments and interest payments on public and publicly guaranteed external debt, a.s.o.

Since the foreign reserves consist of assets denominated in euro, US Dollars and other currencies, the important changes of the exchange rates of these currencies in the international markets have influenced both the inflows and the outflows.

The gold stock held steady at 103.7 tonnes. However, following the developments in the world price of gold, its value amounted to EUR 1,908 million.

The international reserves of Romania (foreign currencies and gold) at October 31st, 2008 stood at EUR 29,226 million, compared to EUR 28,102 million at September 30th, 2008.

In November 2008, payments due on public and publicly guaranteed external debt amount to EUR 57 million.

EU: Euro economy to barely grow next year

BRUSSELS, Belgium — The European Commission forecast Monday (Nov 3, 2008) that the economy in the 15 countries that use the euro will barely grow next year, expanding just 0.1 percent as the financial crisis hits hard, AP reports.

The currency zone's largest economies will come to a standstill or shrink, it said in its latest economic outlook, with Germany, France and Italy not growing at all at 0.0 percent.

Ireland and Spain will see output fall and jobless lines and government deficits swell, the EU executive said.

Among EU members that don't use the euro, Britain's economy will slip into recession with minus 1 percent growth, while Baltic states Estonia and Latvia will also see negative growth.

The 27-member EU warned that things may get even worse as forecasters could not rule out a deeper credit crunch that would brake the economy, strain government finances and put a near-freeze on household spending.

Even slightly higher costs for borrowing — an extra risk premium of 0.5 percent on interest rates — would tighten credit available to households and could "trigger an outright recession, a decline of 1 percent of GDP in the euro area," it said.

The labor market should deteriorate sharply next year, it said, with unemployment in the euro-zone climbing to 8.4 percent in 2009 from a decade-low of 7 percent at the end of 2007.

Spain will see the worst of this as a housing bubble bursts and tourism slows. The jobless rate may shoot up to 15.5 percent in 2010 from 10.8 percent this year, the EU says.

EU economists said the outlook for the euro area and the wider 27-nation European Union "remains bleak" with growth contracting this winter before recovering gradually toward the end of next year as exports start to pick up.

It says the euro area likely shrank in the third quarter of 2008 and may grow 1.2 percent for the entire year, 0.1 percent next year and 0.9 percent in 2010. It forecast EU gross domestic product this year at 1.4 percent, falling to 0.2 percent in 2009 and 1.1 percent in 2010.

The only silver lining it picks out is a slide in inflation, down from record highs to an average of 2.2 percent next year as oil prices cool swiftly. This may increase the amount of money people have to spend but they may be less likely to shop if they fear job losses. Private consumption is nearly stagnant, it says.

Oil prices should fall from a 2008 average of US$104 a barrel to US$86 next year, it says. But food and metal prices will probably stay at high levels.

The cost of bailing out troubled banks while tax revenues shrink and welfare payouts swell will see governments pile on debt and run bigger deficits, the EU executive warns.

It says France and Ireland will break EU budget rules in 2009 by running a yearly government deficit of more than 3 percent of GDP. The ceiling is intended to keep their shared currency stable. Britain, Latvia, Lithuania, Romania and Hungary will also likely exceed the limit.

***

The Commission also expressed concern about Romania and, to a lesser degree, Bulgaria, which like the Baltics have high current-account deficits. Their growth rate is set to slow, Reuters reports.

"Romania's economy is overheating, but growth is set to slow down. Nevertheless, the current-account deficit will remain at worrying and only slightly falling levels," it said.

The European Commission revised its estimation of Romania’s GDP deficit this year from 2.9 percent to 3.4 percent.

Earlier, the ratings agencies have slashed their outlooks and debt ratings for a string of emerging European and other countries as the credit crunch sparks crises in several economies, Reuters reported on Oct 30.

ROMANIA’s country rating was set at: BB+ (by S&P), Baa3 (by Moody’s), and BBB (by Fitch) -- with a Moody’s rating as ‘stable’.

On Oct 27, Standard & Poor's cut Romania's foreign currency credit rating one notch to BB+, putting it at junk status with a negative outlook and citing a lack of policy response to mounting economic risks.

The International Monetary Fund (IMF) and the World Bank (WB) started visit to Romania between Nov. 3-14 to assess its financial system, but no financial assistance for Bucharest will be discussed, the IMF said on Saturday.

Some economists have said Romania may have to seek international help, including from the IMF, to shore up investor sentiment and safeguard its economy from the impact of the global financial crisis.

However, both Bucharest and the IMF have so far said no agreement was in the works. Romania's neighbours Hungary and Ukraine have both sought help from the lender.

"The Romanian authorities requested this follow-up mission long ago, and its actual timing was decided last year," the IMF said in a statement.

"The mission will not discuss or negotiate IMF financial assistance to Romania."

Palestinian Authority Chief sees no peace deal with Israel this year

Palestinian President Mahmoud Abbas, right, reviews the honor guard together with his Romanian counterpart Traian Basescu, left, during a welcoming ceremony at the Cotroceni presidential palace in Bucharest, Romania, Monday, Nov. 3, 2008. Abbas is on a two day visit to Romania. (AP Photo)

BUCHAREST - Israel and the Palestinians will not be able to reach a peace agreement before Washington's target date of the end of this year, Palestinian Authority President Mahmoud Abbas said Monday, at the start of a two-day visit to Romania.

"I don't think it's possible to clear an accord by the end of this year as both the U.S. and the Israeli administrations are now busy with other matters and the very short time does not allow for striking such a deal," Abbas said, as reported by Reuters.

Mr. Abbas met this morning with Romania’s President Traian Basescu. After the meeting, Mr. Basescu stated that “Romania does not want to interfere with the Israeli-Palestinian peace talks.” Instead, Mr. Abbas said Romania has the necessary qualification to help negotiations between the two parties.

"I would like to say after the election processes are over, we will resume negotiations and contacts to clear all the outstanding files in discussion. We will try to close these files because up until now none have been closed," Abbas also said, speaking through an interpreter.

The United States chooses a new president Tuesday and Israel is to hold a parliamentary election on February 10.

Washington launched the latest peace drive at a conference in Annapolis, Maryland, last year with the hope of shepherding Israel and the Palestinians toward a peace deal before President George W. Bush leaves office in January.

But Israel's failure to halt Jewish settlement in the occupied West Bank, divisions among Palestinians and political instability in Israel have made the prospects of meeting Washington's target date for a deal ever more elusive.

Sunday, the Quartet of Middle East peace mediators -- the United States, the European Union, the United Nations and Russia -- plan to convene in Egypt's Red Sea resort of Sharm el-Sheikh, where negotiators will brief them on the peace talks.

Abbas, U.S. Secretary of State Condoleezza Rice and Israeli Foreign Minister Tzipi Livni plan to attend.

Last week, a senior Bush administration official said the Israeli election meant a peace agreement was all but impossible this year. Israeli President Shimon Peres said several weeks ago that both sides were unlikely to conclude a deal in 2008.