On 5 August 2020, the Board of the National Bank of Romania held a meeting in which the following members took part: Mugur Isărescu, Chairman of the Board and Governor of the National Bank of Romania; Florin Georgescu, Vice Chairman of the Board and First Deputy Governor of the National Bank of Romania; Leonardo Badea, Board member and Deputy Governor of the National Bank of Romania; Eugen Nicolăescu, Board member and Deputy Governor of the National Bank of Romania; Csaba Bálint, Board member; Gheorghe Gherghina, Board member; Cristian Popa, Board member; Dan-Radu Rușanu, Board member; and Virgiliu-Jorj Stoenescu, Board member.
During the meeting, the Board discussed and adopted the monetary policy decisions, based on the data on and analyses of recent characteristics and the medium-term macroeconomic outlook submitted by the specialised departments, as well as on other available domestic and external information.
Looking at the incoming statistical data since the last monetary policy meeting in May, Board members shared the view that data showed, in line with expectations, a severe economic impact of the coronavirus pandemic – peaking in April, but starting to diminish as of May – amid the gradual lifting of physical mobility restrictions and in view of the assistance from government support programmes and the NBR’s monetary policy measures.
It was shown that in June the annual inflation rate had climbed slightly above the mid-point of the target to 2.58 percent from 2.26 percent in May, but had remained below – standing even lower than expected – the 3.05 percent level seen in March, owing to the significantly stronger annual decline in fuel prices during that quarter and, to a small extent, to core inflation.
The drop in the annual adjusted CORE2 inflation rate had been, however, minor and smaller than projected (to 3.7 percent in June from 3.86 percent in March), the significant disinflationary base effect notwithstanding. It was noted that downward influences had stemmed from services only and that they had been more subdued than those forecasted, following inter alia the May and June rises in some sectors, possibly also on account of the costs associated with the measures to prevent the SARS CoV-2 infection. At the same time, the contribution of processed food prices had remained nearly flat at a post-September 2011 high – mainly as a result of price increases for milling and bakery products –, while that of non-food items had even seen a marginal advance. The latter was due to hikes in prices of some essential goods and durables, reflecting, apart from the slight depreciation of the leu against the euro, probable disruptions or cost increases in production and supply chains.
It was deemed that the current dynamics of core inflation were, to a large extent, attributable to its persistence, as it continued to reflect pre-pandemic underlying inflationary pressures and the related inflation expectations, and that the disinflationary effects of the radical change in the cyclical position of the economy in Q2 were imperceptible for the time being, in line with expectations. Other relevant influences came from changes in consumption structure and temporary mismatches between demand for and supply of certain goods amid the pandemic and social distancing, as well as from the strong rise in labour costs over the past months, following the notable decline in labour productivity.
As for the cyclical position of the economy, Board members showed that it had remained firmly positive in Q1, posting only a minor narrowing, in the context of the quarterly GDP dynamics staying in positive territory, as a result of the particularly robust performance in the first two months of the year. However, economic growth had witnessed a marked deceleration in annual terms. Domestic demand had, nevertheless, had an insignificant impact thereon, given that the markedly lower contribution of household consumption and the drop in the contribution of gross fixed capital formation had been almost entirely counterbalanced by opposite influences from the change in inventories, as well as from a faster increase in general government consumption, which had made the largest contribution since 2008 Q3. Conversely, net exports had almost quadrupled their negative contribution against the background of a relatively more pronounced slowdown in the dynamics of exports of goods and services. However, the current account deficit had narrowed significantly in Q1, also versus the same year-ago period, given the particularly large improvement in the primary and secondary income balances. Yet, its coverage by foreign direct investment and capital transfers had seen a sharper deterioration, while the growth rate of external debt had posted a slight reacceleration, also on account of short-term debt – trends viewed as worrisome by some Board members, especially in the present global context.
The cyclical position had, however, changed suddenly in Q2, as Board members repeatedly underlined, with incoming data and assessments indicating, similarly to previous forecasts, a severe contraction of the economy for the quarter overall – with a peak in April –, expected to be somewhat reversed in the following quarter. The evolution implied the abrupt opening of a large negative output gap in Q2, as well as its near-halving in Q3, relatively in line with the previous forecast, that outlook being surrounded, however, by great uncertainties – according to the unanimous opinion –, given the renewed growth in the number of infections as of July.
It was noted that, as anticipated, high-frequency indicators revealed a massive economic downturn in April, which had however started to be reversed as of May, when the state of emergency had been replaced with the state of alert. It was agreed that the sizeable fluctuation was mainly ascribable to private consumption – reflecting the varying intensity of physical mobility restrictions and the deceleration in household income growth –, but that investment could also make a substantive contribution to the economic contraction in Q2, in spite of the resilience to the pandemic shock shown in April-May by the construction sector, which had continued to rise at a fast two-digit pace, albeit visibly slower than the post-crisis highs of early 2020. The contractionary impact of net exports is expected to be relatively similar to that in the previous quarter, although the annual growth of the negative trade balance had witnessed a slight slowdown in the first two months of the period. Against that backdrop, the current account deficit had narrowed year on year at a quicker pace, due to the notable contribution made by the marked improvement in the primary and secondary income balances, while the decline in its coverage by foreign direct investment and capital transfers had come to a halt, at least for a while. The FDI flows had however remained negative, some Board members noticed, owing inter alia to the losses reported by foreign-owned companies in the pandemic context.
Board members pointed out that the deterioration of labour market developments had been cushioned in April by firms’ recourse to furlough, which had been financially supported by the authorities, while in May it had been mitigated by the resumption of activity in some sectors, as well as by new government support measures. Specifically, the number of employees in the economy had dropped less than expected, its annual decline – a first in nine years – being modest. Moreover, the ILO unemployment rate had continued to rise relatively slowly, reaching 5.2 percent in May, while it had stagnated in June. Yet, the annual growth rate of average gross nominal wage earnings had gone down more swiftly, primarily on account of developments in sub-sectors greatly affected by restrictive measures, i.e. accommodation and food service activities, transport, non-food trade, also in the context of a wider recourse to furlough. It was considered that, in the near run, labour market developments remained conditional on the current and anticipated situation of the health sector, with an impact on the mobility restrictions imposed by the authorities and on the business conduct in areas more exposed to health risks. Board members argued that the swiftness of re-starting production facilities after the lockdown and the demand outlook in some sectors were equally important. Mention was made of the very low hiring intentions for Q3 shown by specialised surveys, which were seen however to improve somewhat in certain sectors, as well as of some positive signals coming from main economic sectors, such as the automotive industry, even amid the challenging situation on the auto market.
Board members noted that financial market conditions had continued to improve, thanks to the new policy rate cut and given the significant volume of liquidity provided by the NBR via bilateral repo operations and purchases of leu-denominated government securities on the secondary market, in the context of a sizeable liquidity deficit on the money market. Thus, key interbank money market rates had consolidated their decline and subsequently their lower levels, with yields on longer-term government securities having a relatively similar evolution. In turn, the average lending rate on new business had followed a clear-cut downtrend in 2020 Q2, while the drop in the average interest rate on new time deposits had been relatively minor – with a favourable impact on the appeal of leu-denominated deposits (the spread between them shrinking considerably). Attention was also drawn to the long time lags in the pass-through of policy rate impulses, especially in view of the benchmark index for loans to consumers (IRCC) falling only marginally at the start of Q3.
The EUR/RON exchange rate had, however, remained quasi-stable and the leu had even tended to appreciate somewhat against the euro in July, and more visibly against the US dollar, amid the plentiful global liquidity from major central banks’ injections, but especially as a result of the upbeat sentiment instilled by the EU’s comprehensive economic recovery plan, which had also caused the European currency to strengthen versus the US dollar. Nevertheless, relative to the region, the adjustments had been more overshadowed, even in the context of the interest rate differential, some Board members pinpointed while cautioning that a higher-than-expected deterioration of the fiscal position and its outlook or a resurfacing of the internal political tensions could additionally increase the sovereign risk premium. This would have consequences on the leu exchange rate volatility and, implicitly, on inflation and confidence in the domestic currency, and ultimately on financing costs and the pace of economic recovery following the downturn.
Moreover, it was shown that the stock of loans to the private sector had witnessed a notable expansion in June – after the successive declines in April and May –, thus slowing considerably its deceleration in annual terms. The mild revival had owed entirely to the leu-denominated component, which had actually seen its loss of momentum coming to a halt on account of developments on both major customer segments, i.e. households and non-financial corporations. It was deemed that those developments had also reflected the effects of the IMM Invest Romania Programme and the relief measures for some debtors in the pandemic context, as well as the stimulative influence of the downward trend in interest rates. Therefore, the share of domestic currency loans in total credit had climbed to 67.8 percent, hitting a post-May 1996 record high. In turn, broad money growth had remained particularly fast-paced, albeit slightly decelerating, in correlation with the relative improvement in budget execution in June.
Looking at future macroeconomic developments, Board members remarked that the new assessments reconfirmed the trajectory of the previously forecasted annual inflation rate, with a mild downward adjustment in the near run. Thus, the annual inflation rate was expected to go up again slightly in July and remain relatively flat until December 2020, before embarking on a downward trend and converging throughout the relevant policy horizon towards the mid-point of the inflation target.
At the same time, the slight upward adjustment in the annual inflation rate in 2020 H2 was attributable to the action of supply-side factors, reflecting chiefly base effects and the upward correction in oil prices. The action was expected to be more moderate than in previous assessments, given the decline in electricity and natural gas prices starting 1 July 2020, amid market liberalisation, which could be even more pronounced than that foreseen, as some Board members noted. By contrast, it was deemed that higher-than-expected opposite influences might stem from disruptions in production/supply chains and costs associated with infection prevention measures, but also from poorer harvests of some crops and from the price-setting behaviour of some economic agents – all likely to affect core inflation developments.
Against that background, the underlying disinflationary pressures would probably be clearly visible only in the latter part of the forecast horizon, Board members agreed, as the inflationary action of relevant supply-side factors faded away gradually. The delay was also considered to stem from the time lag needed for the disinflationary effects of the aggregate demand deficit probably opened in Q2 to become manifest, but also from the persistence of core inflation, as well as from the high increase in wage costs this year, which was anticipated to be corrected in 2021. Adding to these were temporary influences exerted by the immediate pass-through to consumer prices of some economic agents’ recently-incurred losses, as well as by weakening competition in certain sectors as a number of companies were temporarily closed or went bankrupt.
It was shown that, in 2021, pronounced disinflationary influences were foreseen to come also from import prices, as well as from the base effects associated with the increases in prices of pigmeat and other agri-food commodities earlier this year.
In that context, the adjusted annual CORE2 inflation rate was expected to remain significantly above headline inflation in 2020 H2, at slightly higher-than-previously-anticipated values, but subsequently to experience a somewhat steeper downward correction, falling in mid-2021 and then stabilising at 2.2 percent, similarly to previous assessments. However, core inflation might prove relatively more persistent over the projection horizon, implying a lower sensitivity to the negative output gap, some Board members argued.
Turning to the future developments in the cyclical position of the economy, it was shown that the new assessments reconfirmed the magnitude of the anticipated downturn for this year, showing also a relatively stronger economic recovery in 2021, amid the gradual relaxation of physical mobility restrictions and influences from government support programmes and monetary conditions, together with the effects from the gradual restoration of external demand. The outlook indicated as likely the somewhat faster closure of the large aggregate demand deficit opened suddenly in Q2 and the return of the output gap to positive territory right from the start of 2022, slightly earlier than previously anticipated.
The speed and path of the economic recovery were, however, uncertain, conditional on the evolution of the pandemic and the associated restrictive measures, as well as on the economy’s response to fiscal and monetary stimuli, Board members concluded. Still, some Board members deemed that the widespread re-imposition of drastic social distancing measures was little likely and that the degree to which economic agents adapted to the health crisis could rise.
It was remarked that the recent resurgence of the pandemic was likely to fuel in the short term the uncertainties surrounding household consumption – expected to regain in 2020 Q3 almost half of the ground lost in the previous three months, but to increase gradually later, so that its annual dynamics were seen to return to positive territory in 2021. The developments in real disposable income would be the key driver, which could be impacted by higher-than-expected growth of social transfers, but also by the effects of a relatively sharper worsening of labour market conditions, especially after the withdrawal/reduction of government support schemes. Two-way influences would also be felt by consumer confidence, which was assumed to be gradually recovering, given the probable persistence of concerns over the pandemic and over jobs and income prospects, likely to preserve, in the short run, the consumer behaviour changes emerged in the pandemic context, as well as the shifts in the structure of the consumer basket.
The current epidemiologic situation also added to the uncertainties surrounding the future evolution of investment, which was expected to recover at a slightly faster-than-previously-foreseen pace both in 2020 H2, after the second quarter’s massive contraction, and in the course of next year, also in light of the recently launched or approved government programmes. Nonetheless, it was shown that the recovery dynamics were conditional on the evolution of consumer demand and external demand, implicitly on the restoration of global production chains, but also on corporate income/profits and investor confidence, as well as on the speed of recovery of the home countries of foreign investment – all potentially hit for longer by the resurgence of the pandemic. Moreover, it was noted that, given the very limited fiscal space, the sustained growth of public investment in a more remote perspective depends on the absorption of EU funds, characterised, however, by a modest historical performance.
On the other hand, an enhanced efficiency of EU funds absorption and use would likely boost investment dynamics even beyond expectations starting next year, Board members deemed, given the sizeable resources allocated to Romania via the Next Generation EU, together with the 2021-2027 Multiannual Financial Framework, whose coordinates were agreed by the European Council in July. Over the longer term, such a perspective could be strengthened by possible relocations to Romania of European companies’ production facilities from other continents – amid plans to shorten production chains owing to trade tensions and the pandemic –, conditional, however, on domestic improvements in infrastructure, legal framework predictability and digitalisation of the economy.
It was pointed out that the EU funds recently allocated to Romania could counterbalance, at least partially, the economic impact of fiscal consolidation that would probably be initiated shortly, in line with the requirement under the European Commission’s excessive deficit procedure. Uncertainties and risks thus induced by the future fiscal and income policy stance were magnified by potential features and stages of budget adjustment measures. It was again advocated in favour of their being focused on current expenditure, in order to minimise adverse effects on the recovery and the growth potential of the economy in the medium term, as well as to prevent the external imbalance from worsening. Recent budgetary developments – entailing, in turn, uncertainties and risks – were also discussed, given the possibly sharper increase in budget expenditures this year, under the impact of the pandemic crisis and the support measures adopted, and as a result of the higher-than-anticipated growth of social transfers in the run-up to this year’s elections, affecting the need and cost of financing, but also the budget execution in the years ahead.
Concerns were also expressed over the possible extension this year of the worsening trend of the current account deficit as a share of GDP, as well as of its financing structure. Reference in this respect was made to the economic decline of major trading partners, which also provide significant direct investment, and to the new price competitiveness losses incurred by local companies amid the marked increase in wage cost dynamics and the movements in the exchange rate of the leu. Discussions also touched on somewhat more encouraging signals on the recent developments in Europe’s and global economies, highlighting at the same time, however, the notable risks to their recovery and to international trade posed by the resurgence of the pandemic, as well as by a possible escalation of protectionism and by Brexit.
In view of the monetary policy measures adopted in March and May, as well as of the transmission lags of impulses of policy rate cuts, Board members were of the unanimous opinion that the outlook for macroeconomic and financial developments, along with the related uncertainties and risks, warranted another prudent cut in the policy rate. Thus calibrated, the monetary policy conduct was likely to support the recovery of economic activity over the projection horizon in order to bring and strengthen in the medium term the annual inflation rate in line with the inflation target of 2.5 percent ±1 percentage point, while safeguarding financial stability.
Under the circumstances, the NBR Board unanimously decided to cut the monetary policy rate to 1.50 percent from 1.75 percent; moreover, it decided to lower the deposit facility rate to 1.00 percent from 1.25 percent and the lending (Lombard) facility rate to 2.00 percent from 2.25 percent. Furthermore, the NBR Board unanimously decided to maintain the existing levels of minimum reserve requirement ratios on both leu- and foreign currency-denominated liabilities of credit institutions. Given the liquidity shortfall on the money market, the Board unanimously decided to further conduct repo transactions and continue to purchase leu-denominated government securities on the secondary market.