Summary

Developments in inflation and its determinants

After this inflation cycle peaked in November 2022, the annual CPI inflation rate embarked on a downward path, going down to 14.53  percent in March, i.e. 2.23 percentage points below the peak and 1.84  percentage points below the level posted in December 2022. In March, the indicator stood 0.4  percentage points above the projection in the previous Inflation Report, especially following the developments in VFE prices and in electricity and natural gas prices. However, the annual CPI inflation rate recorded a favourable evolution overall during the period under review, in a context marked by the easing of tensions in commodity markets. In this respect, special mention deserves the lower contribution from fuel price inflation, under the impact of significant base effects, but towards the end of the quarter a favourable influence also came from adjusted CORE2 inflation, which fell to 14.6 percent in March from a 15.1  percent peak in February. The developments in electricity prices had also an important disinflationary impact, following the extension of the scope of the energy bills support scheme as of 1 January 2023. The average annual inflation rate, a measure with inherently higher persistence, remained on an upward path in Q1 too, reaching in March 15.3  percent for the indicator calculated based on the CPI methodology and 13.2 percent for that calculated in accordance with the HICP structure (+1.5  percentage points and +1.2  percentage points respectively compared to end-2022). Thus, the differential versus the EU average rose to 3.3 percentage points, but Romania reports an inflation rate below that recorded by most countries in the region (Bulgaria, Poland, Czechia, Slovakia, Hungary, Latvia, Lithuania and Estonia).

In the first three months of 2023, the annual adjusted CORE2 inflation rate peaked and turned a corner. Thus, the indicator continued its upward movement in January and February, while in March, inter alia as a result of the fast-paced dynamics recorded a year earlier, it reversed its upward trend for the first time in almost two years. Favourable developments were reported especially in the food segment, amid the correction of the main commodity prices (wheat, sunflower, maize). By contrast, pressures on companies’ wage costs stepped up, as a result of both the raise in the minimum wage and firms’ consent to meet wage claims following a long period of high inflation. Pressures remained elevated and relatively persistent for other categories of costs too, owing also to the value chains characteristics, whereas a new increase in excess aggregate demand in the economy eased their pass-through into final prices. Conversely, the downward path of inflation expectations expressed by economic agents and financial analysts alike continued to mitigate the impact of adverse supply-side shocks on the dynamics of final prices of consumer goods.

The annual dynamics of unit labour costs picked up again in 2022 Q4, reaching 9 percent (+0.7  percentage points versus the previous quarter) amid the robust advance in the compensation per employee (13.9  percent) to levels notably higher than labour productivity (4.5  percent). In industry, the annual pace of increase of unit wage costs posted a significant acceleration, climbing to 22.7 percent in October 2022 – February 2023 (compared to 15.8  percent in 2022 Q3). These dynamics show companies’ labour hoarding behaviour, to the extent possible, until the impact of the energy shock fades and external demand recovers. Extremely fast ULC dynamics were further reported in energy-intensive industries, whereas more moderate growth rates (up to 10  percent) were seen in the manufacture of machinery and equipment, the automotive industry, the manufacture of electronic products, footwear and leather goods, as well as in the pharmaceutical industry.

Monetary policy since the release of the previous Inflation Report

In its meeting of 9 February 2023, the NBR Board decided to keep the monetary policy rate at 7.00  percent per annum. The interest rates on standing facilities were also left unchanged at 6.00  percent per annum (the deposit facility rate) and at 8.00 percent per annum (the lending facility rate). The annual inflation rate went down to 16.37 percent in December 2022 from 16.76  percent in November, remaining only marginally above the forecast, mainly as a result of lower fuel prices amid the decline in oil prices and the appreciation of the leu against the US dollar. Consequently, in 2022 Q4, the annual inflation rate reached a plateau, in line with expectations, posting a much more subdued rise in the period overall than in the previous quarters, given the stronger disinflationary impact from the aggregate dynamics of the exogenous CPI components, following the notable decline in fuel prices. In its turn, the annual adjusted CORE2 inflation rate saw a renewed, slight acceleration over the last months of 2022, contrary to forecasts, rising from 11.9  percent in September to 14.6  percent in December 2022, against the background of the continued advance in processed food prices, but also of almost across-the-board price increases in non-food and services segments. The evolution of adjusted CORE2 inflation continued to reflect the effects of large hikes in agri-food commodity prices and energy and transport costs, alongside the influences of bottlenecks in production chains. These were also compounded by high short-term inflation expectations and the resilience of demand in certain segments, as well as by the significant share of food items and imported goods in the CPI basket. The latest forecast, based on the data available and the regulations in force, showed the prospects for the annual inflation rate to fall at a significantly faster-than-previously anticipated pace until mid-2024, especially as of 2023 Q3, amid the extension of energy price capping and compensation schemes until 31 March 2025, concurrently with the changes made to these schemes starting 1 January 2023.

The war in Ukraine and the related sanctions continued to generate significant uncertainties and to pose risks to the outlook for economic activity, hence to medium‑term inflation developments, mainly through the effects exerted on households’ and investors’ confidence, as well as on their income, but also by affecting the economies of major trading partners and the risk perception towards economies in the region, with an impact on financing costs. At the same time, risks stemmed also from the absorption of EU funds, mainly those under the Next Generation EU programme, which is conditional on fulfilling strict milestones and targets for implementing the projects. However, it is essential for carrying out the necessary structural reforms, energy transition included, as well as for counterbalancing, at least in part, the contractionary impact of supply-side shocks, compounded by the war in Ukraine and by the tightening of economic and financial conditions worldwide. The fiscal policy stance for 2023, designed to continue budget consolidation (amid the excessive deficit procedure), the Fed’s and the ECB’s monetary policy decisions, as well as the stance of central banks in the region continued to be significant sources of risks and uncertainties.

Subsequently, the annual inflation rate went down to 15.52  percent in February 2023, relatively in line with forecasts. The decrease was mainly driven by the sizeable drop in the dynamics of fuel and electricity prices, under the impact of significant base effects and the change made to the energy price capping and compensation scheme starting 1 January 2023. At the same time, the annual adjusted CORE2 inflation slowed its rise somewhat more visibly than anticipated, to reach 15.0  percent in February amid disinflationary base effects and falling prices of some commodities, especially agri‑food items, as well as the downward adjustment of short-term inflation expectations. Significant, yet opposite influences continued to come, in the context of the resilience of consumer demand, from the gradual pass-through of increased costs of materials and wages into consumer prices, from higher profit margins, as well as from the rise in the prices of some imported consumer goods. Economic activity slowed down only mildly in 2022 Q4, to 1.0  percent from 1.2  percent in the previous three months (quarterly change), thus exceeding expectations yet again, which made it likely for excess aggregate demand to pick up again over this period, contrary to expectations. In annual terms, economic growth stepped up to 4.6 percent in 2022 Q4, from 3.8  percent in the prior quarter, with the main contribution, for the second quarter in a row, from gross fixed capital formation, followed at a short distance by the contribution from household consumption. The impact of net exports remained contractionary, but decreased significantly against Q3, as the particularly large deceleration in the annual dynamics of the import volume exceeded that in the annual dynamics of the export volume of goods and services. Against this background, the annual increase in the trade deficit slowed down markedly, while that in the current account deficit decelerated by two thirds to a two-year low, inter alia following the improvement in the evolution of the secondary income balance, on account of inflows of EU funds to the current account.

At the time of the NBR Board meeting of 4 April 2023, according to the latest assessments, the annual inflation rate would probably fall at a faster pace over the following months, in line with the latest medium-term forecast (February 2023), under the influence of sizeable base effects and the downward corrections of some commodity prices, as well as amid the changes made to energy price capping and compensation schemes. The previously-identified risk and uncertainty factors remained relevant.

Based on the available data and assessments at that moment, as well as in light of the very elevated uncertainty, the NBR Board decided to keep the monetary policy rate at 7.00  percent per annum. The interest rates on standing facilities were left unchanged at 6.00  percent per annum (the deposit facility rate) and at 8.00  percent per annum (the lending facility rate). Furthermore, the NBR Board decided to keep the existing levels of minimum reserve requirement ratios on both leu- and foreign currency‑denominated liabilities of credit institutions.

Inflation outlook

After the release of the February 2023 Inflation Report, the global macroeconomic environment saw a number of favourable developments: key commodity prices adjusted downwards, in some cases to levels below those prevailing a year ago, value chains continued to restore their efficiency, inter alia due to the recovery of the Chinese economy, while consumer and business confidence made significant progress. Against this background, inflationary pressures abated further and economic activity, in particular across Europe, showed increased resilience, also relative to expectations. However, the overall situation has remained fragile and marked by numerous uncertainties. Financial conditions have tightened, as a result of the ongoing monetary policy normalisation, among other factors, and recently these developments have also led to turmoil on international banking and financial markets. Furthermore, although it underwent a significant correction, inflation proved to be more persistent than anticipated, entailing additional unknowns as to the future evolution of this variable. Finally, the risks associated both directly and indirectly with the unfolding of the war in Ukraine stayed high, given that at least so far it has shown no signs of abating. As a matter of fact, in terms of the projection, the main unknowns continue to be driven largely by geopolitical developments, with a potential impact directly felt in the commodity markets, which are important sources of cost-push inflation. Although since the previous Inflation Report risks to the baseline scenario appear to have increased in number and, at the same time, diversified, their action is not unidirectional.

The current baseline scenario was built on the assumption of persistence, perhaps even a relative intensification, of warfare in Ukraine combined with economic sanctions imposed further on Russia throughout the forecast interval. Thus far, the introduction of such measures has brought about a broad-based, orderly decoupling of European countries from energy imports from Russia. This helped take some pressure off the wholesale energy markets, on the one hand, and preclude disruptions in economic activity, on the other hand, amid diversification of energy supply sources.

According to official statistics, Romania’s economy also showed higher-than-expected resilience in 2022 Q4. By contrast, the latest developments, especially at sectoral level, appear to hint at a slowdown in economic activity in 2023 H1. The assessment reflects, on the one hand, the simultaneous deceleration in the dynamics of the economies of trading partners in Europe, a key factor in the performance of the local economy, and, on the other hand, the pass-through of the joint contractionary effects of monetary policy normalisation and ongoing fiscal consolidation. Given the better-than‑expected fourth-quarter performance, with significant carry-over effects, the GDP dynamics were revised upwards for 2023 as a whole to around 3 percent, implying, however, a notable deceleration from a year ago. Reflecting the latest developments, the positive output gap was, in turn, revised at higher levels, and its correction is assessed to have started in 2023 Q1 already and to be largely completed towards the end of the projection interval. Conversely, the medium-term dynamics of potential GDP are projected to gain some momentum, given the assumption of a relatively large volume of EU funds, as a  percentage of GDP, coming from multiplesources, i.e. the 2014-2020 multiannual financial framework, with 2023 set as deadlinefor absorption, the 2021-2027 financial framework, the Next Generation EU programme.

As the main recipient of these funds, gross fixed capital formation is expected to be one of the components with a substantial medium-term contribution to GDP, after in 2022 its annual dynamics exceeded those of household consumption, among others. Apart from the EU funds, another source of investment financing could be foreign direct investment, which has already grown markedly during both 2021 and 2022. Nonetheless, for 2023, the main contribution to economic growth will be further made by household consumption, but its dynamics will slow down against the previous year, given the persistent decline in the purchasing power of households’ disposable income, the adverse effect of still high consumer uncertainty, as well as the fading of the one-off effect on consumer demand from the removal of pandemic restrictions in 2022. Compared to the major impact of these determinants, the temporary stimulus package recently adopted by the authorities to support particularly the purchasing power of some groups of low-income earners will only lend consumption a transitory resilience.

On the external front, the current account deficit is likely to have reached the peak of the current business cycle in 2022. Unlike the adverse developments seen over the past two years, commodity prices in general and energy prices in particular have recently recorded downward corrections, which could significantly mitigate the unfavourable price effects reflected in the trade deficit dynamics. Looking ahead, adjustments to the deficit on trade in goods will be supported also by the renewed pick-up in European partners’ economies, as well as by the unwinding of global supply bottlenecks that were previously compounded by the war in Ukraine and China’s problems. Nevertheless, wider corrections to the current account shortfall, over the medium term in particular, will hinge strictly on the progress in fiscal consolidation, as well as on addressing the persistent structural issues of Romania’s economy as effectively as possible. These measures could be significantly spurred by the considerable volume of EU funds allotted to Romania, having both a direct impact (by increasing the financing sources of external deficits) and an indirect one (by implementing targeted investment and structural adjustment programmes with favourable effects on economic activity and hence on the narrowing of fiscal deficits).

After peaking in November 2022, the annual CPI inflation rate has embarked on a downward path, which is expected to continue throughout the projection interval, yet staying above the variation band of the target. For the end of 2023, headline inflation is foreseen to reach 7.1  percent, before falling to 4.2  percent in December 2024 and 3.9 percent at the projection horizon, i.e. March 2025. Compared to the previous Inflation Report, for the end of this year, the new projection was revised marginally upwards by +0.1 percentage points, with differences owing to the dynamics of some exogenous components, mainly the VFE group, to which add some smaller ones associated with electricity prices. However, after two years of very strong pressures on energy prices, 2023 is marked by a sizeable ongoing slowdown in the contribution of this group to inflation dynamics. This comes chiefly from substantial base effects amid the hikes recorded in the same year-ago period and, to some extent, from the extension of the electricity and natural gas price capping and compensation scheme as of 1 January 2023. On the whole, the “energy” group (fuels, electricity, natural gas) is seen making a slightly negative contribution to the annual CPI inflation rate in December 2023, equivalent to an approximately 4.5 percentage point correction of its contribution to CPI inflation as against end-2022.

In contrast, the impact of the across-the-board rise in firms’ production costs will continue to feed through persistently to core inflation, which is also facilitated by still very favourable demand conditions. Therefore, the annual dynamics of the adjusted CORE2 index will ease only gradually throughout the projection interval, down to 9.3 percent in December 2023, 4.8 percent in December 2024 and 4.3 percent in March 2025. For this component, the projected values were revised downwards for this year compared to those in the previous Report (-0.5  percentage points in December 2023, mainly due to an improved performance of the food component), while for end-2024 the revision is marginally upwards (+0.1 percentage points). In terms of dynamics, as early as end-Q1, the annual core inflation rate will exceed headline inflation, their spread being anticipated to widen to a high of 3.1 percentage points in 2023 Q2 and Q3, before narrowing to a low of 0.4 percentage points in March 2025. The downtrend in adjusted CORE2 inflation will be driven by the gradual unwinding of supply-side shocks amid easing tensions in commodity markets and global supply chains, as well as by the progressive closing of the positive output gap and the receding imported inflation pressures. As a result of all the above-mentioned factors, inflation expectations will decline to values nearing the inflation target over the medium term, thus adding to downward underlying pressures. For the current year, the analysis also included the effect of retailers’ voluntary decision to lower the shelf price of milk, a temporary measure anticipated to remain in force May through October 2023.

The NBR’s recent monetary policy stance aims to bring the annual inflation rate back in line with the 2.5  percent ±1  percentage point flat target on a lasting basis, inter alia via the anchoring of inflation expectations over the medium term, in a manner conducive to achieving sustainable economic growth.

Following overly high inflationary pressures over the past two years, in the current round the balance of risks associated with the annual inflation rate is assessed to remain relatively in equilibrium. The multifaceted effects of the war in Ukraine, especially the economic ones, continue to pose most of the risks and uncertainties to the macroeconomic projection. Much more recently, the risk of escalating tensions between China and the USA, including trade-related ones, has also emerged, alongside the risk of higher volatility in a broad range of macroeconomic indicators following the strains on international banking and financial markets. The separate and – all the more so – the combined materialisation of these risks would likely postpone or even reverse the progress in restructuring and streamlining value added chains, which could entail new inflation bouts. At the same time, through contagion effects via multiple channels (firms’ higher production costs, households’ weaker purchasing power, postponement of investment projects amid elevated uncertainty, bottlenecks in export and import flows), such adverse developments would also put a drag on economic activity, thus fuelling the risk of stagflation. This poses challenges in terms of the optimal calibration of the macroeconomic policy mix, which is essential for an absolutely necessary and orderly adjustment of domestic and external imbalances.

The inflationary environment, coupled with the possibility that excess aggregate demand may persist over a longer period than anticipated in the baseline scenario, could further increase corporate profit margins after two years of similar developments. This might lead to a lower share of wage costs in total production costs, on the one hand, and to possible new inflationary episodes, weighing directly on households’ purchasing power, on the other hand. In an economy such as Romania’s, affected by a negative natural population change and a negative net migration, maintaining a low ratio of wage expenses to total costs over the medium term is unsustainable and could in return push wage claims higher, potentially boosting inflation. The effect could be amplified given the increased need for skilled workforce, driven by the large share in the years ahead of EU funds earmarked for innovative digitalisation and green economy projects (Next Generation EU programme). Finally, this could increase the skills mismatch, with consequences on both inflation rate (upside pressures) and economic activity (downside pressures).

On the domestic front, the future conduct of fiscal policy is a further relevant risk to the macroeconomic environment. Over the short term, difficulties in narrowing the public deficit in line with the target were confirmed over the past weeks. While a preliminary set of fiscal adjustment measures took shape until the cut-off date of the Inflation Report, it is still challenging to assess the extent to which they will be enough to address the immediate adjustment of the public deficit, as well as their optimality in terms of balancing public finances over the medium term, given that most of them exert corrective effects mainly this year. Moreover, in view of the extremely busy election schedule of 2024, it cannot be ruled out that the authorities may subsequently decide to supplement the expansionary measures or, as the case may be, to extend the applicability of some of the measures already in force, which would compound the fiscal correction effort committed to by the authorities under the excessive deficit procedure. In such an event, the current account deficit correction could also be jeopardised, with all the consequences this would have on the orderly financing of twin deficits and, subsequently, the implications for the coordinates of the domestic macroeconomic environment (inflation, economic growth, risk premium, etc.).

Monetary policy decision

Given the prospects of an ongoing decline in the annual inflation rate until the end of the projection horizon on a path almost similar to that envisaged earlier, and in view of the related risks and uncertainties, the NBR Board decided in its meeting of 10 May 2023 to keep the monetary policy rate at 7.00  percent. Moreover, it decided to leave unchanged the lending (Lombard) facility rate at 8.00  percent and the deposit facility rate at 6.00  percent. Furthermore, the NBR Board decided to keep the existing levels of minimum reserve requirement ratios on both leu- and foreign currency‑denominated liabilities of credit institutions.

1. Inflation developments

After this inflation cycle peaked in November 2022, the annual CPI inflation rate embarked on a downward path amid the easing of tensions in commodity markets, going down to 14.53 percent in March 2023, 1.84 percentage points lower than at end-2022 Q4. The disinflationary trend was attributable to energy prices, on the back of developments in fuel prices, whose annual dynamics reflected strong favourable base effects in the context of a stable Brent oil price in the current period, as well as due to the broadening of the scope of the electricity bills support scheme as of 1 January 2023. The annual core inflation rate discontinued its rise at end-2023 Q1, returning to 14.6 percent in March, i.e. a similar value to the end-2022 level. Behind this trajectory stood, inter alia, the lower pressures from energy and agri-food commodity prices, but also improved inflation expectations. On the other hand, demand conditions in the economy have remained however favourable for the implementation of price hikes (Chart 1.1).

The international oil market was characterised by a balanced ratio of demand to supply for the most part of 2023 Q1, so that the Brent oil price remained relatively stable, ranging between USD 80 and USD 85 per barrel (compared to an average of approximately USD 90 per barrel in the previous quarter). An episode of volatility was recorded in the last two ten-day periods of March, with international financial sector turmoil temporarily pushing the Brent oil price below USD 75 per barrel[1]. In early April, OPEC+ announced its intention to reduce notably oil output as of May, with the oil price returning to approximately USD 85 per barrel.The EU ban on Russian refined petroleum products, in effect as of February, had no significant impact on domestic prices in the related industry, signalling that supply was within adequate parameters, due to the diversification of sources and to stock‑piling in the second half of 2022. By contrast, the withdrawal of the lei 0.50 per litre of motor fuel compensation scheme starting on 1 January 2023 had an inflationary effect, which was partly offset by the cut in the excise duty on motor fuels as of the same date. Moreover, the price cap on firewood, in force until end-March, further limited the impact of inflationary pressures on non-motor fuels. Apart from the influence of the above-mentioned factors, the annual dynamics of fuel prices were visibly marked by favourable statistical effects, associated with the shocks caused by the outbreak of the war in Ukraine dropping out of the calculation; the value for March (-2.8 percent) thus stood 15.2 percentage points below that at end-2022 (Chart 1.2).

Furthermore, looking at energy prices, the adoption of a new version of the electricity bills support scheme, introducing a price capped at lei 1.3/kWh also for households with a monthly consumption exceeding 255 kWh (who paid the market price until end-2022), had a significant disinflationary effect. The new provision led to the fall in the average electricity price paid by households by approximately 16 percent in January compared to December, with slight monthly changes in both directions recorded on this segment in the other months of 2023 Q1 as well, solely due to the migration of consumers among the three consumption brackets.

The path of the annual adjusted CORE2 inflation rate seems to have also witnessed a turning point during 2023 Q1, decreasing from 15.1 percent in February to 14.6 percent in March, a level similar to that recorded at end-2022. Most commodity markets continued to ease, and in some cases (wheat, sunflower, maize), the prices went back to or even below the levels recorded before the onset of the war in Ukraine (Chart 1.3). Apart from the favourable outlook for this year’s crops, in the period under review as well, the international agri‑food commodity markets benefited from smooth trade flows from Ukraine, which slowed down the hike in prices on this segment following the latest supply shocks (energy crisis, drought, the outbreak of the military conflict). In turn, in 2022 as a whole, Romania imported considerable quantities of inexpensive cereals and oleaginous plants from Ukraine, yet the market disruptions caused by excess supply required, more recently, discussions about measures to protect farmers in the region, including those in our country. Conversely, the raise in the minimum wage and the wage claims arisen after a long period of high inflation have fuelled companies’ labour costs. At the same time, the persistent excess demand in the economy influences the behaviour of firms, which are more inclined to adjust prices upwards whenever there is a justifiable pretext.

The breakdown of adjusted CORE2 shows a slight slowdown (-1.6 percentage points versus December) in the annual dynamics of processed food prices (the component responsible for the fast pace of this indicator in 2022; Box 1), which was primarily driven by the prices of bakery products and edible oils (Chart 1.4). Although decelerating, the current dynamics of food prices remain, however, at very high levels by historical standards (monthly changes of over 1 percent). By contrast, the annual inflation rate of volatile food prices climbed to 24.0 percent in March, with vegetable prices posting hikes markedly larger than the seasonal average in the last two months of 2023 Q1, given that production in the EU was affected by wide and frequent temperature fluctuations during winter. The earthquake in Turkey and the war in important vegetable areas in Ukraine also contributed to a weaker supply in the region.

The dynamics of the other two core inflation segments further increased in 2023 Q1, with non-food items and market services recording 10.1 percent and 9.1 percent, respectively, in March. In the case of these two groups, cost pressures usually build up and pass through more slowly, given the complexity of value chains, as well as higher demand elasticity. For example, clothing and footwear or cosmetics contributed significantly to the step-up in the growth rate of non-food prices; the celebrations in early March increased demand for this type of products, thus creating an opportunity for price hikes. As for market services, worth noting is the inflationary contribution of telephony subscriptions and of accommodation and food service activities (for which the VAT rate went up from 5 percent to 9 percent as of January 2023).

Expectations on price developments remained, for the third quarter in a row, on a downward trend, with industry, services and trade recording larger declines in inflation expectations on a three-month horizon against end-2022 (Chart 1.5). Financial analysts’ expectations followed a similar path, pointing to lower annual changes in CPI than those anticipated at the end of the previous quarter for the one‑year and two-year horizons; in the latter case, the indicator neared even more the upper bound of the variation band of the target, compared to December 2022.

The average annual inflation rate remained on an upward path, stepping up to 15.3 percent for the indicator calculated based on the CPI methodology and to 13.2 percent for that calculated in accordance with the HICP structure (+1.5 percentage points and +1.2 percentage points respectively compared to end-2022). Although the differential versus the EU average further widened to 3.3 percentage points in March, Romania continued to fare better than the other countries in the region in terms of average HICP inflation (Chart 1.6).

The annual CPI inflation rate at end-2023 Q1 stood above the level projected in the February 2023 Inflation Report (+0.4 percentage points). Higher-than-expected annual changes were recorded by the group of electricity and natural gas prices, following the slightly weaker impact of the broadening of the electricity bills support scheme compared to in-house estimates, as well as by the VFE prices. The latter witnessed hikes greater than the multi-annual average of the period, given the supply shortage at European level and the events in Turkey and Ukraine, which weighed on production in the region.

2. Economic developments

1. Demand and supply

In 2022 Q4, real GDP rose at a brisker annual pace than in the previous period (up by 4.5 percent), due to the upward path in domestic absorption and the lower negative contribution from net external demand (Chart 2.1).

Household final consumption went up by 5 percent (annual change), a significant contribution coming from the automotive trade, whose turnover expanded by over 12 percent, due inter alia to the delayed deliveries of orders placed in the course of 2022, on the back of the logistical disruptions affecting the automotive industry worldwide. Retail trade (except for motor vehicles) also recorded faster growth, albeit of a lower magnitude. In this case, worth noting is the resumption of the upward trend in sales of durables, after two quarters of contractions. Behind the still robust consumer demand stood, to a large extent, the favourable effects exerted on household budgets by the electricity and natural gas price capping schemes and the heating vouchers for vulnerable individuals, as well as the mild winter, which limited the increase in utility bills. Nevertheless, the peak in demand at end-2022 seems to have been overcome, as suggested by the drop in the EC-DG ECFIN confidence indicator in February-March to half the average for the previous three months, amid expectations of a slowdown in sales, concurrently with moderate stock building. Conversely, the automotive trade does not currently show signs of a loss of momentum in the local market of new motor vehicles, given that the deliveries for the January-February period expanded by 28 percent and the confidence indicator advanced to 9 points in March (Chart 2.2).

In 2022 Q4, the general government deficit increased substantially to lei 39.3 billion[8], Relative to the level in the previous quarter (lei 18.2 billion, the equivalent of 1.3 percent of GDP), which had also recorded an increase.markedly exceeding that recorded in the same year-ago period (lei 35.6 billion), yet its share in GDP contracted to 2.8 percent from 3.0 percent in 2021 Q4. Its widening compared to the previous quarter was ascribable to the considerable growth of total budget expenditure[9], Nevertheless, its real annual dynamics re-entered negative territory (to -0.3 percent from 10.3 percent in the previous quarter).mainly on the back of capital expenditure, spending for projects financed from non-repayable external funds[10], Which had, however, a low impact on the budget balance, following the similar developments in disbursements from the EU.and spending on goods and services[11], However, spending for projects financed from non-repayable external funds and spending on goods and services contracted in real annual terms, and staff costs stepped up their negative real annual dynamics.whose impact was only slightly offset by the decrease in social security spending[12]. As a result, it reduced its slightly positive real annual dynamics.The advance in total budget revenues remained modest in this period[13] The real annual dynamics of revenues slowed down in turn, yet remained in positive territory (1.2 percent versus 5.9 percent in the previous quarter). and resulted primarily from larger disbursements from the EU and the increase in tax revenues[14], Mainly attributable to receipts from other taxes and fees on goods and services – which also include budget revenues from the energy sector –, from VAT (which in real annual terms, however, decreased, yet also on the back of higher tax refunds), from wage and income taxes and corporate income tax, as well as from the tax on use of goods.whereas the decline in non-tax revenues[15] Yet amid their faster real annual dynamics. and receipts from excise duties had an opposite impact.

Thus, in 2022 as a whole, the budget execution posted a deficit of lei 81.0 billion, relatively similar to the one recorded in the prior year (lei 79.9 billion), accounting however for 5.7 percent of GDP compared to 6.7 percent of GDP in 2021.

In 2023 Q1, the budget deficit reached lei 22.8 billion – significantly higher than in 2022 Q1 (lei 15.7 billion) –, accounting for 1.4 percent of GDP compared to 1.1 percent of GDP in 2022 Q1.

Gross fixed capital formation posted again a swift growth pace (11.8 percent in annual terms) and will probably maintain its positive dynamics over the projection horizon (the main contribution coming further from construction works), as 2023 is the decisive year for capitalising on the EU funds allocations under the 2014‑2020 multiannual financial framework (MFF)[16] At end-March 2023, the absorption rate of funds in the form of capital transfers was 76.3 percent, Romania still having at its disposal EUR 6 billion (the equivalent of about 8.4 percent of total gross fixed capital formation in 2022) – calculations based on the Net Financial Balance (Source: Ministry of Finance). (Chart 2.3). The pace of financing through the National Recovery and Resilience Plan (NRRP) is turning, however, into a matter of concern, in view of the European Commission’s extending the assessment of the second payment request (submitted by Romania in mid-December 2022), as well as of some tensions arising from the list of preconditions for the third payment request.

Investment in construction expanded by around 20 percent as against 2021 Q4, marking the end of a particularly dynamic year in terms of non‑residential construction and civil engineering works (Chart 2.4). The positive developments in these segments will probably continue in the first part of 2023, although non-residential buildings are envisaged to witness a relative slowdown (owing to a base effect). Favourable expectations are seen particularly for commercial property (large-sized property or retail parks), as well as for road and air transport infrastructure and local heating, water and sewerage networks, largely due to the use of European funding sources.

Equipment purchases[17] According to national accounts data on gross fixed capital formation. lost momentum (their annual growth rate went slightly below zero, from 13 percent in 2022 Q3), on account of purchases of machinery and ICT equipment, as well as of transport equipment bought by companies and public institutions (Chart 2.5). While a recovery in this segment has failed to become apparent at the onset of 2023, as suggested by the slight reduction in the volume of domestic orders placed with industrial producers of capital goods (except for motor vehicles) in the period from October 2022 to February 2023, there are certain positive signals over 2023 as a whole. Specifically, according to the results of PwC Global CEO Survey 2023, the corporate sector in Romania plans to invest in the automation of production processes, to implement advanced technologies and to use alternative energy sources.

The annual dynamics of the volume of foreign trade decelerated significantly, i.e. to 0.8 percent for exports and 3.5 percent for imports of goods. Apart from the base effect associated with the relative easing of bottlenecks in global value chains towards the end of 2021, the loss of momentum was due to the contraction reported by the two trade balance components in the current period (Chart 2.6). Specifically, the volume of exports of goods fell by 3.8 percent (quarterly change), which may be rather ascribed to some incidental factors – the poor maize and sunflower crops led to the 8.5 percent drop in exports of agri-food commodities, whereas moving beyond the peak of energy stockpiling worldwide caused the sharp reversal of coal exports[18]. They gained momentum during 2022, on the back of the global energy crisis. Manufacturing exports saw a relative rebound (quarterly change of 2.1 percent in the turnover volume for the external market), against the background of lower cost pressures. The breakdown shows faster rises in industries manufacturing electrical equipment, fabricated metal products, rubber and plastic products (quarterly changes in a range from 8 to 12 percent), and the discontinuation of the decline in chemical industry and metallurgy (up 0.9 percent and 0.7 percent respectively). In the short term, the uptrend in manufacturing exports will probably weaken, given that the boost from the easing of disruptions in global supply chains is fading as firms work off order backlogs, and that industrial activity in the economies of major trading partners remains fragile.

Imports of goods posted a stronger decline than exports (-11.3 percent, according to the national accounts series, real quarterly changes). Looking at the breakdown, the main contribution came from intermediate goods, particularly crude oil (as the entry into force of the sanctions imposed on imports from Russia on 5 December 2022 was preceded by massive imports), natural gas, wood, as well as chemical products, possibly in association with the local industry recovery towards the year-end. The volume of imports of consumer and capital goods decreased marginally, the fourth quarter possibly recording a higher contribution of local production to meeting domestic demand (as suggested by the rebound in the industrial turnover volume of the two groups in the domestic market).

In 2022 as a whole, the negative differential between the growth rate of exports and that of imports of goods in terms of volume, together with the unfavourable terms of trade, caused the widening of trade imbalance[19] The price component made a negative contribution of 49 percent to the increase in the goods trade deficit (calculations based on BPM5 international trade data; Source: Eurostat). by approximately EUR 9 billion and the deterioration of the current account balance to the same extent (to EUR 26.7 billion, up 52.7 percent as against 2021), Chart 2.7.

Labour productivity

In 2022 Q4, the annual dynamics of labour productivity stepped up slightly, to 4.5 percent (+0.7 percentage points from the preceding quarter). The breakdown shows that the profile of the indicator was further similar to that recorded previously: ICT services were at the heart of these favourable developments, posting a two-digit rate of increase for the fourth quarter in a row, together with construction, on the back of the dynamism in non-residential construction and civil engineering works. Conversely, productivity indicators in industry and agriculture fell deeper into negative territory (Chart 2.8).

The rebound in European manufacturing, supported by the sharp decline in energy prices over the autumn months, was short-lived, giving way to more reserved prospects. In November 2022, the annual growth rate of the volume of new orders in manufacturing in Romania re-entered negative territory and remained there over the following three months, triggering, in turn, a decrease in the capacity utilisation rate for all main industrial groupings, except for non-durables (Chart 2.9). The still important, albeit abating, cost pressures (related to energy, commodities[20], Commodity prices have started to normalise, but still significantly exceed the pre-crisis average (2015-2019).labour), the higher interest rates and the likelihood of a slowdown or even a recession in advanced economies call into question some of economic agents’ decisions to invest and expand. Additionally, firms’ more prudent behaviour translates into a cut in inventories of raw materials/materials and of finished goods, with immediate consequences on production and labour productivity[21]. Companies do not resort to layoffs as soon as the economic climate dictates a slowing in the pace of production. Hence, the labour productivity indicator (output/employee) declines immediately, at least temporarily.

Even though in the short run the outlook remains rather subdued, several developments that may occur over the longer term may lead to labour productivity gains in industry. A trend that manufacturers are increasingly bringing into discussion amid the geopolitical tensions is the relocation of certain operations or suppliers from geographical areas far away in terms of position and cultural values to allied countries (friend-shoring). A recent study conducted by Horváth, a management consultancy company, shows that two out of three European companies with business activities in China intend to transfer part of their operations to other countries, particularly in Europe.

Another relevant development is the EU industrial policy, which focuses on facilitating the green transition. To this end, in early 2023 the European Commission presented the Green Deal Industrial Plan, a package of measures meant to support the competitiveness of Europe’s industry against the substantial subsidy schemes in force in other countries, especially in the US[22]. Recently, there has been even a shift in major investments from Europe to the US, amid the significant state aid made available under the Inflation Reduction Act.The provisions of the Net-Zero Industry Act, which is part of the Green Deal Industrial Plan, supplement and simplify the mechanisms for state aid for green industries and for manufacturers of technologies that are key to meeting climate goals. Investments in the development of sustainable energy sources have been a major concern of Romanian producers in the energy and manufacturing sectors ever since the onset of the energy crisis in 2021, the aforementioned framework providing an additional boost to such spending, with potential long-term productivity gains.

Labour market developments

In 2022 Q4, labour market tightness continued to ease, the trend becoming more pronounced than in the previous quarters (Chart 2.10). Given the prospects of slower economic activity both domestically and internationally, local companies were more prudent in deciding whether to expand payrolls. Thus, the job vacancy rate decreased (to 0.8 percent from 0.9 percent in Q3), while the unemployment rate posted a slight increase (to 5.6 percent, up 0.1 percentage points from the level in the prior quarter). The ICT sector witnessed a substantial drop in job vacancies, in correlation with the global trend, which may have caused uncertainty on the domestic front with regard to future labour demand developments. According to the DG ECFIN survey, labour shortage stabilised somewhat in the final months of 2022, with companies, however, perceiving it less stringent in early 2023.

Yet, the latest data on the unemployment rate signal a possible trend reversal, the indicator falling to 5.4 percent in March. This has occurred amid further positive, albeit decelerating, annual dynamics of the number of employees economy-wide (from 1.6 percent in 2022 Q4 to 1.4 percent in January-February 2023) and companies’ robust employment expectations over the short term (106 in 2023 Q1, 107.9 in April).

Most economic sectors (trade, construction, services, the budgetary sector) recorded slower growth rates of the number of employees (Chart 2.11). In industry, headcount remained relatively stable. Nevertheless, cost pressures (particularly related to energy) that have built up over time further exert an uneven adverse effect on labour in various sub‑sectors, despite the easing of commodity markets. Specifically, firms in energy‑intensive industries, such as the chemical industry, metallurgy, the manufacture of wood or of building materials, as well as in the light industry and the manufacture of furniture[23] Apart from the constraints arising from the energy shock, the light industry and the manufacture of wood and of furniture are more strongly affected by the higher wage costs, as they are labour-intensive industries. In addition, the manufacture of wood and of furniture were hit by the scarcity of raw materials, as a large part of the wood supply was channelled by the authorities into providing heating to homes. resorted to layoffs, which were, however, limited as compared to the size of the contraction in activity; the other manufacturing sub-sectors increased their payrolls, the food industry standing out with a substantial rise in the number of employees, spurred by the tax breaks granted in the field of labour taxation.

January through February 2023, the annual growth rate of the average gross wage economy-wide accelerated to 13.1 percent (from 11.7 percent and 12.2 percent in 2022 Q3 and Q4 respectively). The upward path was further driven by the wage increases in the private sector (15.7 percent in the first two months of 2023), under the influence of the hike in the minimum gross wage (by approximately 33 percent in construction and almost 18 percent in the other economic sectors); the decision made by the authorities can be seen as an implicit adjustment of part of wages for the inflation rate. In fact, according to a specification of the wage Phillips curve in Romania that captures wage dynamics with a satisfactory accuracy, the pick-up is mainly accounted for by inflation expectations (modelled as adaptive); labour productivity and labour market tightness made minor contributions to the faster-paced growth of wages (Chart 2.12). In the public sector, the rate of increase of wages remained moderate, stepping up however to 5 percent in January-February 2023 (from 3.7 percent in 2022 Q4) following some pay rises in public administration and education.

2. Import prices and producer prices on the domestic market

In January-February 2023, import prices, as well as industrial and agricultural producer prices on the domestic market posted a stronger downward trend, amid the easing of tensions in international commodity markets, particularly the energy market, and some favourable base effects. Over the short term, the trend is seen to remain unchanged, the weak global demand dampening pressures in external commodity markets.

2.1. Import prices

International energy commodity prices continued to decline, their annual dynamics entering negative territory in 2023 Q1 (-20.9 percent), according to World Bank data (Chart 2.13). Crude oil prices have followed a relatively flat trajectory starting mid-December 2022 (roughly USD80-85/barrel), amid the diversification of supply to European customers and a balanced supply/demand ratio. In the latter part of the period, prices declined abruptly below USD 75/ barrel, against the backdrop of financial turmoil, which prompted new waves of uncertainty. However, this development was short-lived, as the announcement made by some OPEC+ members of a cut in production starting from May, in response to the pessimistic outlook for global demand, led oil prices to resume their increase, returning to around USD 85/barrel in early April. The prices of natural gas traded on the European market contracted in annual terms, i.e. -48.4 percent, with the adequate storage levels of natural gas in Europe representing an important contributor thereto, apart from the fall in consumption.

On the metals market, the signs of economic activity recovery in China boosted prices towards end-2022 and in early 2023. Subsequently, concerns surrounding the evolution of global demand became prevalent, so, in 2023 Q1 as a whole, the annual price dynamics remained in negative territory (declines of almost 16 percent).

According to FAO data, agri-food commodity prices stayed overall on the downtrend seen over the past months, their annual contraction deepening from -0.1 percent in Q4 to -11.4 percent in 2023 Q1. This trend mirrored significant decreases in price indices for most categories, which were more pronounced in the case of vegetal oils and grains[24], Segments heavily affected by the outbreak of the war in Ukraine in February 2022.owing also to some base effects; in the opposite direction acted the steep rise in sugar prices. At the same time, some price spikes were visible in the vegetable segment, as producers in Europe were affected by the adverse weather conditions, as well as by the higher energy and fertiliser costs, while the supply of products from Ukraine to the EU market posed problems.

The easing of tensions in commodity markets and some favourable base effects caused inflationary pressures stemming from external prices to abate further in 2022 Q4, the annual unit value index of imports (UVI) shedding another 2.4 percentage points to reach 113.9 percent. The trend was more pronounced for base metals, their UVI dropping by 8.9 percentage points to 109.3 percent. Similar developments were recorded for some food items, such as fats and oils, as well as for some non-food items (clothing, fuels). In the opposite direction moved the UVIs of ores (driven solely by some base effects), sugar, fruit and meat, amid the lower supply (in the case of meat, another determinant was the spread of avian flu across the EU).

2.2. Producer prices on the domestic market

In January-February 2023, the annual dynamics of industrial producer prices on the domestic market remained on a downward trend (28.2 percent, i.e. 18.5 percentage points below the 2022 Q4 average), all groups of goods posting decelerating growth rates (Chart 2.14). The trend will persist in the period ahead as well, given that the easing of tensions in the international energy commodity markets will reflect in the domestic prices of the other categories of goods that are energy intensive; the smoother functioning of international supply chains will further contribute to this trend. The continuity of the disinflationary trajectory is also suggested by the DG ECFIN survey for March 2023, the balance of answers standing below the level recoded in January-February.

The slower growth rate of producer prices at aggregate level owed mainly to developments in energy prices (a 41.7 percentage point decrease in their annual rate of change, to 42.9 percent). Specifically, some significant favourable base effects led to a drop in the annual rate of increase of the electricity, gas, steam and air conditioning supply prices from 101.5 percent in Q4 to 58.5 percent in January-February. As for electricity, a contribution to the deceleration came also from the lower system fees, the contribution for cogeneration, and the mandatory quota for green certificates, as of 1 January 2023. For the time being, the strong correction of spot prices for electricity and natural gas on the domestic wholesale markets (in line with the external trend) and the entry into force of the centralised electricity purchasing mechanism[25] As of January 2023, producers are obliged to sell amounts of their electricity output through OPCOM, except for those already contracted, at a fixed price of lei 450/MWh. have had a low impact, given that contracts are usually concluded for longer periods. However, there are prospects for downward adjustments in the coming period. Crude oil processing prices also posted a slower advance, in correlation with movements in international oil prices.

Producer prices of intermediate and capital goods also recorded decreases in their annual rates of change, albeit of a moderate magnitude, driven by developments in metallurgy, chemicals and fabricated metal products. Lower energy costs played an important role, probably along with the energy efficiency measures taken by some of the major producers. At the same time, these segments are subject to competitive pressure from cheap imports (as is the case of metallurgy, where manufacturers complain of competition from lower-priced products from Turkey, made with raw materials from Russia).

The annual growth rate of producer prices for consumer goods decelerated slightly from 2022 Q4 (-1.6 percentage points to 20 percent), primarily on account of non-durables. In the food industry, after having peaked in September, the annual dynamics of producer prices followed a downward path; the main disinflationary driver was the alleviation of pressures from commodity costs, particularly for cereals and oleaginous plants, as Ukraine’s exports of agri-food commodities on the Black Sea was instrumental in soothing the grain and oilseed markets.

The annual advance in agricultural producer prices slowed down January through February 2023 (from 30.8 percent to 23.5 percent), owing solely to prices for vegetal products (-10.4 percentage points to 18.4 percent), with grains and oleaginous plants posting stronger declines (Chart 2.15). Some vegetables witnessed faster price increases, amid subdued global output and limited domestic off‑season supply due to the lack of storage facilities. The annual change in prices for animal products edged up by 0.4 percentage points, to 37.7 percent, with pressures visible especially in the eggs segment, given the increase in the number of avian flu cases.

Unit labour costs

The annual dynamics of unit labour costs economy-wide picked up again in 2022 Q4, reaching 9 percent (+0.7 percentage points versus the previous quarter). The rise in compensation per employee (13.9 percent) continued to run noticeably above the growth rate of labour productivity (4.5 percent), which would indicate a build-up in inflationary pressures via this channel (Chart 2.16).

In industry, the annual pace of increase of unit wage costs posted a significant acceleration, climbing to 22.7 percent in October 2022 – February 2023 (compared to 15.8 percent in 2022 Q3). While tensions in international commodity markets have eased over recent months, the dynamics of domestic industrial activity still reflect the slow recovery of production in industries severely hit by the energy shock, as well as the weakness of global demand. At the same time, despite high wage growth rates, economic agents further resort to labour hoarding, to the extent possible, until these constraints fade. Against this background, most industrial sub‑sectors posted high rates of change of ULC, i.e. over 20 percent. Particularly fast ULC dynamics continued to be recorded in energy‑intensive industries, such as metallurgy and the chemical industry[26] However, the chemical industry saw an improvement at the beginning of 2023, activity being resumed, to some extent, due to the sharp decline in natural gas prices. (over 50 percent), as well as in other non-metallic mineral products, manufacture of wood, plastic products and the light industry (changes ranging between 30 percent and 50 percent). More moderate growth rates in ULC (up to 10 percent) were seen in the manufacture of machinery and equipment, the automotive industry, the manufacture of electronic products, footwear and leather goods, as well as in the pharmaceutical industry.

3. Monetary policy and financial developments

1. Monetary policy

February through April 2023, the NBR kept the monetary policy rate at 7.00 percent and left unchanged the lending facility rate and the deposit facility rate at 8.00 percent and 6.00 percent respectively (Chart 3.1). Moreover, the central bank kept the existing levels of minimum reserve requirement ratios on both leu- and foreign currency-denominated liabilities of credit institutions at 8 percent and 5 percent respectively. The measures aimed to bring the annual inflation rate back in line with the 2.5 percent ±1 percentage point flat target on a lasting basis, inter alia by anchoring inflation expectations over the medium term, in a manner conducive to achieving sustainable economic growth.

The NBR Board decisions in February 2023 were taken in a context in which the annual inflation rate had reached a plateau in 2022 Q4, in line with expectations, and the new forecast saw it fall at a significantly faster-than-previously anticipated pace until mid‑2024, amid the extension of energy price capping and compensation schemes until 31 March 2025.

Specifically, the annual inflation rate went down to 16.37 percent in December 2022[27] From 16.76 percent in November. – only marginally above the forecast –, while during 2022 Q4 overall it posted a much more subdued rise than in the previous quarters[28], From 15.88 percent in September.given the stronger disinflationary impact from the aggregate dynamics of the exogenous CPI components, following the notable decline in fuel prices[29],Amid the fall in crude oil prices and the appreciation of the leu against the US dollar. Minor additional disinflationary influences stemmed from energy and administered prices, on account of some base effects. [30]. By contrast, the annual adjusted CORE2 inflation rate posted a renewed, slight acceleration in 2022 Q4, contrary to forecasts, rising from 11.9 percent in September 2022 to 14.6 percent in December. This time round, its advance was mainly triggered by the non-food sub-component and to a lower extent by the hikes in processed food prices.

At the same time, the new medium-term forecast indicated the outlook for the annual inflation rate to fall at a significantly faster-than-previously anticipated pace until mid-2024, especially as of 2023 Q3, given the extension of energy price capping schemes until 31 March 2025 and the changes made to these schemes starting 1 January 2023. Therefore, the annual inflation rate was envisaged to decline to one-digit levels starting in 2023 Q3 already – almost three quarters earlier than in the November 2022 forecast – and then to 7.0 percent in December 2023, far below the previously-anticipated 11.2 percent. It was then seen remaining slightly above the variation band of the target at the end of the projection horizon, i.e. at 4.2 percent, similarly to the prior forecast.

The decrease in the annual inflation rate would be mainly attributable to supply-side factors, whose disinflationary impact was expected to rise progressively over the following quarters and to visibly affect the evolution of exogenous CPI components, but also core inflation dynamics to a certain extent. The major influences were anticipated to stem from increasingly strong disinflationary base effects and downward corrections of some commodity prices[31], Including of crude oil and agri-food commodities, amid the easing of wholesale markets.as well as from the improvement of global production and supply chains. To these would add the influences presumably generated by the new setup of energy price capping schemes. Moreover, the balance of supply-side risks to the new inflation outlook remained in relative equilibrium, at least in the near future, given the recent trends in key energy and agri‑food commodity prices, as well as the nature of their major determinants.

Underlying inflationary pressures were expected to have a stronger-than-previously-anticipated impact, although progressively on the wane, until fading out completely towards the end of the projection horizon, given the new widening of the positive output gap in 2022 Q3, contrary to expectations, but also the likelihood for its gradual contraction and closing in mid-2024[32].Excess aggregate demand was anticipated to shrink somewhat more gradually and from a higher level than envisaged earlier, implying that the output gap would close three quarters later than previously projected and enter only slightly into negative territory towards end-2024. The pattern stemmed from the milder-than-expected moderation in economic growth during 2022 Q3 and the outlook for its significant deceleration in 2023 – in the context of high energy costs and the protraction of the war in Ukraine, as well as amid the monetary policy stance and the fiscal consolidation –, followed by a somewhat more visible-than-previously anticipated revival in 2024, given the faster absorption of EU funds, inter alia under the Next Generation EU instrument.

At the same time, the war in Ukraine and the related sanctions continued to generate significant uncertainties and risks to the outlook for economic activity, hence to medium-term inflation developments, the same as the absorption of EU funds, especially those under the Next Generation EU programme, amid the attached conditionality. Major uncertainties and risks were, however, further associated with the fiscal policy stance as well, given the packages of support measures to be implemented or extended during 2023, in a very challenging economic and social environment domestically and globally, with potential adverse implications for budget parameters.

According to subsequently-released statistical data, the annual inflation rate went down to 15.52 percent in February, relatively in line with forecasts[33], The decrease was driven by the exogenous CPI components, whose disinflationary impact stepped up during this period, as a result of the sizeable drop in the dynamics of fuel and electricity prices, under the impact of significant base effects and the change made to the energy price capping and compensation scheme starting 1 January 2023.while the annual adjusted CORE2 inflation rate slowed its rise in the first two months of 2023 somewhat more visibly than anticipated[34]. Reaching 15.0 percent in February against the backdrop of disinflationary base effects and falling prices of some commodities, especially agri-food items, as well as amid the downward adjustment of short-term inflation expectations. At the same time, significant opposite influences continued to come from the gradual pass-through into consumer prices of increased costs of materials and wages, as well as from the pick-up in profit margins, in the context of the resilience of consumer demand, but also from the rise in the prices of some imported consumer goods.At the same time, economic growth exceeded expectations yet again in 2022 Q4, slowing down only mildly in quarterly terms[35], To 1.0 percent from 1.2 percent in 2022 Q3.which made it likely for excess aggregate demand to pick up again over this period, contrary to forecasts.

In annual terms, economic growth stepped up, however, to 4.6 percent in 2022 Q4 from 3.8 percent in the prior quarter, with the main contribution coming from gross fixed capital formation, followed at a short distance by that from household consumption, which saw a visible advance versus Q3. At the same time, the contractionary impact of net exports decreased significantly, as the particularly large deceleration in the annual dynamics of the import volume exceeded that in the annual dynamics of the export volume of goods and services. Consequently, the annual increase in the trade deficit slowed down markedly, while that in the current account deficit decelerated by two thirds to a two-year low, inter alia following the improvement in the evolution of the secondary income balance, on account of inflows of EU funds to the current account.

On the labour market, the growth in the number of employees in the economy lost even more pace in December 2022-January 2023, while the ILO unemployment rate posted only a very slight decline in January-February 2023, after its advance to 5.7 percent in 2022 Q4 from 5.5 percent in Q3, and the job vacancy rate saw a sharper decline. Moreover, in 2023 Q1 the labour shortage reported by companies saw a re-intensification of the downward trend visible since 2022 Q3, while employment intentions for the near-term horizon remained on a downward path overall. The annual growth rate of average gross nominal wage earnings recorded, however, increasingly higher double-digit levels in 2022 Q4, especially in the private sector, while in January 2023 it witnessed a slightly faster increase[36]. Largely on account of the hike in the gross minimum wage economy-wide and that in the construction sector.Against this background, the annual change in the nominal unit labour costs economy-wide remained on an upward trend in 2022 Q4, while the particularly fast rise in unit wage costs in industry stepped up in September 2022-January 2023, also owing to increased productivity losses in this sector.

On the financial market, the main interbank money market rates remained on a downward path in February-March. However, the downward adjustment slowed and came to a halt towards the end of the period. At the same time, yields on government securities posted increases in February, which were fully corrected in March – in line with developments in advanced economies and in the region –, against the backdrop of successive revisions in investor expectations on the Fed’s and the ECB’s prospective monetary policy stance, as well as of the turmoil created by the collapse of Silicon Valley Bank and Signature Bank in the US and by the situation of Credit Suisse. The leu further exhibited, however, a strengthening trend versus the euro, reflecting the high relative attractiveness of investments in domestic currency and the broadly favourable risk perception towards financial markets in the region. The EUR/ RON returned only for a short while, in the closing days of March, to the vicinity of the values prevailing in 2022 H1. The USD/RON exchange rate halted, nevertheless, its downward path seen since mid-2022 H2[37], Posting a small increase in February, followed by a decline of a similar magnitude in March.as the US dollar stopped its depreciation versus the euro.

The annual growth rate of credit to the private sector decelerated more moderately in the first two months of 2023[38]. Reaching 10.6 percent in February from 12.1 percent in December 2022.This owed to the slower decline in the dynamics of the leu-denominated component, under the influence of the marked increase in January in the volume of new loans to non-financial corporations under government programmes. Conversely, after the relatively abrupt step-up in the previous two quarters, the annual rate of change of foreign currency loans remained relatively steady, although at a particularly high level. As a result, the share of the leu‑denominated component in credit to the private sector continued to fall[39]. To 68.3 percent in February 2023 from 68.8 percent in December 2022.

The assessments updated in this context showed that the annual inflation rate would fall at a faster pace over the following months, in line with the latest medium‑term forecast, driven by disinflationary base effects and downward corrections of some commodity prices, as well as amid the changes to energy price capping and compensation schemes as of 1 January 2023.

Uncertainties were, however, associated with the presumed impact of the new setup of energy price capping and compensation schemes, while the balance of supply-side risks to the inflation outlook became tilted to the upside in the reviewed context, given inter alia the crude oil output cuts announced by OPEC countries and the vegetable shortage in Europe.

At the same time, the cyclical position of the economy was envisaged to exert stronger inflationary pressures over the near-term horizon and more gradually abating than in the prior forecast, as the new assessments indicated a much more subdued slowdown in quarterly economic growth in 2023 H1 than previously anticipated, after a GDP advance above expectations during 2022 Q4 as well. The developments rendered it likely for excess aggregate demand to see a more moderate contraction in the first part of 2023 than previously anticipated and stay on a higher path[40]. They implied still robust annual GDP increases in 2023 Q1 and Q2, albeit gradually decelerating.

However, the war in Ukraine and the related sanctions continued to generate substantial uncertainties and risks to the outlook for economic activity, hence to medium-term inflation developments, to which added those stemming from the turmoil in the banking systems in the US and Switzerland. This could have adverse effects by affecting the economies of developed countries and the risk perception towards the region, with an impact on financing costs. A significant source of uncertainties and risks also remained the absorption of EU funds, especially those under the Next Generation EU programme, amid the attached conditionality.

Major uncertainties and risks were further associated, nevertheless, with the fiscal policy stance as well, given, on one hand, the public deficit target set for 2023 in order to continue budget consolidation amid the excessive deficit procedure and the significant increase in financing costs and, on the other hand, the characteristics of the budget execution in the first months of the year and the packages of support measures to be implemented or extended during 2023, in a challenging economic and social environment domestically and globally, with potential adverse implications for final budget parameters.

The reviewed context overall warranted keeping the monetary policy rate unchanged, with a view to bringing the annual inflation rate back in line with the 2.5 percent ±1 percentage point flat target on a lasting basis, inter alia by anchoring medium‑term inflation expectations, in a manner conducive to achieving sustainable economic growth.

Thus, the NBR Board decided in its meeting of 4 April 2023 to keep the monetary policy rate at 7.00 percent. Furthermore, it decided to leave unchanged the lending facility rate at 8.00 percent and the deposit facility rate at 6.00 percent. In addition, the NBR Board unanimously decided to keep the existing levels of minimum reserve requirement ratios on both leu- and foreign currency-denominated liabilities of credit institutions (8 percent and 5 percent respectively).

2. Financial markets and monetary developments

During 2023 Q1, the daily average interest rate on interbank transactions[41] The average interest rate on transactions in deposits on the interbank money market, weighted by the volume of transactions. stayed close to the lower bound of the interest rate corridor, while longer‑term rates on the interbank money market stuck to a gradually downward path, although the latter slowed in the second part of the period. The EUR/RON exchange rate declined, however, again in January and remained until towards the end of the quarter at values below those prevailing in 2022 H1. The annual growth rate of credit to the private sector decreased more slowly January through February 2023, while that of liquidity across the economy halted its decline.

2.1. Interest rates

During 2023 Q1, the daily average interest rate on interbank transactions remained near the lower bound of the interest rate corridor[42], The daily average interest rate on interbank transactions fell to the vicinity of the deposit facility rate at the onset of November 2022.climbing implicitly once with the increase by another 0.25 percentage points in the NBR’s key rates in January. Therefore, the quarterly average[43] Weighted by the volume of transactions. of the indicator edged down 0.08 percentage points versus the previous three months’ rising level, to stand at 5.96 percent.

Relevant from the perspective of developments in this indicator were the larger money market excess liquidity during the quarter, as well as the central bank mopping it up solely via the deposit facility[44], The average daily stock of these deposits rose to lei 22.8 billion in 2023 Q1 from lei 6.5 billion in the previous three months.amid the ongoing favourable risk perception towards financial markets in the region and the higher relative attractiveness of investments in domestic currency.

At the same time, 3M-12M ROBOR rates stuck to the gradually downward path they had embarked on in mid-2022 Q4, although it slowed in the second part of the period. Specifically, the 3M rate fell below the monetary policy rate in mid-Q1, while 6M and 12M rates further saw their positive spread vis‑à‑vis the key rate narrow gradually. Therefore, the quarterly averages of interbank rates halted their advance from the previous six quarters, decreasing to 7.10 percent for the 3M maturity (down 0.83 percentage points against the previous period), 7.42 percent for the 6M rate (down 0.68 percentage points) and 7.77 percent for the 12M maturity (down 0.51 percentage points) (Chart 3.2).

On the government securities market, significant influences also stemmed from the shifts in direction witnessed in Q1 by long-term government security yields in advanced economies. These reflected the successive revisions of investor expectations on the Fed’s and the ECB’s prospective monetary policy stance – with implications inter alia for the global risk appetite –, but also the turmoil created by the collapse of Silicon Valley Bank and Signature Bank in the US and by the situation of Credit Suisse[45]. These yields posted declines in January, followed however by relatively more sizeable increases in February, amid the upward revision of investor expectations on the magnitude of the Fed’s policy rate hike in the near run. In March, the yields recorded however sharp drops, fully correcting the previous month’s advance, owing to financial market tensions. Moreover, major influences came from the considerable increase in the relative attractiveness of domestic currency-denominated government securities in January, also amid the NBR’s new monetary policy decision.

Under the circumstances, yields on the secondary market for government securities[46] Bid-ask averages. either resumed or extended their generally downward path in the first month of Q1, hitting lows for the past approximately eight months, and then recorded increases in February, which were however fully corrected in March[47] Rates on 6- and 12-month securities posted the lowest readings in 10 months during this period. (Chart 3.3). Hence, the monthly averages of these rates declined in March against the December 2022 values by 0.60 percentage points and 0.40 percentage points for the 6- and 12-month securities (to 6.28 percent and 6.60 percent respectively), by up to 0.35 percentage points for the 3- and 5-year maturities (to 7.18 percent and 7.31 percent respectively), and by 0.52 percentage points for 10‑year securities (to 7.46 percent). Against this background, the yield curve saw its positive slope moderate slightly in March 2023 versus the closing month of 2022.

The average accepted rates at primary market auctions[48] In January 2023, the MF issued on the external market USD-denominated government securities with 5-, 10- and 30-year maturities and average rates of 6.72 percent, 7.22 percent and 7.67 percent respectively, totalling USD 3,992.6 million. This operation also included the buyback of Eurobonds maturing in August 2023 and January 2024, totalling USD 242.6 million. Moreover, the MF issued leu-denominated government securities for households under the “Tezaur” programme in January 2023, with 1-, 2- and 3-year maturities, at rates of 7.35 percent, 7.60 percent and 8.00 percent respectively, as well as in February and March, with 1-, 2- and 3-year maturities, at rates of 7.20 percent, 7.50 percent and 8.00 percent respectively. recorded relatively similar developments as well. Specifically, compared to December 2022, their monthly averages went down in March by 0.28 percentage points for 12-month securities (to 6.70 percent), by 0.43 percentage points for the 5-year maturity (to 7.26 percent) and by 0.81 percentage points for 10-year securities (to 7.51 percent)[49]. With the exception of rates on 2-, 6- and 13-year securities, which posted slight increases (reaching 7.27 percent, 7.59 percent and 7.99 percent respectively), the auctions for these securities being conducted in the early days of March. The unprecedented rise in investor appetite for this type of investments during the first month of the year, but also in Q1 overall, is also reflected by the marked increase in January, to historical highs, in the ratio of the amounts of bids submitted to the announced volume and in the ratio of the volume of issues to the announced volume (to 5.24 and 4.13 respectively). This was followed by a decline in February and a mild advance in March (to 2.59 and 1.26 respectively[50]). During the quarter overall, the ratio of the amounts of bids submitted to the announced volume and that of the volume of issues to the announced volume re-widened to 3.37 (from 2.14 in 2022 Q4) and 2.25 (from 1.43) respectively.Against this backdrop, the total volume of securities issued hit in Q1 a new historical high of around lei 40.4 billion[51] In January, the volume of issues reached a historical high of lei 26.2 billion. (lei 19.5 billion in 2022 Q4), well above the previous peak recorded in 2022 Q3 (lei 22.5 billion). The value of net issues stood only slightly below the gross reading[52], Given the relatively low volume of securities maturing in the three months overall.thus advancing markedly, to lei 35.1 billion (versus lei 8.4 billion in the previous quarter).

Amid the developments in relevant ROBOR rates and in the IRCC during the first months of the year, the average interest rate on new loans to non-bank clients went up further January through February 2023, albeit much more slowly, adding 0.18 percentage points against the 2022 Q4 average, to 10.02 percent[53], As the indicator grew in both months, reaching 10.15 percent in February, the highest level in the past almost 10 years.while that on new time deposits shed 0.56 percentage points, to 6.42 percent (Chart 3.4).

Developments in average lending rates on new business were heterogeneous across the two customer categories. Specifically, the average lending rate on new business to households climbed again significantly versus the prior quarter (up 0.71 percentage points, to 10.33 percent[54]). In February, it peaked at a nine-and-a-half year high of 10.47 percent.This reflected the further considerable advance in the average interest rate onnew housing loans(+0.80 percentage points, to 7.66 percent – in correlation with the IRCC performance), but also the slower rise in the average interest rate on new consumer credit, which added 0.22 percentage points, to 12.71 percent (Chart 3.5).

Conversely, the average lending rate on new business to non-financial corporations shrank by 0.57 percentage points against the 2022 Q4 average, to 9.61 percent, thus halting the upward path seen in the previous five quarters[55] Against this background, the average interest rate on new loans to non-financial corporations fell again below that on new loans to households, after having atypically stayed above it May through December 2022. (Chart 3.6). The turning point was visible acrossboth major types of loans, although the average interest rate onhigh-value loans (above EUR 1 million equivalent) witnessed a more sizeable decrease (down 0.85 percentage points, to 9.07 percent). The average interest rate on low-value loans (below EUR 1 million equivalent) shed 0.32 percentage points, to 9.98 percent.

Looking at new time deposits, the average remuneration went down January through February overall for both households, after a steady rise in the previous five quarters (down 0.17 percentage points from the prior three months’ average, to 6.89 percent), and non-financial corporations. In the latter case, the adjustment was more pronounced, including in relation to the quarter-earlier reading (down 0.69 percentage points, to 6.25 percent).

2.2. Exchange rate and capital flows

The EUR/RON exchange rate declined again in the first part of 2023 Q1 and rose more modestly afterwards, reverting only temporarily towards the end of the period to the vicinity of the values prevailing in 2022 H1 (Chart 3.7).

The EUR/RON remained quasi-stable in the early days of 2023, after the relatively abrupt increase at end-2022[56], As a result of which the currency pair returned to the higher readings seen in the first half of 2022.before witnessing a new decline in mid-January amid the higher relative attractiveness of leu-denominated government securities[57] Given inter alia the monetary policy decision by the NBR in the reported month. (Table 3.1), but especially due to the considerable improvement in investor sentiment vis-à-vis financial markets in emerging economies. Behind the latter stood mainly the expectations on a slowdown of monetary policy tightening by major central banks[58], Considering the larger-than-expected decline of the annual inflation rate in the respective countries.but also the improved performance and outlook of China’s economy after giving up the zero-COVID policy, as well as the downward adjustment of natural gas prices in Europe, conducive to underpinning the resilience of the euro area economy. At the same time, the leu continued to strengthen significantly in relation to the US dollar in the first month of the year, as the latter weakened even further against the euro[59], The EUR/USD climbed at the beginning of February to 1.0988, the highest reading since April 2022 (Source: ECB). inter alia amid the narrowing of the interest rate differential between the two economies.

Table 3.1. Key financial account items

The EUR/RON exchange rate then witnessed small fluctuations[60], Amid the ongoing favourable sentiment on the international financial market, given also that the Fed’s and the ECB’s monetary policy decisions at the onset of the period were in line with investor expectations.before stabilising at only slightly higher levels as of the latter part of February. Developments reflected the influences stemming, on one hand, from the temporary reduction in global risk appetite[61] Following the upward revision of investor expectations on the size of the rate hike by the Fed in the near run, given the higher-than-expected resilience of economic activity, as well as the prospects for a slower-than-anticipated pace of disinflation, according to the data released during this period. and from the turmoil in the banking systems of the US and Switzerland – appeased however swiftly by the authorities’ actions and by the ECB’s and the Fed’s monetary policy decisions – and, on the other hand, from the persistence of the broadly favourable risk perception towards financial markets in the region and from the considerable improvement in the trade balance, also in correlation with the improved terms of trade. Moreover, in the closing days of March, the exchange rate of the leu climbed only temporarily to the vicinity of the values prevailing in 2022 H1[62] On the financial market in the region, the exchange rates of the major currencies versus the euro posted mixed developments in Q1. Specifically, the exchange rates of the Czech koruna and of the forint stuck to the downward trend in February, which was then temporarily reversed in the first half of March, while the exchange rate of the zloty remained relatively stable, witnessing only an episodic increase in the middle of the period. (Chart 3.8). Nevertheless, the USD/RON saw the downward path it had embarked on in mid-2022 H2 come to a halt, posting a mild advance in February, followed by a decline of a similar magnitude in March, as the US dollar stopped its depreciation against the euro.

During 2023 Q1 overall, the interbank forex market turnover stayed high and exhibited a surplus for the first time in the past approximately nine years, inter alia amid the rise in the positive balance on residents’ transactions.

In this period, the domestic currency weakened against the euro by 0.1 percent in nominal terms[63], Based on the December and March averages of the exchange rate. [64] During the same period, the zloty saw a similar depreciation versus the euro (0.1 percent), while the Czech koruna and the forint appreciated 2.5 percent and 5.9 percent respectively. and strengthened 2.3 percent in real terms. In relation to the US dollar, the leu appreciated 1.0 percent in nominal terms and 3.3 percent in real terms, given the former’s further weakening versus the euro. Looking at the average annual exchange rate dynamics, the leu saw its appreciation against the euro remain constant and diminished significantly its depreciation vis-à-vis the US dollar.

2.3. Money and credit

Money

The annual growth rate[65] Unless otherwise indicated, percentage changes in this section refer to the average of annual growth rates in nominal terms. of broad money (M3) discontinued its decline in January-February 2023, the average dynamics remaining at 6.9 percent[66] In real terms, the negative annual dynamics of broad money slowed slightly, reaching an average of -7.3 percent in January-February 2023, from -8.0 percent in 2022 Q4, amid the decrease in the annual inflation rate. as in 2022 Q4 (Table 3.2), amid the relative easing of budget execution compared to the same year-ago period.

Table 3.2. Annual growth rates of M3 and its components

However, the M3 composition continued to change, under the influence of the further step-up in portfolio shifts from overnight deposits in lei and foreign currency to time deposits, especially in lei, in the case of both households and non-financial corporations, amid the high interest rates on time deposits and the developments in the EUR/RON exchange rate.

Specifically, narrow money (M1) saw a steeper contraction in annual terms in the first two months of the year[67], In this period, the annual dynamics of M1 hit a 13-year low in terms of quarterly data.as a result of a sharper year-on-year decrease in overnight deposits in lei of both main customer categories, as well as of a marked decline in similar foreign-currency denominated deposits[68], After their annual dynamics dropped to one-digit levels in 2022 Q4, for the first time in approximately 8½ years. Calculations based on balances expressed in euro. for the first time in 11 years. An additional, albeit far more modest, influence came from the further deceleration in the annual dynamics of currency in circulation (Chart 3.9).

By contrast, time deposits with a maturity of up to two years posted a significantly faster annual growth rate in this period as well[69], Reaching a new 13-year high.in the context of a new leap in the dynamics of domestic currency-denominated deposits, but also due to the swift increase in foreign-currency-denominated deposits, amid the high/rising interest rates. Similarly to the previous quarter, the step-up was driven mainly by household deposits, given that the annual dynamics of the leu-denominated component almost doubled, while those of foreign currency-denominated deposits rose to two-digit levels. At the same time, the particularly high annual rate of change of non-financial corporations’ time deposits with a maturity of up to two years further followed and uptrend, primarily on account of the evolution of leu-denominated deposits, but also due to the increase in foreign currency deposits.

At sectoral level, behind the M3 evolution in this period stood the near-halt of the decline in the rate of change of non-financial corporations’ deposits, amid the slower deceleration in the growth of loans to this sector and the improvement in the trade balance, but also due to the higher disbursements from the budget, according to budget execution data. At the same time, household deposits saw a renewed slight pick-up in their annual dynamics, in correlation with the relatively faster rate of wage increases and with the slacker pace of purchases of goods and services.

From the perspective of major M3 counterparts, the halt in the slowdown in the growth rate of M3 reflected the diverging influences, on the one hand, from the faster dynamics of net foreign assets of the banking system[70], Mainly following the Ministry of Finance’s issue of USD-denominated bonds amounting to USD 4 billion, as well as the rise in non-residents’ purchases of leu-denominated government securities.as well as of credit institutions’ investments in government securities, and, on the other hand, from the larger advance in long-term financial liabilities[71] Capital accounts included. and the change in households’ holdings of government securities.

Credit to the private sector

The annual dynamics of credit to the private sector fell at a slacker pace in the first two months of the year, averaging at 11.1 percent from 13.3 percent in 2022 Q4[72], In real terms, the annual dynamics of credit to the private sector went deeper into negative territory, falling to -3.7 percent in the period overall, from -2.4 percent in 2022 Q4.given the slower deceleration in the growth of leu-denominated credit (Chart 3.10). By contrast, after the swift rise in the previous two quarters, the annual rate of change of foreign currency-denominated credit (expressed in euro) held relatively steady, albeit at a very high level. Hence, the share of the leu component in total credit to the private sector further narrowed, down to 68.3 percent in February from 68.8 percent in December 2022.

From a sectoral perspective, the deceleration in the contraction of the growth rate of credit to the private sector was ascribable to the change in loans to non-financial corporations, whose leu component slowed its loss of momentum, under the impact of the substantial increase in January in the volume of new loans granted under government support programmes (IMM Invest Plus) (Chart 3.11). The influence of the very high dynamics of foreign currency-denominated credit in this sector was minor in this period, given the strong slowdown in its advance, particularly due to the evolution of short-term loans.

The increase in credit to households continued to decelerate at a relatively similar pace compared to the previous quarter, given the further declines in the dynamics of both main categories of leu-denominated loans, but especially those of housing loans[73], Whose flow returned to the 12-month low recorded in November 2022, even amid the renewed step-up in renegotiation operations in this period; adjusted for the influence of renegotiated loans, the flow of these loans saw its annual contraction widen considerably.amid higher interest rates and tighter credit standards. The influences thus exerted were only slightly mitigated by the further slowly diminishing trend of the annual contraction in households’ foreign-currency denominated loans (expressed in euro), which it had started in 2021 Q1.

4. Inflation outlook

The annual CPI inflation rate is forecasted to decline steadily until the projection horizon, i.e. March 2025, with notable progress especially during this year, its new path being relatively similar to that anticipated in the previous Report. The expected values will remain above the upward bound of the central target. For the end of this year, the updated baseline scenario foresees a moderation of the indicator to 7.1 percent, before falling to 4.2 percent in December 2024 and 3.9 percent in March 2025. The breakdown shows anticipated heterogeneous developments of adjusted CORE2 inflation and the exogenous components of the basket. Thus, the impact of the across-the-board rise in companies’ production costs will further feed through persistently to the adjusted CORE2 index, inter alia amid still particularly favourable demand conditions. Against this background, the annual dynamics of core inflation will go down only gradually throughout the projection interval, remaining at levels above those of headline inflation (CPI). Conversely, the contribution of energy prices (fuels, electricity, natural gas) to the annual CPI inflation rate will even turn negative this year, mainly due to the substantial base effects associated with the price hikes seen in the same year-ago period, but also to the changes in the electricity and natural gas price capping and compensation schemes as of 1 January 2023.

The balance of risks to the projected CPI inflation path in the baseline scenario is assessed to be relatively in equilibrium. The multiple implications, especially the economic ones, of the war in Ukraine remain the main source of risks and uncertainties to the macroeconomic projection.

Baseline scenario

4.1. External assumptions

Compared to the previous Report, the outlook for trading partners’ economic activity improved overall. The euro area posted a better-than-expected performance late last year, and preliminary data point to a slight quarterly rise in external demand (EU effective GDP) in 2023 Q1 as well. Insofar as data are confirmed, it may be asserted that the previously expected scenario of a technical recession in 2022 Q4 and 2023 Q1 was avoided. Subsequently, a rebound of the economy is foreseen, coupled with the easing of shocks that had affected supply chains and commodity prices. Specifically, the external demand dynamics were revised upwards in 2023, due mainly to a more favourable contribution from net exports, given the softer demand for energy imports (mild weather), the diversification of energy supply sources and the unwinding of global supply bottlenecks (Table 4.1).

Table 4.1. Expected developments in external variables

The brighter outlook for economic activity also entailed an upward revision of the effective external demand gap both in the short and medium term. However, this gap is expected to remain in negative territory for most of the projection interval and even to open throughout this year, with an overall less favourable impact on domestic economic activity. The effective external demand gap is foreseen to reach neutral values at end-2024.

The euro area average annual inflation rate (HICP) was revised downwards for 2023 and is expected to run at 5.3 percent (compared with 5.9 percent in the prior Report). Looking at quarterly rates, inflation is assessed to have peaked during 2022 Q4 (10.6 percent in October). Thus, starting 2023 Q1, the indicator will embark on a mostly downward path, with small swings in the latter part of the projection interval, remaining however above 2 percent at the forecast horizon (2.4 percent in 2025 Q1). The decline in inflation will mainly reflect the favourable moves in energy prices (on the back of significant base effects), partly mitigated by the faster dynamics of the euro area HICP inflation excluding energy[74]. A measure of core inflation.For 2023, the latter was revised upwards to 6.4 percent from 5.5 percent in the previous Report. Looking at quarterly rates, the euro area annual inflation excluding energy is assessed to have peaked during 2023 Q1. Later, the indicator is expected to decline over the projection interval, reaching a level similar to headline inflation at the forecast horizon. The determinants of HICP inflation excluding energy over the short term include the lagged effects of recent high energy prices and of past euro depreciation. Over the medium term, a moderating trend of this measure is envisaged, given the subsiding inflationary pressures from energy prices and the ongoing pass-through of the effects of tighter monetary policy into the economy.

The nominal 3M EURIBOR rate advanced in positive territory in 2023 Q1, being expected to keep rising until 2023 Q3 and to decline mildly starting 2024 Q1 until the projection horizon. The impact of the real 3M EURIBOR rate is assessed to remain stimulative only over the near term, amid the ECB’s monetary policy normalisation and the abating inflationary pressures in the medium term. As from 2023 Q3, the real 3M EURIBOR rate is foreseen to enter positive territory and stay there until the projection horizon. At the same time, the deviation of this variable from the trend is assessed to return to positive territory in 2023 H2 and remain above nil in most quarters of the projection interval.

The path of the EUR/USD exchange rate continues to be surrounded by broad uncertainty. In the near run, the euro is expected to strengthen against the US dollar amid the specifics of the ECB’s monetary policy normalisation and in the medium term the appreciation trend looks set to carry on, albeit at a markedly slower pace.

The scenario for the Brent oil price is based on futures prices and foresees a downward path in view of the looming slowdown in global economic activity, although at the beginning of 2023 Q2, following the OPEC+ announcement of production cuts, oil prices saw an increase, which later proved short-lived. Specifically, at the projection horizon, the Brent oil price is projected at around USD 75/ barrel (Chart 4.1). On the demand side, two diverging factors act over the short and medium term: on the one hand, the further widespread tightening of central banks’ monetary policies and, on the other hand, China’s oil demand resumption after COVID-19 restrictions were lifted. On the supply side, the determinants include possible new decisions on oil production cuts by OPEC+ members, partly offset by an increase in production by non-OPEC countries (the USA in particular). The projection of future developments in oil prices is thus further fraught with elevated uncertainty.

4.2. Inflation outlook

After peaking in November 2022, the annual CPI inflation rate has embarked on a downward trend, which is expected to continue until the projection horizon (March 2025), yet staying above the variation band of the target (Chart 4.2). Similarly to the previous Report, the return to single-digit levels is anticipated for 2023 Q3. Following notable disinflationary developments, which are expected throughout this year, the indicator will reach 7.1 percent in December 2023, before falling to 4.2 percent at end‑2024 and 3.9 percent in March 2025.

Looking at the breakdown, the downward correction of the annual CPI inflation rate is anticipated amid heterogeneous developments in the index sub-components. On the one hand, the impact of the across-the-board rise in firms’ production costs (especially the costs of energy and other commodities, as well as labour costs) will continue to feed through persistently to core inflation, inter alia amid still particularly favourable demand conditions. Therefore, the annual dynamics of the adjusted CORE2 index will ease only gradually throughout the projection interval, remaining high relative to the inflation target and the projected headline inflation values alike (Chart 4.2). On the other hand, the annual rate of increase in energy prices will continue to decelerate very quickly in the first part of the current year, chiefly amid substantial base effects associated with price rises in the same year-ago period (caused primarily by the outbreak of the war in Ukraine) and, to a lesser extent, as a result of the electricity and natural gas price capping and compensation schemes. Specifically, after posting extremely high dynamics over the past two years, energy prices will record a negative annual rate of change at end-2023, equivalent to an approximately 4.5 percentage point correction of their contribution to CPI inflation versus end-2022. Against this backdrop, the pace of CPI disinflation will be particularly fast in 2023 Q2[75], The annual CPI growth rate is projected to decline by approximately 4.3 percentage points March through June.before slowing down somewhat afterwards.

The updated forecast envisages a path and values that are relatively similar to those presented in the previous Report, posting a marginal upward revision of 0.1 percentage points for the end of this year, while for December 2024, the previous forecast was reconfirmed. The breakdown shows that the contributions made by CPI components were subject only to a slight revision against the earlier Report. Specifically, in the first part of the forecast interval, core inflation, fuel price inflation and administered price inflation (excluding electricity and natural gas) are expected to record somewhat lower values, whereas the dynamics of volatile food (VFE) prices and electricity prices have been revised upwards. Over the latter part of the projection interval, the contribution of core inflation is seen to be a little higher, whereas those of fuel and VFE prices are anticipated to be marginally lower.

Following the reversal of the upward trend at end‑2023 Q1, the annual adjusted CORE2 inflation rate is projected to decline steadily, yet only gradually, remaining above the variation band of the target (Chart 4.2, Table 4.2). Given the much slower annual dynamics of the exogenous components of the consumer basket, core inflation will steadily exceed the CPI inflation rate as of March 2023. Their spread will widen to a high of 3.1 percentage points in 2023 Q2 and Q3, before narrowing to a low of 0.4 percentage points in March 2025. The projected values are 9.3 percent at end-2023, 4.8 percent atend-2024 and 4.3 percent at the forecast horizon, i.e. at end-2025 Q1.

Table 4.2. CPI and adjusted CORE2 inflation in the baseline scenario

Core inflation is foreseen to remain above the variation band of the target due to the persistence of inflationary pressures associated with the sizeable hikes in firms’ production costs. These hikes have started ever since 2021 and subsequently picked up pace throughout 2022 (especially in the costs of energy and other commodities, as well as labour costs), their pass‑through into final prices of goods being facilitated inter alia by still very favourable demand conditions. One of the consequences was also that the companies’ profit margins have remained at high levels over the past two years. After peaking in 2022 Q4, the positive output gap is projected to narrow steadily and almost close towards the end of the forecast interval[76]. For further details, see Section 4.3. Demand pressures in the current period and over the projection interval.Reflecting the influence of all the above‑mentioned determinants, inflation expectations will follow a downward path until the projection horizon, starting from elevated levels. A relatively faster decline in inflationary pressures, especially in 2024, is expected for prices of imported goods, which will mirror the projected dynamics of euro area HICP inflation excluding energy[77].According to the March 2023 ECB staff macroeconomic projections for the euro area, the average annual growth rate of the indicator will fall from 5.8 percent in 2023 to 2.7 percent in 2024.

Compared to the projection published in the February 2023 Inflation Report, the updated values of core inflation were revised downwards for the first part of the forecast interval. Over the short term, more favourable developments were reported in the food segment, amid the correction of the main commodity prices, an additional influence being expected to come from the voluntary decision of retailers to temporarily cut (May through October) the shelf prices of domestically produced milk. Another contributing factor to the revision was the downward adjustment in the inflation expectations of consumers and economic agents. For the latter part of the interval, core inflation was revised marginally upwards, mainly due to the reassessment of the output gap path at higher levels over the entire eight-quarter period.

The cumulative contribution of inflation components beyond the scope of monetary policy – i.e. administered prices (including electricity and natural gas prices), volatile food prices (VFE), fuel prices, tobacco product and alcohol beverage prices – to the annual CPI inflation rate is forecasted at 1.2 percentage points at end-2023 and end‑2024, and at 1.3 percentage points at the projection horizon (Chart 4.3). Compared to the previous Report, the values for 2023 were revised upwards, while those for 2024 marginally downwards. Behind the revision for the end of the current year stood primarily the lower-than-anticipated impact associated with the change made to the electricity price capping and compensation scheme, alongside the swifter growth of volatile food (VFE) prices.

The annual inflation rate for fuels is forecasted to post negative values until 2023 Q3 (Chart 4.4, Table 4.3). This is due to the substantial base effects associated with the price hikes recorded in the same year-ago period amid the war in Ukraine, as well as to the authorities’ decision to cut the excise duty on motor fuels starting1 January 2023 (affecting their annual price dynamics over a four-quarter period). The favourable developments are partly offset by the expiry, again from 1 January, of the motor fuel price compensation measure, but also by the rise in oil prices[78] For further details, see Section 4.1. External assumptions. in early Q2. Furthermore, firewood prices were expected to rise in April, once the cap applied on them expired. The projection for the end of this year points to fuel price dynamics returning to positive territory – given the unfavourable statistical effects associated with the decreases in oil prices recorded at end-2022 dropping out of the calculation – and remaining therein over the remainder of the forecast interval. The path was revised downwards compared to the previous Inflation Report, more substantially during 2023. Behind this revision stood expectations of lowerthan-previously-projected quarterly oil price dynamics, based on futures prices, starting 2023 Q3, but also a weaker path of the US dollar against the euro, with an impact on the USD/RON exchange rate, which is relevant for the evolution of the leu‑denominated prices of this category of goods.

Table 4.3. Inflation of CPI exogenous components

The annual growth rate of electricity prices[79] According to the NIS Press Release No. 37/14 February 2023, electricity and natural gas were re-included in the group of administered price items of the CPI basket, following the changes made to the energy price capping and compensation schemes as of 1 January 2023. is projected to run in negative territory in 2023 H2 and in 2024 Q1 (Chart 4.4, Table 4.3), owing mainly to the effect of the measures to cap electricity prices for households. Under the impact of these measures, the projected price levels for both December 2024 and the forecast horizon are anticipated to stay on a relatively steady path. Compared to the previous Report, the path was revised upwards, given the less favourable-than-previously-anticipated developments associated with the effect of the change made to the electricity price capping and compensation scheme starting 1 January 2023. Turning to natural gas prices, the assumptions on a relatively steady path over the projection interval were maintained, as the related commodity market prices have already exceeded the level set by the price cap legislation.

Despite the significant upward revisions for the current year and early next year, the annual pace of increase of volatile food (VFE) prices is expected to embark on a downward path until 2024 Q3 (Chart 4.5, Table 4.3). The forecast for this component relies on the assumption of normal harvests[80]. Relative to their multiannual averages.The upward revisions compared to the previous forecast were driven by external factors (the vegetables shortage in Europe, together with the lower supply from Ukraine and Turkey, which was particularly visible in the off-season), amid the realignment of local prices to import prices, as well as by seasonal factors (adverse weather developments during the winter). For the remainder of the forecast interval, the revisions are low compared to the previous Report.

The exogenous scenario for the annual dynamics of administered prices, other than electricity and natural gas prices[81], The main items included in this group are heating, water, sewerage, sanitation services and medicines.which is built chiefly on historical data, foresees a deceleration throughout 2023 (Chart 4.6, Table 4.3), on the back of recent declines in prices of some medicines. Over the rest of the projection interval, their annual growth rate is anticipated at levels close to those forecasted in the previous round, based on the historical pattern of changes to the prices of the main items in this group.

The annual path of tobacco product and alcoholic beverage prices is shaped primarily by the increases in excise duties provided by legislation, but also by the behaviour of companies in this field as regards the final price adjustment. For this year, the dynamics of this group (Table 4.3) are influenced by a price increase in the packet of cigarettes for heated tobacco devices as of February. Under the circumstances, the projection for the end of the current year was revised upwards.

4.3. Demand pressures in the current period and over the projection interval[82] Unless otherwise indicated, quarterly percentage changes are calculated based on seasonally adjusted data series. Source: NBR, MF, NIS, Eurostat, EC-DG ECFIN and Reuters.

Output gap

In 2022 Q4, real GDP posted further robust developments, recording quarterly dynamics of 1 percent[83], NIS press release No. 84 of 07 April 2023 regarding second provisional data.above the expectations in the latest Report. Looking at the demand side, the positive contribution from net exports is worth mentioning. This was a result of the steep drop in imports, which may be ascribed, only to a certain extent, to the enforcement of sanctions against the purchase of crude oil from Russia starting with 5 December 2022. Despite the decline in real disposable income, household consumption still reported a strong advance, exceeding expectations. This may be linked, to some extent, to the decrease in the saving rate of households[84]. NIS press release No. 83 of 6 April 2023 regarding household income and expenditure in 2022 Q4.Gross fixed capital formation registered moderate negative dynamics[85], Although the previous NIS press release in March showed positive dynamics for the indicator during this quarter.in the context of a further contraction in industrial output volume (against the background of high energy costs), despite the faster-than-expected increase in construction. The particularly elevated contribution from residual components (statistical discrepancy and the change in inventories) in the recent period suggests potential significant revisions of the data series in the future. This assumption is also supported by the latest NIS press release, which continues to indicate a discrepancy between the annual GDP dynamics based on gross data and those based on seasonally adjusted data. In this context, some adjustments[86] These adjustments were made to GDP and its components for the period in which the statistical data are provisional (2021 Q1 – 2022 Q4). continued to be applied in order to assess the cyclical position of the economy.

Short-term projections point to slower dynamics in the economy during the first part of the year, amid a gradual pass-through into the economy of the effects stemming from the tightening of financial conditions and the still high uncertainty (due to the ongoing war in Ukraine, but also to the recent banking and financial issues at global level). In 2023 Q1, the easing of the energy crisis, on the back of the relatively high temperatures throughout the winter, is assessed to have made a positive contribution. Moreover, the international prices for natural gas and oil remained on a downward trend, whereas in Romania the authorities made again favourable adjustments to the electricity price capping and compensation scheme for households. Worldwide, supply bottlenecks eased, as shown by indicators such as GSCPI[87]. Global Supply Chain Pressure Index, a composite index developed by the Federal Reserve Bank of New York, which includes information on international transportation costs and manufacturing indicators.Under these circumstances, mention should be made about the positive, albeit modest from a historical perspective dynamics of both domestic industrial production and industrial production in the euro area, in the first two months of 2023 as a whole compared to 2022 Q4. The wage increases at the beginning of the year are deemed to have contributed to a certain extent to the upswing in retail trade and market services to households in January-February 2023. Conversely, the strong rise in labour costs in construction, associated with the minimum wage hike in the field (+33 percent in nominal terms) is considered to have acted as a deterrent for the activity in this sector and the related ones, given also the less favourable developments in the specific monthly indicators in 2023 Q1. Another factor that is assessed to have had a downward impact on economic activity was the lower confidence of economic agents, as pointed out by the ESI (Chart 4.7), which continues, however, to post values above the long-term average[88]. In 2023 Q1, worsening signals came from some of the monitored high-frequency indicators: company and freelancer registrations, the ESI, industrial output, the return on the BET index, the Google searches for the keyword “crisis”. Favourable signals were sent by: the retail trade turnover, the nights spent at tourist accommodation establishments and the unemployment rate.

The developments in 2023 Q1 are envisaged to persist in Q2 as well. The economic advance will benefit from the resilience of domestic demand, the anticipated drop in inflation (including among trading partners) and the continued absorption of EU investment funds, although the latter process is seen to have rather high inertia. Positive contributions[89] Most of the monitored high-frequency indicators available for April showed improvements. The declines in Google searches for the keywords “unemployment” and “crisis” and in the VIX (volatility index) are noteworthy in this respect. are also foreseen to arise from the easing of the energy crisis, the alleviation of bottlenecks in supply chains (inter alia on account of the relatively fast overcoming of the latest COVID-19 wave in China) and, last but not least, the rebound in external demand. Economic activity is however expected to also continue to reflect the restrictive joint effects coming from the gradual pass-through of monetary policy normalisation decisions and the ongoing fiscal consolidation process.

For the current and next year, the annual real GDP growth is projected to reach values around 3 percent, lower than that recorded in 2022 (4.7 percent)[90]. The data on GDP developments in 2022 are provisional, whereas the semi-final and final ones are expected to be released at end-2023 and end-2024, respectively.The slowdown of domestic economic activity mirrors the overlapping of several influences: the further erosion of household purchasing power, the uncertainty fuelled at multiple levels by the protraction of the war (which could impact energy prices and the functioning of supply chains, after the improvement seen at the beginning of 2023) and the effects stemming, on the one hand, from the anticipated continued fiscal consolidation process and, on the other hand, from the gradual pass-through of the decisions made in the context of monetary policy normalisation. However, a favourable contribution to economic growth is expected to come, particularly over the medium term, from turning European funds from multiple sources[91] The Multiannual Financial Framework 2021-2027, the Next Generation EU programme (2021-2026), the (derogatory) extension of disbursements within the Multiannual Financial Framework 2014-2020. to good account (including funds from the Next Generation EU programme, the allocation of which is conditional on fulfilling strict targets and milestones).

The breakdown[92] The contribution of the change in inventories to average annual GDP dynamics is assessed to be relatively high, suggesting potential significant revisions of the historical data series in future press releases, which may reshape the economic growth forecast. shows that the real GDP path is shaped by that of final household consumption, albeit slowing versus 2022. To this adds the GFCF contribution, envisaged to remain relatively robust, mainly under the assumption of EU funds absorption and foreign direct investment inflows. The recent trend of real net exports making a negative contribution to GDP dynamics is estimated to be temporarily discontinued in 2023, when a value close to zero is expected (due to marked decelerations in both components). Subsequently, this contribution will turn again slightly negative over the medium term.

The potential GDP trajectory is projected to post further annual robust dynamics over the medium term, slightly gaining momentum. Compared to the previous Report, the forecast did not witness any significant revisions. Capital accumulation continues to be the key driver of potential GDP dynamics, given the ongoing implementation of investment projects. These are envisaged to be financed through European funds as well, in particular via the Next Generation EU programme, which features a large share of the investment component. To this add the EU funds allocations from the multiannual financial frameworks (MFF), with an expected boost in the absorption from the 2021-2027 MFF, following the use of the last funds from the 2014-2020 MFF (in 2023). The contribution of labour is foreseen to remain stable over the medium term, albeit low, in parallel with the slightly upward trend in the activity rate, along with that in the number of employees, against the background of prospects for economic growth. However, in the longer run, adverse demographic developments in Romania are expected to have opposite effects, especially the rather fast-paced decline in the working-age population. The projected evolution of the TFP trend captures, on the one hand, the impact of investment increases on the rise in total factor productivity[93], According to the PwC Global CEO Survey 2023, technology-oriented investments are considered a priority (73 percent of respondents). Also, according to Realworld Eastern Europe, in 2023 the local business process automation industry is expected to grow by about 15 percent to optimise internal processes.including through digitalisation and automation (aspects covered by the Next Generation EU programme), and on the other hand, the persistent adverse effects of the technological shock generated by the recent hikes in energy and commodity prices[94]. According to the Moneycorp Barometer — 5th edition, 48 percent of respondents consider the increasing operating costs (prices of materials, services, transport costs, interest, etc.) to be the main challenge in 2023 for their activity, along with the falling sales, mentioned by 40 percent of respondents.In the medium term, in a still uncertain macroeconomic environment, this component’s contribution is further affected by structural deficiencies in the economy, which limit the companies’ efforts towards innovation and digitalisation[95].For example, the European Commission’s Digital Economy and Society Index (DESI) 2022 Report ranks Romania last among EU countries, with a satisfactory score only in the Connectivity sector, whereas digital skills, SMEs and 5G networks are lagging behind. In addition, the Global Innovation Index 2022 highlights the areas of “Institutions” and “Human capital and research” as being the most modest in terms of promoting innovation. As for competitiveness, the EU Regional Competitiveness Index 2.0 – 2022 edition shows large differences in Romania between the Bucharest-Ilfov region and the rest of the country.

Given the most recent actual GDP data (which are above the estimates in the previous Report) and the more favourable near-term outlook, the excess aggregate demand (the output gap) was revised upwards. The effects of this revision also reflect in the indicator’s course over the following periods, placing it at a higher level, even though it appears to have peaked during 2022 Q4 (Chart 4.8). Specifically, against the background of an expected slowdown in economic activity, the output gap will progressively narrow from the beginning of the year throughout the projection period and will almost fully close towards the end of the projection interval[96]. From the perspective of aggregate demand components, the output gap path is shaped by those of domestic demand, whereas net exports make a negative contribution. The assessment of the output gap and the gaps of GDP components continues to feature considerable difficulties, amid the overlapping of post-pandemic developments with those generated by the ongoing war, to which adds a series of issues associated with the volatility of historical data series.The described path involves the correction of the excess aggregate demand (and implicitly of the related inflationary pressures) with a certain delay compared to the prior Report.

Looking at the output gap drivers, restrictive effects are seen stemming, on the one hand, from the gradual pass-through into the economy of the decisions made in the context of monetary policy normalisation (assessed to be more significant than in the previous forecast), and on the other hand, from the ongoing fiscal consolidation process (which is expected to continue). Additionally, the demand deficit of Romania’s trading partners continues to have a negative, albeit smaller impact on the domestic output gap.

Aggregate demand components

The average annual growth rate of final consumption is projected to decelerate in 2023 versus the prior year, mirroring a merely modest increase in real disposable income (in the context of further high inflation) and lingering uncertainties. Compared to the major impact of these determinants, the temporary stimulus package recently adopted by the authorities to support particularly the purchasing power of some groups of low-income earners[97] Among these measures, worth mentioning are the extension of the electricity price capping and compensation schemes, in accordance with GEO No. 27/2022, and the further granting of state aids such as: (i) the 12.5 percent raise in the pension point and (ii) the extension into 2023 of financial aid granted to certain social categories (financial support for low-income pensioners in January and October, as well as the distribution of social vouchers throughout the year). Moreover, starting 1 January 2023, according to Government Decision No. 1447/2022, the gross minimum wage economy-wide was raised from lei 2,550 to lei 3,000. At the same time, pursuant to Government Emergency Ordinance No. 168/2022, the minimum wage in the construction sector was increased to lei 4,000 and measures targeting public sector employees were implemented, i.e. a wage hike of up to 10 percent against the end-2022 level. will only lend consumption a transitory resilience. For the following year, this component is foreseen to witness moderate dynamics, being hindered by the further erosion of household purchasing power and by the persistent uncertainty associated with the effects of war.

Although gross fixed capital formation is projected to lose momentum in 2023, the component is expected to continue to post robust annual growth rates throughout the forecast interval, assuming EU disbursements from multiple sources[98]. These are envisaged to be allocated mainly via the Multiannual Financial Framework 2021-2027 and the Next Generation EU programme.GFCF is expected to be one of the components with a substantial contribution to GDP. Apart from EU funds, another source of investment financing could be foreign direct investment, which has already grown markedly during both 2021 and 2022. Some of these investments could materialise due to the highly ambitious measures to stimulate investment projects in certain niche areas, including those related to green energy, which are globally promoted.

The contribution of net exports to GDP growth is forecasted to be approximately nil in 2023 and subsequently to turn again slightly negative. Trade flows are expected to be affected during this year by the lingering elevated uncertainty surrounding the war in Ukraine, and by a certain persistence, albeit declining relatively fast, of the bottlenecks in supply chains.

Exports of goods and services are projected to be further hampered by high commodity and energy prices (which could potentially reduce production in energy‑intensive industries), but also by the persisting modest external demand amid the multiple challenges and uncertainties related, inter alia, to geopolitical tensions and fragmentation. Another factor weighing on competitiveness is the real effective exchange rate (see Box 2 for alternative microeconomic evidence regarding the impact of the real effective exchange rate on exports), which is anticipated to remain overvalued. Conversely, a positive contribution to the medium-term increase in the productivity of exporting firms could come from the absorption of EU funds (for instance, the Next Generation EU programme). Imports of goods and services are expected to see their annual rate of change significantly decline in 2023[99] This also reflects, even more strongly than in the case of exports, the persistent unfavourable carry-over effects stemming from the quarterly contraction at end-2022. and to pick up afterwards, owing to the developments in domestic demand components and to the stimulating effects coming from exports.

Having widened progressively in the previous years, the current account deficit is anticipated to follow a moderately downward path as of this year. Its anticipated correction reflects the overlapping of several factors, such as: the reduction of disruptions in global value chains, the easing of the energy crisis and the ongoing fiscal consolidation process. In the medium term, however, the indicator’s path is conditional on the size of fiscal adjustment, to which add structural factors that are ingrained in Romania’s economy.

The current account deficit coverage by stable, non-debt-creating capital flows is anticipated to remain relatively low over the entire projection interval. This is chiefly attributed to the fast-paced widening of the current account deficit over the past years, only partially offset by the more favourable developments in non-debt-creating flows. The latter are mainly associated with capital transfers, amid the overlapping of EU disbursements from multiple sources. The path of foreign direct investment is projected to decelerate compared to its robust values in 2022. Nevertheless, these flows are expected to remain at high levels from a historical perspective, reflecting inter alia an improved investment climate, along with the advance in the implementation of the National Recovery and Resilience Plan, as well as the favourable effects of some foreign company relocations, also amid the reconfiguration of global value chains.

Broad monetary conditions

According to the transmission mechanism, broad monetary conditions capture the cumulative impact exerted on future developments in aggregate demand by the real interest rates applied by credit institutions on leu- and foreign currency-denominated loans and deposits of non-bank clients and by the real effective exchange rate[107] The relevant exchange rate for the NBR’s macroeconomic model for analysis and forecasting relies on the EUR/RON and USD/ RON exchange rates, with the weighting system mirroring the weights of the two currencies in Romania’s foreign trade. of the leu. The exchange rate exerts its influence via the net export channel, as well as via the effects on the wealth and balance sheets of economic agents.

Similarly to the previous Report, the baseline scenario of the projection foresees, over the short term, a further reduction in the stimulative nature of real broad monetary conditions. As of 2023 H2, the latter are envisaged to post increasingly restrictive values. This will occur amid a gradual pass-through into the economy of the decisions made in the context of the monetary policy normalisation, their aim being to facilitate a correction of excess aggregate demand in the economy and implicitly to reduce the associated inflationary pressures.

Looking by component, real interest rates on both new loans and new time deposits in lei are anticipated to exert a joint stimulative impact; nevertheless, over the medium term, it will gradually diminish to close-to-neutral values at the forecast horizon. This process will take place as monetary policy decisions pass through to nominal interest rate dynamics, along with a gradual downward adjustment in inflation expectations. The real effective exchange rate (Chart 4.9) plays a decisive role, being foreseen to exert restrictive effects via the net export channel until the forecast horizon. The contribution of the real effective exchange rate is estimated in the context of the appreciation in real terms of the domestic currency, associated with the prevailing effect of the higher domestic inflation rate compared to those of Romania’s trading partners.

The wealth and balance sheet effect is assessed to stop being stimulative in 2023 Q2 and turn slightly restrictive thereafter. The breakdown shows that its dynamics will be attributable to the impact of the foreign real interest rate (3M EURIBOR) becoming restrictive, amid the gradual decline of inflation expectations in the euro area and the ongoing ECB’s monetary policy normalisation. The sovereign risk premium has a lower restrictive influence, reflecting investors’ improved risk perception of the financial assets of the countries in the geographical proximity of the war zone in Ukraine. The impact of the leu’s real effective exchange rate gap on the wealth and balance sheet effect is quasi-neutral.

The NBR Board decisions aim to bring the annual inflation rate back in line with the 2.5 percent ±1 percentage point flat target on a lasting basis, inter alia via the anchoring of inflation expectations over the medium term, in a manner conducive to achieving sustainable economic growth.

4.4. Risks associated with the projection

At the current juncture, the risks of a more persistent and stronger pass-through of previous supply-side shocks into final goods prices remain particularly relevant. Thelonger-term prevalence of elevated inflationary pressures could fuel the risk of stagflation. However, the likelihood of wide corrections to economic activity diminished compared to the previous rounds, especially in the context of the unexpected resilience of aggregate demand over the recent quarters. Overall, the balance of risks to the annual inflation rate projection is assessed to remain relatively in equilibrium compared to the path in the baseline scenario (Chart 4.10).

The relevance of the economic implications of the war in Ukraine was reconfirmed as a major source of risks. Its future stages and intensity are marked by numerous uncertainties, but, starting from the actual on-site developments, an increasing number of opinions seem to lean towards the possibility of an extension of the armed conflict for a longer period of time. Geopolitical risks mounted, including from the perspective of a possible escalation of the trade disputes between China and the US. This would likely postpone or even reverse the progress in restructuring and streamlining value added chains, which could entail new inflation bouts and new slowdowns in economic activity. As shown by several recent episodes – in particular the one that resulted in China’s self-isolation as part of its response to the COVID pandemic in this country – the contagion effects are numerous and have the potential to be relatively far reaching.

Additional inflationary pressures could also be visible in the case of agri-food prices, given that globally their dynamics are already decoupled from those of the relevant commodity prices. New price hikes could be triggered by the suspension of imports of such goods from Ukraine (particularly cereals), especially in the economies in close proximity to the conflict area. At the same time, against the background of a still deficient infrastructure (e.g. extensive irrigation and drainage systems) and the absence of adequate storage facilities, adverse effects could result from wide and frequent temperature fluctuations and from possible less favourable weather conditions.

In the case of natural gas, uncertainties continue to be associated with possible difficulties in sourcing supplies for the 2023-2024 cold season. However, this risk decreased somewhat, in the context of higher-than-usual temperatures experienced in the recent cold season, on the one hand, and amid the rapid decline in European economies’ dependence on gas imports from Russia and their recourse to alternative sources such as liquefied natural gas, on the other. Together, these caused the storage levels to remain high at the end of last winter.

Turning to the evolution of oil prices, marked by numerous fluctuations over the past years, uncertainties stem from the oil production cuts announced by OPEC+ members, although it should be noted that, following this decision, the implications for oil prices were visible particularly over a short time horizon, with adverse effects being almost entirely offset in the recent period. At present, in light of medium-term futures prices, this risk is not as equally relevant. Similarly to previous rounds, but with a lower probability of materialising at the current juncture, disinflationary pressures could emerge in the event of a stagflation episode arising, against the background of several factors (companies’ high production costs for a longer period of time, the erosion of households’ purchasing power, postponement of investment projects) overlapping.

A downward adjustment in global aggregate demand could also be triggered by a possible spike in volatility in international banking and financial markets, which could entail a number of adverse ripple effects. However, the turmoil in the US and Switzerland is expected to have a subdued impact on the economies in the euro area and, implicitly, on those in Central and Eastern Europe, in the context of an increased resilience of the banking and financial sector to recent adverse shocks. In addition, a risk whose importance was reconfirmed refers to the Fed’s and the ECB’s monetary policy stance.

A further strong inflationary environment could lead companies to carry on raising profit margins. In this context, the share of wage costs in total production costs may diminish. Furthermore, simultaneously, new inflationary bouts could be fuelled, with adverse impact on households’ purchasing power. Amid the latter’s erosion, claims may emerge for a faster advance in wages, differentiated in both magnitude and accommodation potential, depending on the business sectors most affected. This could also be attributed to the increased need for skilled workforce, driven by the large share of EU funds earmarked for innovative digitalisation and green economy projects under the Next Generation EU programme.

The future fiscal and income policy stance remains a relevant risk factor. Over the short term, difficulties in narrowing the public deficit in line with the target became apparent. While a preliminary set of fiscal adjustment measures took shape until the cut-off date of the Inflation Report, it is still challenging to assess the extent to which they will be enough to ensure compliance with this year’s adjustment benchmark, as well as their optimality in terms of balancing public finances over the medium term, given that most of them are temporary. Moreover, in view of the extremely busy election schedule of 2024, the excessive deficit correction could be additionally compounded in the event of new expansionary measures being taken or some of those already in force being extended. Significant deviations from the public deficit adjustment path could directly impact the sovereign rating. Furthermore, the current account deficit correction could also be jeopardised, with all the consequences this could have on the orderly financing of twin deficits in the economy.