The National Bank of Romania Board decided:
- to cut the policy rate to 15.75 percent;
- to broaden the reserve base of foreign exchange liabilities for which banks set up required reserves with the NBR;
- to increase the interest rate on USD-denominated required reserves of banks.
The NBR Board has reiterated the 7 percent inflation target for 2005, as established together with the Government of Romania.
In its meeting of 10 February 2005, the NBR Board looked at the recent developments in real economy as well as in financial and monetary sectors, and at their prospects for 2005. The discussions focused on the economic policy mix set by the Government together with the National Bank of Romania and agreed upon by the IMF.
Economic growth, which has been backed by sustained expansion in all components of domestic demand, is estimated at about 8 percent for 2004 and at over 5 percent for 2005. Disinflation stayed close to the projected path, so that the annual inflation rate dropped to 9.3 percent in December 2004. Disinflation continued in January 2005, with the 12-month inflation rate falling below 9 percent.
Monetary developments have painted a bright picture as well. At the start of 2005, broad money was 28 percent higher year on year in real terms, pointing to a strong remonetisation of the economy, owing mainly to the rise in ROL-denominated savings, against the background of clear disinflation. Lending continued to expand, yet at a moderate pace, which is sustainable in the long run. Analysis of lending components further shows some risky trends that may lead to imbalances. Thus, in 2004, non-government credit advanced by 26 percent in real terms. Nevertheless, foreign exchange credit in euro terms surged by 57 percent, which has given an additional boost to imports and may pose prudential risks to banks and their clients.
Romania's main macroeconomic challenge is that the current output fails to accommodate the significant increase in domestic demand. Consequently, the current account deficit ran at almost 7.7 percent of GDP in 2004, according to the revised methodology, compared with 6.7 percent of GDP according to the former methodology. Although the deficit was financed via autonomous capital inflows and the foreign exchange reserves of the NBR increased considerably in 2004 and January 2005, reaching 5 months of imports, a cautious economic policy stance requires measures to allow the simultaneous fulfilment of three goals, i.e. sustainable, long-term economic growth, keeping the current account deficit within manageable limits, and further disinflation in 2005 and the years to come, when inflation rate is set to fall to 2-3 percent, in line with EU requirements.
To this end, the Government together with the NBR decided to adopt a package of fiscal, monetary and structural measures aimed at accomplishing the ambitious, yet feasible, goals set for 2005. In particular, the significant fiscal adjustment, which is to materialise in the further contraction of the consolidated general government deficit to 0.4-0.5 percent of GDP in 2005 from 1.2 percent of GDP in 2004, is meant to curb the worsening trend in the current account, to foster disinflation further, and to keep in place the easing trend of monetary policy (especially the interest rate should adjust to the new monetary and foreign exchange conditions in Romania).
The monetary policy to be pursued by the NBR in 2005 will be subordinated to the achievement of the main goal, i.e. bringing the annual inflation rate down to 7 percent in December 2005 versus December 2004. The assumptions underlying the economic policy mix, the envisaged adjustment of administered prices and the exchange rate trends confirm that this goal may be fulfilled, despite possible monthly variations in the consumer price index. Romania's current and prospective foreign exchange and financial conditions are supportive of disinflation. The surplus in the foreign exchange market entails maintenance of the strengthening trend of the domestic currency, which contributes directly to the alleviation of inflationary pressures and indirectly to the restructuring of the economy and the reduction of domestic production costs, against the backdrop of heightened external competition.
The current intricate macroeconomic environment allowed the NBR Board to cut the policy rate by 0.75 percentage points to 15.75 percent. In order to alleviate the pace of growth of foreign exchange credit due to higher foreign liabilities of banks, their foreign-exchange-denominated liabilities with maturities longer than 2 years shall also be subject to the 30 percent reserve ratio starting 24 February 2005. The interest rate on USD-denominated required reserves was raised to 0.80 percent from 0.75 percent effective 24 January 2005, in line with the developments in money market rates. These measures confirm both the National Bank of Romania's cautious monetary policy stance and the recalibration of its instruments to reflect money and credit market conditions.