In its meeting of February 8, 2006, the Board of the National Bank of Romania analysed the latest monetary and macroeconomic developments and their prospects, and decided the following:
- to raise the monetary policy rate by one percentage point to 8.5 percent per year from 7.5 percent;
- to continue to significantly sterilize excess liquidity via open-market operations;
- to increase the minimum reserve ratio on foreign exchange-denominated liabilities of credit institutions to 40 percent from 35 percent, starting with the March 24 - April 23, 2006 maintenance period;
- to maintain the prudential measures aimed at containing non-government credit expansion, especially in what concerns its foreign exchange component, and implement rapidly the legislation regulating the lending activity of non-bank financial institutions.
The NBR Board also examined and approved the quarterly Inflation Report that will be released to the public in a press conference organized on February 15, 2006, along with a 12-month calendar of NBR Board meetings dedicated to monetary policy issues.
The inflation rate reached 8.6 percent at the end of last year versus 9.3 percent in 2004, marginally overshooting the upper limit of the target band of 6.5-8.5 percent, associated with the 7.5 percent target. The slippage arose due to sharp adjustments in administered prices, substantial increases in disposable incomes following the introduction of the flat tax, rises in volatile food prices under the impact of floods, as well as non-government credit expansion.
However, core inflation, which monetary policy is better able to influence effectively, stayed on a downward path, with its decrease becoming stronger in the last part of 2005.
The overall analysis of economic developments reveals a slowdown in economic growth, with consumption staying at an unsustainable level and with strong investment dynamics. Domestic output has lagged significantly behind demand expansion, deepening both external and domestic imbalances.
Credit expansion continued, with leu-denominated loans witnessing a revival of their growth while foreign exchange credit saw a deceleration in pace following the NBR measures implemented in the latter part of 2005.
Foreign exchange reserves saw a steep rise throughout last year, reaching an adequate level, amounting to the equivalent of 6.1 months of imports, which has allowed the central bank to refrain from foreign exchange market interventions since October 2005, in the context of maintaining the managed float exchange rate regime.
The approaching European Union integration implies the achievement of significant disinflation, an overriding objective that requires a mix of tight economic policies - monetary, fiscal and wage, together with an acceleration of structural reforms. Under the circumstances, the NBR Board adopted a comprehensive set of measures to tighten monetary policy.
Therefore, the NBR Board has decided to raise the monetary policy rate to 8.5 percent a year from 7.5 percent and to maintain the practice of substantial sterilization of excess liquidity via open-market operations, a decision which will help keep the effective monetary policy rate on a path consistent with meeting the medium-term inflation objective. Moreover, in order to increase the predictability and efficiency of one-month deposit-taking operations, the NBR Board decided to set a timetable of auctions for such deposits, which will be held on a weekly basis, every Monday.
In order to contain the accelerated dynamics of non-government credit, especially of foreign exchange borrowing, and taking into account the need to minimize a resurgence of volatile capital inflows, the NBR Board decided to increase the minimum reserve ratio on foreign exchange denominated liabilities of credit institutions to 40 percent from 35 percent, starting with 24 March - 23 April 2006 maintenance period, and also decided to maintain the prudential measures adopted so far.
The measures to tighten monetary policy, along with rapid implementation of the legislation regulating the lending activity of the non-bank financial institutions will help bring inflation back on the trajectory set under the forecast horizon, which has been extended to eight quarters from six quarters previously coming into line with the time frame of complete transmission of monetary policy impulses through the economy.
The NBR Board also considers that maintaining the inflation targets at 5 percent for 2006 and 4 percent for 2007 while implementing a consistent package of restrictive economic policies and providing a medium-term outlook would better anchor inflation expectations, thus ensuring a smooth achievement of an effective disinflation process and the convergence towards the inflation levels recorded in the EU. The NBR Board reaffirms that it is ready to use the entire available array of instruments to counter inflationary pressures.