ROMANIA RISK OBSERVER

Is Romania a subprime territory?

Valentin Mandache — Tue, 24 Feb 2009 12:15:21 +0000

YES- is the straight answer if one looks at the parameters that define the Romanian financial landscape. The country has together with Bulgaria, the lowest per capita income in the EU and is also one the poorest members. Its population and companies are overburden with large loans denominated in Euro and Swiss Franc, secured with questionable property and other assets that in the last few months have dramatically decreased in value. One might add a property bubble that is still clinging on prices higher than in established western markets, which is at its first bursting stages, a fatally shrinking export market and a heavy dependence on imports, including basic foodstuff. That context prompted rating agencies such as Standard&Poor’s to downgrade Romania to junk status in October 2008.

NO- according to Mugur Isarescu, Romania’s Central Bank governor. He even blames the press and the international rating agencies for stoking a “crisis mood” regarding the Romanian economy and hastening the heavy depreciation of the leu since December last year. Isarescu points out, that the banks functioning in Romania are well capitalised, with a high level of minimum capital requirement, able to offer credits and withstand payment demands. Also the country has the highest reference interest rate in Europe, making any speculative attack on its currency very expensive. However, Isarescu’s recent joint statement with other central bankers form Hungary, Czech Republic and Poland, on 24 February, indicates that things are not so rosy as previously stated and heavy clouds are gathering on the economies of Central and South East Europe.

Where then the balance inclines?

Romania has too many financial, economic and social problems to pretend through voices of its central banker or government officials that is less affected by the ongoing crisis. The country has become too expensive and overrated for what it has to offer and a heavy correction is necessary. Also the much praised competitive advantage factors of Romania are not what they seemed in the eyes of many investors: the workforce is not as highly educated as it was thought by the western companies opening shop in the country, the education system once praised for its supposed high standards is in reality probably the lowest quality in Europe from apprentice schools to universities, there is very low productivity in all sectors, with less than tepid steps to improve it, employers are bombarded with unrealistic salary demands, property prices are detached from the Romanian economic reality, the country has a crumbling transport infrastructure worse than 1950s southern Italy and the list can continue… All of these translate in parameters that indicate with increasing clarity that Romania is already in subprime territory. ©Valentin Mandache

ROMANIA’s CURRENCY FALL: context and expectations

Valentin Mandache — Tue, 20 Jan 2009 23:36:55 +0000

On January 19, Bloomberg reported that the Romanian currency, the leu, categorised as the “worst performing emerging-market currency,” may be devalued with as much as 9% this year. That is on a background of sharp economic downturn and, shall I add, contemplated from the crest of an unravelling huge property bubble where prices for real estate are even at this hour higher than in Western Europe, coupled with toxic corporate and individual Euro-borrowing. And to make things nuclear, add the rapid exit of the western investment funds and money, together with an ineffective government that governs in name and has not yet even seriously discussed the budget project for 2009. Within that context, the Romanian financial system and implicit economy are open to speculative attacks and may enter one of the most serious recession spirals within the EU.

Also, the prognosed budget deficit is worrisome:

Romania is likely to post a budget deficit of 7.5 percent of gross domestic product, the biggest among emerging-market economies in the region, the European Union said today. Industrial output plunged in November by the most in more than eight years, while the current-account deficit widened to 16 billion euros ($21 billion).

Because the previous government that was voted out less than two moths ago had tried to bribe the electorate with a very relaxed fiscal policy, widening the budget deficit, there is no room for manoeuvre left for the new government in order to stimulate consumption and make tax cuts. On the contrary, they have to curb all of those.

Romania’s economy may contract 3.5 percent this year [...]. While Europe, the U.S. and China are providing packages of spending and tax cuts to stimulate their economies, Prime Minister Emil Boc has pledged to cut expenditure on goods and services by 20 percent and keep consumer taxes unchanged.

Moreover:

The International Monetary Fund, which has already offered aid to Latvia, Hungary, Iceland, Serbia and Ukraine, is due to visit Romania at the end of this month. Romania, which has $75 billion in external debt to be refinanced, hasn’t sought IMF help to date.

The conclusion is that those who now take positions on the Romanian leu would probably gain substantially and Romania’s finances and economy would experience a serious systemic shock (the overvalued real estate is a prime candidate), with bleak prospects for the population.

ROMANIA’s ECONOMY goes Latvian (or even Argentinian)

Valentin Mandache — Mon, 19 Jan 2009 15:36:58 +0000

Paul Krugman, the US Nobel laureate economist, published the following post entitled Latvia is the new Argentina that also gives useful insights into the evolution of the new EU member economies, Romania among them. The current very steep, unprecedented, devaluation of the Romanian currency, the leu, and worrying current account deficit, not speaking of the massive Euro-indebtedness of the population and companies bring back home to roost all of Romania’s chickens:

I’ve been saying this for a couple of weeks, but Edward Hugh has the goods.

Hugh puts his finger, in particular, on one gaping hole in the logic of the opponents of devaluation. We can’t devalue, they say, because the Latvian private sector has a lot of debts in euros, and a devaluation would make it very hard for borrowers to service those debts. As Hugh points out, the proposed alternative – sharp wage cuts, and basically a major domestic deflation – will also make it hard to service those debts. In fact, I’d be a bit more specific than Hugh: other things equal, a nominal devaluation and a real depreciation achieved through deflation should have exactly the same effect on debt service (unless some of the debt is in lats rather than euros, in which case devaluation would do less damage.)

This looks like events repeating themselves, the first time as tragedy, the second time as another tragedy.

One has only to imagine how the Romanian real estate bubble would fare in a quite possible Latvian/ Argentinian scenario.