Abstract
This Selected Issues paper analyzes the developments and determinants of inflation in Romania, and reviews the salient trends in public finance. The study describes the monetary policy issues and the improvements required to clean up the financial sector. The paper chronicles the balance-of-payments crisis in 1999, the external viability trends, reviews the economic and financial implications, and assesses Romania's compliance with EU economic criteria. The paper also provides a statistical appendix for the country.
III. Monetary Policy Issues1
A. Overview
1. The main obj ective of the National Bank of Romania (NBR)—to ensure the stability of the national currency, for the overall purpose of price stability—has proved to be elusive. Except for a superficial and unsustainable improvement in inflation performance in the mid-1990s, inflation has remained above 40 percent since the beginning of the transition in 1990—with the peaks in 1991-92 and 1997 associated with measures to liberalize the price and exchange systems. This is in part because monetary policy often pursued inconsistent objectives and was carried out inconsistently during much of the last decade. Moreover, monetary policy has had to operate in a difficult economic environment. For instance, widespread financial indiscipline, in conjunction with the very fragile position of the corporate and banking sectors, has raised the economic costs of monetary tightening, while a vulnerable external position has prevented the effective use of the exchange rate as a nominal anchor. In addition, monetary policy has had to deal over time with the entrenchment of inflation expectations and the informal indexation of the economy.
2. Romania’s experience suggests that a successful disinflation effort must rely not only on the consistent implementation of an appropriately tight monetary policy, but also on the hardening of budget constraints in the state sector. The latter requires measures to contain wage growth and reducing arrears in the state sector, pending the restructuring of banks and enterprises, notably through privatization, to address the root cause of financial indiscipline. The authorities’ past efforts to contain wage growth in the state sector, reduce domestic arrears, and impose financial discipline through restructuring of state enterprises have frequently given way to political resistance and hence has achieved little in terms of disinflation.
3. The monetary policy and exchange rate framework underwent a radical reform in early 1997, when monetary policy was relieved of its quasi-fiscal functions; the price, exchange, and trade systems were liberalized; and market-based policy instruments were introduced. Since then, the NBR has adopted an exchange rate regime of managed floating, with the exchange rate, net foreign assets (NFA), reserve money, and net domestic assets (NDA) all serving at various times as intermediate targets. The NBR has mainly relied on sterilized intervention in the foreign exchange market in conducting its monetary policy. In 1997, the NBR simultaneously targeted the exchange rate and reserve money through large sterilized purchases of foreign exchange to address concerns on inflation and competitiveness in the face of large foreign exchange inflows that followed a sharp depreciation. In 1998, the NBR sought to contain the rate of leu depreciation to reduce inflation; and as foreign exchange inflows subsided and then reversed in the course of 1998, the NBR initially defended the exchange rate through a drawdown of reserves but was unable to sustain such a policy. In late 1998 and early 1999, the NBR tried to restore external competitiveness and limited downward pressures on reserves by accepting a large acceleration of the leu depreciation. Since April 1999, when an acceptable level of external competitiveness was reached, the NBR has followed a policy of allowing the leu to depreciate broadly in line with the targeted rate of inflation, while seeking to adhere to the NDA and NFA targets that have been set under the Fund’s Stand-by Arrangement.
4. The sources of growth in monetary aggregates have varied in recent years, reflecting changes in the monetary policy stance as well as the external environment. Broad money growth mainly came from that of the NFA in 1997 and 1999, and exclusively from NDA growth in 1998. In 1997, money supply grew much less than inflation, since it did not fully accommodate the price and exchange rate liberalization, and the large foreign exchange inflows were sterilized. Consequently, bank credit showed a sharp real contraction in 1997 from the already very low level. In 1998, the rapid expansion of domestic credit, against the background of the overvalued exchange rate and loss of central bank reserves, drove the growth of broad money. Since mid-1999, monetary policy has been tight as the NBR sterilized most of the foreign exchange inflows.
5. Although Romania still has a very low level of monetization, domestic credit started to recover in the last 1½ years, following the clean-up of the balance sheets of troubled banks. Problems of the insolvent state banks also led to high and volatile interest rates and to the expansion of the spread between lending and deposit rates, in particular in 1997 and 1999. Thus the closure of Bancorex and the clean-up of the banking sector in 1999 have contributed to the gradual decline of interest rates, as has the fiscal consolidation, which lowered the government’s financing need.
6. Section B below outlines recent developments in Romania’s monetary policy framework and policy stance; section C analyzes the monetary policy conduct and sources of reserve money growth; section D depicts the impact of banking sector fragility on monetary policy; and section E describes the developments in broad money and credit.
B. Monetary Policy Framework and Policy Stance
The period 1990-96
7. Before 1997, Romania’s monetary and exchange rate policies were predominantly quasi-fiscal in nature. Inflation and balance of payments (external reserves) targets consistently gave way to demands for directed credit for the agricultural sector and state-owned enterprises, and for an overvalued currency to keep energy prices low - to subsidize the energy-intensive state sector (see Chapter II, Box II.1). As a result, monetary policy was highly accommodating, reserves were depleted while defending an overvalued currency and replenished with borrowing from the international capital market. By late 1996, the disequilibrium in the external sector created by the over-valued exchange rate and excess domestic demand became unsustainable.
The period 1997-98
8. In early 1997, the newly elected reformist coalition government, faced with rising inflation, mounting downward pressure on exchange rate, growing fiscal and current account deficits, and a real possibility of a financial crisis, embarked on a different policy path. The quasi-fiscal functions of monetary and exchange rate policy were shifted to the state budget, the exchange rate regime was liberalized following a sharp downward correction, and directed (subsidized) credit by the central bank was terminated. This was accompanied by other reforms, including price and trade liberalization, and the initiation of structural reform in the enterprise sector.
9. Confronted with large foreign exchange inflows during most of 1997, the NBR simultaneously targeted the nominal exchange rate and the reserve money to prevent a nominal appreciation and control inflation. The downward correction and liberalization of the exchange rate in early 1997 not only served to foster exports (at least initially), but also encouraged large amounts of capital inflows as well as private transfers. In order to prevent the erosion of the competitiveness gains through a nominal appreciation, the NBR engaged in large purchases of foreign exchange. It also aimed, but with limited success, to contain the growth in reserve money and inflationary pressures through sterilization operations.
10. However, starting in late 1997, external sector developments started to turn unfavorable, owing to rapid wage growth in conjunction with a low rate of leu depreciation. Rapid wage growth eroded the competitiveness correction by late 1997. The NBR’s decision to loosen monetary policy (along with fiscal policy) while continuing to target a nominal exchange rate served to reinforce the unfavorable trend. Although no single intermediate target for monetary policy unambiguously held sway, the exchange rate provided the main guide for reserve money management. The leu generally depreciated by 1-2 percent, well below the rate of inflation (Figure III.1.-III.2), resulting in real appreciation of the leu, and foreign exchange inflows ran dry. The loss of external competitiveness contributed to the worsening of the current account deficit, and finally rendered the external imbalance unsustainable. The stance and conduct of monetary policy in 1998 were complicated by the need to inject liquidity to two large ailing state banks and by the low credibility of the NBR. In 1998 as a whole, monetary policy was loose-the NBR relaxed the monetary policy stance by using its foreign reserves to defend the currency. Finally, the Russian crisis in the fall of 1998 triggered a decline of confidence in Romania, and the NBR no longer could defend the currency after losing large amounts of reserves. The currency realignment in late 1998 and early 1999 reflected the need to return the leu to its equilibrium real level after inappropriate macroeconomic policies had misaligned it, and the fact that Romania economy had become increasingly vulnerable to changes in market sentiment.
Romania: Exchange Rate and Inflation Developments, 1996-2000
Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A003
Sources: Romanian authorities; and Fund staff estimates.Romania: Exchange Rate and Inflation Developments, 1996-2000
Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A003
Sources: Romanian authorities; and Fund staff estimates.Romania: Exchange Rate and Inflation Developments, 1996-2000
Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A003
Sources: Romanian authorities; and Fund staff estimates.
Romania: Nominal and Real Exchange Rate Developments, 1996-2000
Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A003
Source: National Bank of Romania.1/ The official reference rate is published by the National Bank of Romania, computed as a weighted average based on the daily reports of foreign exchange operators.Romania: Nominal and Real Exchange Rate Developments, 1996-2000
Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A003
Source: National Bank of Romania.1/ The official reference rate is published by the National Bank of Romania, computed as a weighted average based on the daily reports of foreign exchange operators.Romania: Nominal and Real Exchange Rate Developments, 1996-2000
Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A003
Source: National Bank of Romania.1/ The official reference rate is published by the National Bank of Romania, computed as a weighted average based on the daily reports of foreign exchange operators.The period 1999 to the present
11. The current monetary policy framework seeks to strike a balance between two potentially conflicting objectives of (a) reducing inflation through a degree of exchange rate stability, and (b) safeguarding the external position. This monetary policy framework was instituted in early 1999 in the context of the SBA program, under the circumstances of a weak and highly uncertain external position and a history of volatile inflation and exchange rate movements. Specifically, the NBR’s managed float exchange rate regime operates in practice as an unannounced crawling peg that crawls at a rate broadly in line with targeted inflation. There is thus no explicit NBR commitment to a specific exchange rate or inflation path; the exchange rate target is subject to revision in the event of external shocks and unexpected developments, with a view to safeguarding the external position. In light of large and often uncertain foreign exchange flows (including official financing) and significant dollarization (which raises the level of capital mobility), as well as the low policy credibility, a nominal exchange rate anchor may not provide sufficient flexibility to reconcile domestic and external objectives. On the other hand, avoiding excessive exchange rate volatility would serve to ensure smooth external trade transactions, and help to stabilize inflation expectations, given that the exchange rate is the key element of the transmission mechanism in Romania.
12. Turning to the operational aspects of the monetary framework, in principle the NBR has one policy instrument—the NDA—but two intermediate targets: the NFA and the exchange rate. In practice, the NBR is guided in its day-to-day operations by the exchange rate target, as long as the NFA remains above its targeted path. Broadly in line with this policy, the NBR has been able to achieve the exchange rate target over the past one year, in the context of a NFA over-performance, thereby helping to stabilize exchange rate and price expectations.
Were the NFA target to be put at risk, however, the priority would effectively be the achievement of a minimum level of NFA. Thus, in the case of a negative shock and downward pressures on foreign reserves, the exchange rate target might be sacrificed after a point.
By contrast, in the case of a positive shock, the NBR would face—and indeed has repeatedly faced over the past year—a choice between adding to reserves or letting the exchange rate appreciate. In light of the weak external position, the authorities would normally opt for a buildup in reserves in this case and, moreover, to sterilize the foreign exchange inflows associated with the larger-than-programmed NFA. However, the NBR would reassess whether the underlying money demand had picked up if the external over-performance persists.
13. The current monetary policy framework has proven to be instrumental in the buildup of reserves and the maintaining of external competitiveness and exchange rate stability, but it has had limited success in bringing down inflation. Amid large foreign exchange inflows, monetary policy remained tight in 1999 and early 2000, although it was loosened temporarily in mid-2000 as the NBR only partially sterilized the unexpected high inflows and its liquidity injection that bailed out depositors of a failed bank.2 In the meantime, the NBR’s net foreign assets, including gold, rose from US$1.3 billion at the end of 1998 to US$1.8 billion at the end of 1999 and US$2.1 billion in June 2000. After the downward correction in early 1999, the exchange rate has depreciated in line with inflation and largely maintained its competitiveness. However, inflation rose to 55 percent at the end of 1999 compared with 40 percent in 1998, and has since decelerated only modestly.
14. While the main objective of monetary policy shifted, the circumstances surrounding the operation of monetary policy changed markedly as well. The favorable external conditions in 1996 and 1997, reflected in large capital inflows and relatively easy access to international capital markets, gave way to adverse sentiment following first the Asian crisis, and then the Russian crisis in August 1998, resulting in the denial of Romania’s access to international capital markets in 1999. The strong policy effort in the areas of budget and external competitiveness in 1999 helped to avert a financial crisis and restore some confidence in the economy by mid-2000. In addition, the privatization and liquidation of large state-owned banks have drastically reduced the need for the NBR to constantly provide liquidity support to the ailing state banks which compromised its monetary policy conduct.
C. The Conduct of Monetary Policy and Sources of Reserve Money Growth
15. Reserve money management in the last three and a half years mainly consists of large sterilized intervention in the foreign exchange market by the National Bank of Romania—sterilizing the accumulation of reserves from the inflows in 1997 and since mid-1999, and sterilizing the massive reserve loss and foreign exchange outflows in 1998. leu reserve money3 soared by 87 percent in 1997 (although end-December inflation was much higher, at 150 percent), following the exchange rate and price liberalization, before decelerating in 1998 and 1999, to about 30 percent4 (Table III.1). In 1997, reserve money developments were driven exclusively by the large inflow of foreign exchange following the sharp depreciation and the liberalization of the exchange rate regime. The NBR sterilized most of the US$ 1.5 billion increase in its net foreign assets, which in turn tightened credit conditions. As a result, NFA growth contributed more than 100 percent to the growth of reserve money, while NDA declined slightly in 1997. In sharp contrast to 1997, reserve money developments in 1998 were led by a decline in NFA. In the course of defending the stability of the nominal exchange rate, NFA dropped by US$800 million in 1998 (Figure III.3), or some 46 percent from the level at the end of 1997 (excluding valuation effects). As the NBR sterilized the foreign exchange outflows, credit conditions were loosened, and domestic credit growth turned from large and negative to large and positive. Under the SBA program of 1999, building NFA became the paramount objective, and thus the forces underlying reserve money developments again reversed their courses. Following the large depreciation in early 1999, the exchange rate stabilized, while the real depreciation significantly improved the current account and increased the inflows of foreign exchange. The accumulation of foreign reserves contributed to about 70 percent of reserve money growth, while domestic credit growth decelerated. This trend has continued so far in 2000.
Contribution to Reserve Money Growth, 1997-99
(Percent change in relation to reserve money at the beginning of the year)
Contribution to Reserve Money Growth, 1997-99
(Percent change in relation to reserve money at the beginning of the year)
| 1997 | 1998 | 1999 | 2000 | ||||
|---|---|---|---|---|---|---|---|
| Actual | Program | HI | |||||
| Reserve money excluding changes in reserve requirements & assuming full compliance | 87.5 | 29.4 | 32.4 | 30.7 | 14.3 | ||
| NFA | |||||||
| Excluding valuation effects | 89.7 | (45.5) | 22.6 | 17.4 | 14.2 | ||
| NDA | (2.1) | 74.9 | 9.8 | 13.3 | … | ||
| Domestic Credit | (99.3) | 82.7 | 30.7 | 8.6 | 3.0 | ||
| Banks | (147.3) | 37.9 | (18.6) | 24.0 | (0.3) | ||
| Government | 48.0 | 44.8 | 49.3 | (15.4) | 3.3 | ||
| Changes in required reserves | (12.4) | (19.6) | (51.4) | - | - | ||
| Other items, net | 92.2 | 12.1 | 25.7 | 5.7 | 9.9 | ||
| Of which: Valuation change | 62.8 | 8.5 | 30.8 | 14.8 | 14.2 | ||
| Shortfall of required reserves | (0.3) | 4.7 | (1.0) | (12.9) | |||
Contribution to Reserve Money Growth, 1997-99
(Percent change in relation to reserve money at the beginning of the year)
| 1997 | 1998 | 1999 | 2000 | ||||
|---|---|---|---|---|---|---|---|
| Actual | Program | HI | |||||
| Reserve money excluding changes in reserve requirements & assuming full compliance | 87.5 | 29.4 | 32.4 | 30.7 | 14.3 | ||
| NFA | |||||||
| Excluding valuation effects | 89.7 | (45.5) | 22.6 | 17.4 | 14.2 | ||
| NDA | (2.1) | 74.9 | 9.8 | 13.3 | … | ||
| Domestic Credit | (99.3) | 82.7 | 30.7 | 8.6 | 3.0 | ||
| Banks | (147.3) | 37.9 | (18.6) | 24.0 | (0.3) | ||
| Government | 48.0 | 44.8 | 49.3 | (15.4) | 3.3 | ||
| Changes in required reserves | (12.4) | (19.6) | (51.4) | - | - | ||
| Other items, net | 92.2 | 12.1 | 25.7 | 5.7 | 9.9 | ||
| Of which: Valuation change | 62.8 | 8.5 | 30.8 | 14.8 | 14.2 | ||
| Shortfall of required reserves | (0.3) | 4.7 | (1.0) | (12.9) | |||
Romania: Foreign Reserve, 1997-2000
Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A003
Sources: Romanian authorities; and Fund staff estimates.Romania: Foreign Reserve, 1997-2000
Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A003
Sources: Romanian authorities; and Fund staff estimates.Romania: Foreign Reserve, 1997-2000
Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A003
Sources: Romanian authorities; and Fund staff estimates.16. The key instruments of monetary policy conduct have evolved in the last three years (Box III.1). The elimination of directed credit by NBR, the subsequent need to inject liquidity into the ailing banks, and the large foreign exchange inflows transformed the NBR from a net creditor in the liquidity market to a net debtor vis-a-vis the commercial banks. Sterilization operations, the driving force behind the evolution of NDA, were conducted mainly through NBR’s deposit-taking operations, and the increases in minimum reserve requirements on banks’ deposits. Deposit-taking operations by the NBR were introduced in June 1997, initially to absorb the large amount of liquidity resulting from the NBR’s foreign exchange purchases, and then to sterilize the liquidity support to two ailing state-owned banks. The financial market conditions—the existence of large distress borrowing, the dominance of certain banks, and not the least, the large sterilization requirement—rendered deposit-taking operations too costly and insufficient to mop up all the liquidity desired, and the NBR repeatedly turned to a more effective but heavy-handed instrument—the increase of minimum reserve requirements. Minimum reserve requirements for leu deposits were raised steadily from 7.5 percent in early 1997 to 30 percent in late 1999 (Table III.2).
Monetary Policy Instruments and Their Evolution
Open market-type Operations:
Deposit-taking operations: Deposit-taking operations began in June 1997 to absorb large amounts of excess liquidity, mostly resulting from the NBR’s purchases of foreign exchange. Later in 1997, liquidity support to the two ailing state-owned banks (BX and BA) required subsequent sterilization from the system, which led to the sharp rise of deposit-taking operations. In December 1997, the stock of deposit-taking operations peaked at 5.8 trillion lei, or 50 percent of reserve money. Apart from the heavy-banded adjustment of reserve requirements, deposit-taking operations have since been the most heavily utilized instrument to drain liquidity from the market. These operations are held frequently and maturities are usually for one week or two weeks, but they vary between one day and one month depending on liquidity conditions. Each day a set of bilateral transactions (and now, increasingly, auctions) are conducted, and terms and conditions can be different for different operations. The interest rates of the deposits with the NBR were often affected by the distress borrowing of troubled banks and competition from large financing needs of the government (T-bills) in the past - the high cost often drove the NBR to resort to changes in reserve requirements. The NBR has published a set of regulations governing money market operations, and started to rely more on the auction format in deposit-taking operations beginning in the third quarter of 2000.
Government securities operations: The two other instruments available to NBR to carry out open-market-like operations are outright purchases and sales of Treasury bills (T-bills), and repurchase and reverse repurchase agreements. To date there have been a few outright sales of T-bills (average daily amount of 120 billion lei in the last 12 months). The purchase of T-bills from two ailing banks were related to the need to inject liquidity into these banks and cannot be counted as true open market operations. The NBR conducted experimental repos and reverse repos with a few banks in 1998-99 and then formalized the regulations on such operations in March 2000. As the terms and maturities of T-bills have increased, and interest rates are more market related, the NBR began to use reverse repos as an important means of monetary policy conduct starting in August 2000. Nonetheless, the high inflation and highly uncertain interest rate environment remain an obstacle to further development in this area.
Reserve Requirement:
The system of reserve requirements underwent major reforms in 1998 and early 1999. Since March 1999, reserve requirements have been calculated for the average of the previous half month, and the coverage is in line with the international norm. In August 1998, reserve requirements on domestic currency deposit and foreign currency deposits were unified at 15 percent. The requirements diverged in November 1999, when the reserve ratio on leu deposits was raised to 25 percent and then in December to 30 percent, while the reserve ratio on foreign currency deposits remained at 20 percent. On lei reserve requirements, the first 15 percent is remunerated at the sight deposit rate, and the second 15 percent is remunerated at a rate determined by various market indicators, including the interbank market rate. The NBR’s decision to raise reserve ratios to the current high level stemmed partly from the large sterilization need in light of large foreign exchange inflows in 1999, and liquidity injections to ailing state banks. The financial distortion created by the ailing banks, including nonobservance of their reserve requirements, also contributed to the need to tighten reserve requirements across the board.
NBR Credit Facilities:
Auction credit: The NBR introduced auction credit in 1993 as a semi-market-based means of monetary policy to replace soft credit dictated by government decisions. However, as the rules of the auction were not sound and very low bids were submitted in an environment of excess liquidity, auction credit was initially used exclusively by a few major state-owned banks to borrow at below-market interest rates. The auctions were reformed in 1995, whereby credit is granted for a maximum of 15 calendar days with collateral acceptable to the NBR, and interest rates are set competitively by the auctions. Credit auction loans reached a high of 1.5 trillion lei in December 1996 and dropped to zero after April 1997. From June 1997, the NBR has become a net borrower instead of lender vis-a-vis the banking system and has not used credit auctions.
The discount window (or structured credit facility) was once the main facility through which the NBR provided directed credit at heavily subsidized rates (about 70-90 percent of NBR’s total refinancing credits were issued as directed credit during 1993-96). Structural credit was granted on the basis of laws passed by the parliament or government decisions to support activities in certain sectors (such as the agriculture sector). In 1997, structured credit was terminated, and discount credit volume declined subsequently, as maturing credit was not renewed. It has not been used since 1997, especially as the liquidity conditions have changed (with the NBR being a net borrower).
The Lombard facility is an overnight lending facility for banks to bridge temporary liquidity needs. This facility has not been used since December 1997. The NBR law of 1998 prohibits the NBR from providing overdraft credit, although the Lombard facility existed. The rate is set to be money market rate plus penalty, or the highest short-term money market rate. The regulation issued in 2000 provides a marginal lending facility, which will take the place of the Lombard facility, to allow overnight collateralized lending at the highest market interest rate to facilitate settlement.
The special credit facility is used for banks in serious distress and credit is granted for a maximum of 30 days, requires a submission of a financial recovery plan, and is collateralized with T-bills. In practice, there have been exceptions to the collateral requirement as well as the financial recovery plan. The facility was used to extend liquidity support to BX (1999) and BA (1999-2000).
Reserve Requirements, 1997-2000
Depending on the foreign currency liquidity level.
Reserve Requirements, 1997-2000
| Period in Effect | Leu Deposits | Foreign Currency Deposits |
|---|---|---|
| January 1997 to July 1997 | 7.5 | 20-30* |
| July 1997 to February 1998 | 10 | 20-30* |
| February 1998 to August 1998 | 12.5 | 20-30* |
| August 1998 to July 1999 | 15 | 15 |
| July 1999 to October 1999 | 20 | 20 |
| November 1999 | 25 | 20 |
| December 1999 to present | 30 | 20 |
Depending on the foreign currency liquidity level.
Reserve Requirements, 1997-2000
| Period in Effect | Leu Deposits | Foreign Currency Deposits |
|---|---|---|
| January 1997 to July 1997 | 7.5 | 20-30* |
| July 1997 to February 1998 | 10 | 20-30* |
| February 1998 to August 1998 | 12.5 | 20-30* |
| August 1998 to July 1999 | 15 | 15 |
| July 1999 to October 1999 | 20 | 20 |
| November 1999 | 25 | 20 |
| December 1999 to present | 30 | 20 |
Depending on the foreign currency liquidity level.
17. Among open market-like operations, apart from deposit-taking, the NBR could—but rarely did—resort to the sale and purchase of government securities to conduct its monetary policy. While the NBR has sold some of its holdings of T-bills, its purchase of non-marketable T-bills from state-owned banks derived mainly from the need to pump in liquidity to support the ailing banks, and cannot be categorized as open market operations. Progress has been made in the development of open market operations through the development of more marketable government securities, a set of regulations clarifying the money market operations, the shift toward the auction format in conducting deposit-taking operations by the NBR, and the introduction of repurchase (repo) and reverse repurchase agreements of government securities. As of August 2000, most of the deposit-taking operations were conducted in auction format, and the NBR also started to rely more on reverse repo transactions to mop up liquidity.
D. Banking Sector Fragility and Monetary Policy
18. The conduct of monetary policy in Romania has been complicated in recent years by the fragile condition of the banking system. This section is devoted to the impact of banking sector problems, especially the two large insolvent state-owned banks—Bancorex and Banca Agricola - on the conduct of monetary policy.
19. The insolvent state banks were the main agents for quasi-fiscal support to the state enterprises and the agricultural sector before 1997. Bancorex (BX), the former bank of foreign trade and the largest bank in Romania, had mainly dealt with foreign currency lending and deposit taking, trade finance, foreign exchange, and international settlements. BX financed a significant portion of Romania’s energy import requirements, as well as imports of capital goods under the previously highly subsidized exchange rate. In addition, BX was used as a major vehicle for providing quasi-fiscal support to the energy sector and energy-intensive industry. When the exchange rate regime was liberalized and subsidized credit was terminated by the NBR in 1997, BX’s already high level of nonperforming loans ballooned and the bank ran into serious liquidity and solvency problems. Banca Agricola (BA), the agricultural bank, had traditionally relied on extending subsidized credit to the agricultural sector. In early 1997, when such credits were eliminated, BA also encountered serious liquidity and solvency problems.
20. Large distress borrowing by the two insolvent state banks and the subsequent bailout by the government and the NBR compromised the monetary policy stance. As shown in the attached charts (Figure III.4), BX and BA pushed up interest rates via large distress borrowing at various times in the last few years. Their behavior forced the central bank to raise interest rates by a greater margin to absorb the liquidity in the system.5 The subsequent bailout of BX and BA by the government and the liquidity injection by the NBR required huge consequent sterilization.6 As a result, the conduct of monetary policy was significantly undermined.
Romania: The Impact of Bancorex and Banca Agricola, 1997-2000
Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A003
Sources: Romanian authorities; and Fund staff estimates.Romania: The Impact of Bancorex and Banca Agricola, 1997-2000
Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A003
Sources: Romanian authorities; and Fund staff estimates.Romania: The Impact of Bancorex and Banca Agricola, 1997-2000
Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A003
Sources: Romanian authorities; and Fund staff estimates.21. The liquidity support to the two banks made NBR’s sterilization operations very expensive and caused distortion in the financial market. First, the large sterilization requirements stemming from NBR’s massive liquidity support made its deposit-taking operations very expensive. As interest rates skyrocketed, the NBR resorted to increasing minimum reserve requirements on all bank deposits. Second, the two ailing banks’ nonobservance of the minimum reserve requirements, along with other prudential regulations, clouded the true picture of the monetary situation and caused distortion in the banking system by shifting the burden to other banks.
22. The aforementioned distortion caused by the two banks altered the transmission of monetary policy. The level of interest rates associated with a given quantity of reserve money was often skewed upward by the presence of BX and BA—through, for example, large distress borrowing—while the overall volatility and uncertainty of interest rates increased. This in turn hindered financial market development—for example, the development of the secondary market for government securities—and discouraged the financing of real activities, as such activities are less sensitive to interest rate (see the next section on the low level of financial intermediation).
E. Recent Developments in Broad Money and Credit
Broad money developments
23. Romania’s monetary programming is based on leu broad money (henceforth M2),7 but both leu broad money and broad money including foreign currency deposits (henceforth M2X) are monitored. Table III.3 shows developments in broad money and sources of growth in the last three years. Even though M2 grew by 91 percent in 1997, this was still far below that of end-year inflation of 151 percent, resulting in a sharp real contraction that year. In 1998, M2 grew by 40 percent in 1998, in line with end-year inflation, though the credit policy stance in 1998 was loose, as money demand declined in the latter part of the year. Reflecting a tightening of monetary stance since early 1999, M2 grew by 34 percent in 1999. The developments in M2X in the meantime mainly reflected developments in M2 and exchange rate movements, as the dollar amount of foreign currency deposits has changed little.
The low level of monetization
24. The level of financial intermediation is extremely low in Romania, and has been so for many years. Measured by the share of broad money (including FCDs) in GDP, Romania ranks the lowest among countries in the region, falling behind Bulgaria, the Slovak Republic, Poland, the Czech Republic, and Hungary (Figure III.5). The monetization levels of these countries, with the exception of Bulgaria, were between 40 percent and 70 percent of GDP at the end of 1999. In contrast, Romania’s M2X to GDP was a mere 26 percent, lower than the ratio of post-crisis Bulgaria, which saw its broad money-to-GDP ratio halved from some 70 percent of GDP following the banking crisis in 1996.
Romania: International Comparison of Monetization, 1992-1999
(Broad money as a percent of GDP)
Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A003
Source: EBRD Transition Report 2000.Romania: International Comparison of Monetization, 1992-1999
(Broad money as a percent of GDP)
Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A003
Source: EBRD Transition Report 2000.Romania: International Comparison of Monetization, 1992-1999
(Broad money as a percent of GDP)
Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A003
Source: EBRD Transition Report 2000.25. Moreover, unlike most transition countries in Eastern Europe, the broad money-to-GDP ratio in Romania shrank by half at the beginning of the transition process between 1991 and 1993. The main reason behind Romania’s rapid demonetization is that rampant inflation in the first three years of the 1990s resulted in highly negative real interest rates and hence heavy taxation on holdings of domestic currency; meanwhile, controls on foreign exchange were not liberalized, which led to the collapse of demand for money.8 (Table III.4). Since then, progress in re-monetization and financial intermediation in Romania has been slow, owing to the persistence of high inflation and, for the most part, negative interest rates on leu deposits, and concerns about the health of the banking system.
26. As shown in Figures III.6 and III.7, commercial banks’ average deposit rate have fluctuated widely and have often been highly negative in real terms. Real deposit rate was consistently positive in only two periods, 1995-96, and much of 1999, and both periods witnessed a recovery of broad money-to-GDP ratio.
Romania: Real Monthly Deposit Rate, 1993-2000
Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A003
Source: Romanian authorities.Romania: Real Monthly Deposit Rate, 1993-2000
Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A003
Source: Romanian authorities.Romania: Real Monthly Deposit Rate, 1993-2000
Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A003
Source: Romanian authorities.
Romania: End-Year Commercial Bank Deposit Rate and Inflation, 1992-1999
Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A003
Source: Romania authorities.Romania: End-Year Commercial Bank Deposit Rate and Inflation, 1992-1999
Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A003
Source: Romania authorities.Romania: End-Year Commercial Bank Deposit Rate and Inflation, 1992-1999
Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A003
Source: Romania authorities.27. Most recently, the development of capital markets in Romania may have offered people some alternatives to bank savings—the securities market, investment funds, and treasury bonds. However, the market capitalization of these alternatives remains low, and hence it has not been among the main reasons so far for the low level of monetization in Romania. Stock market capitalization reached about 2 percent of GDP in the last two years, while bonds sold to households accounted for another 1½ percent of GDP. Investment funds are estimated to account for less than 1 percent of GDP (most of which was the failed FNI), as do deposits at credit cooperatives—although data from these latter two sources are imprecise and should be viewed with caution.
Developments in bank credit
28. Associated with the low monetization level, bank credit to the nongovernment sector, especially the private sector, is very low (Figure III.8). Compared with other countries in the region, Romania again ranked at the bottom, along with Bulgaria. Unlike Bulgaria, whose credit level declined sharply after the financial crisis in 1996, Romania’s credit to the private sector has always been low. More recently, credit to the nongovernment sector declined sharply in 1997, along with a sharp contraction of domestic credit owing to the tightening of the monetary stance, and the erosion of credit by inflation. Credit to the private sector has since recovered, although still at a very low level, from some 8.5 percent of GDP in 1997 to some 12-13 percent in 1999.9 Credit to the state-owned enterprises (SOEs) has shrunk over time, from some 12 percent of GDP at end-1996 to about 3-4 percent of GDP at end-1999, The shift of banking credit from SOEs to the private sector partly reflected the accelerated enterprise privatization and reform, and partly reflected the termination of subsidized directed credit to the SOEs and enhanced banking supervision.
Romania: Credit to the Private Sector, 1993-1999
Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A003
Source: Romanian authorities.Romania: Credit to the Private Sector, 1993-1999
Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A003
Source: Romanian authorities.Romania: Credit to the Private Sector, 1993-1999
Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A003
Source: Romanian authorities.29. Apart from the generally low level of financial intermediation, the exceptionally low credit level in Romania is also attributable to the following demand and supply factors: on the demand side, the lending rates are very high, even in real terms, owing to both the high cost of financial intermediation and the lack of competition in the banking sector; wide-spread financial indiscipline renders much of the nongovernment sector able to use arrears as an alternative to bank financing; on the supply side, banks’ capacity to enforce contracts and collect debt is limited, which makes them unwilling to extend credit; banks are saddled with nonperforming loans and hence are unable to expand credit significantly; banks could be better off investing in T-bills, which offer good rates of return as a result of high domestic financing needs.
30. As a result, on average, less than half of bank assets in Romania are loans. Healthier banks have even smaller shares of assets in loans, and often more than one-third in Treasury bills. T-bill rates have often been much higher than the average lending rates charged by the banks in the last few years (Figure III.9). Given that T-bills are low risk compared to lending, banks are therefore provided with an extra incentive to hold Treasury bills rather than lend to real economic activities.
Romania: Developments of Interest Rates, 1996-2000
Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A003
Source: Romanian authorities.Romania: Developments of Interest Rates, 1996-2000
Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A003
Source: Romanian authorities.Romania: Developments of Interest Rates, 1996-2000
Citation: IMF Staff Country Reports 2001, 016; 10.5089/9781451832716.002.A003
Source: Romanian authorities.31. The maturity of the loan structure has evolved in recent years as well. While in 1991 three-fourths of all credit to the nongovernment sector involved long-term credit, only one-tenth of such credit was long term at end-1999. This is closely related to the fact that foreign currency loans now account for some 60 percent of total loans (even after transferring BX’s bad foreign currency loans to AVAB) to the nongovernment sector, up from one-fourth a few years ago. More than 85 percent of foreign currency loans are short- or medium-term lending. In addition, domestic currency loans are now almost exclusively short and medium term, as banks are not willing to lend on a long-term basis in an environment characterized by highly variable interest rates and general uncertainty.
References
Tomas J.T. Balino, Adam Bennett, and Eduardo Borensztein, 1999, Monetary Policy in Dollarized Economies, International Monetary Fund, Occasional Paper No. 171.
Tarhan Feyzioglu and R. Gaston Gelos, 2000, Why is Private Sector Credit So Low in Bulgaria? In Bulgaria: Selected Issues and Statistical Appendix, IMF Staff Country Report No. 00/54.
EBRD, 1999, Transition Report 1999—Ten Years of Transition.
International Monetary Fund, 1997, Romania—Recent Economic Developments, IMF Staff Country Report No. 97/46.
This chapter was prepared by Tao Wang.
The loosening of monetary policy was influenced in part by an assessment that the higher-than-programmed increase in reserve money should be accommodated, as it reflected increased demand for currency, and in part by political pressure to lower the domestic financing costs of the budget deficit. The authorities started to tighten monetary policy in September 2000.
In Romania, the analysis typically focuses on the leu component of reserve money, for reasons explained in Section E.
The rate of change is calculated at an unchanged required reserve ratio, using the beginning of the period required reserves ratio as a reference point, and assuming full compliance with reserve requirements.
When the two banks offered excessively high interest rates to attract deposits and avoid bank runs in 1997, they added to the upward pressure on interest rates arising from tight liquidity conditions owing to the NBR’s sterilization of foreign exchange inflows.
In late, 1997, the government bailed out the two banks with US$1 billion in government bonds. The NBR immediately purchased a significant amount of those securities from the two banks and injected cash liquidity into the banking system. In 1999, as BX collapsed, the NBR stepped in again to extend about 10 trillion lei—or about 50 percent of reserve money—in special credit to the bank.
Even though the share of FCDs in M2X is significant, hovering around 30 percent in recent years, there is no strong evidence of foreign currency as a means of payment or unit of account in a significant way. FCDs are mostly a form of assets that the population uses in a high inflation and volatile exchange rate environment to substitute for domestic deposits.
This did not happen in some other high inflation economies such as Poland, because its population was able to hold dollar deposits freely.
In mid-1999, before BX was merged with BCR, its bad assets were transferred to the newly founded asset recovery agency (AVAB), removing the bad loans from the banking sector. While the transfer of these assets did not affect underlying credit to the economy, it did change the statistics on banking system credit. As a result of the transfer, credit in the amount of 4½ percent of GDP was removed from the banking system—of which about 3 percent of GDP represented nonperforming foreign currency loans.
