Romania: Selected Issues and Statistical Appendix
Author: International Monetary Fund
Publication Date:
09 May 2006
eISBN:
9781451832860
Language:
English
Keywords:
ISCR; CR; exchange rate; Romania; EU accession; product; export performance; exchange rate misalignment; wood product; cost advantage; ULC relative; Imports; Wages; Global
Download PDF (622.1 KB)

This Selected Issues and Statistical Appendix paper assesses Romania’s external competitiveness by reviewing recent developments in a range of standard indicators and estimating equilibrium real exchange rates. The results suggest that, although Romania’s historical cost advantage vis-à-vis trading partners has eroded since end-2004, on account of a strong real exchange rate appreciation, some undervaluation still remains. Furthermore, evidence suggests that the recent weak output and export performance in some of the traditional exporting sectors mainly reflects the transition toward higher value-added products.

Abstract

This Selected Issues and Statistical Appendix paper assesses Romania’s external competitiveness by reviewing recent developments in a range of standard indicators and estimating equilibrium real exchange rates. The results suggest that, although Romania’s historical cost advantage vis-à-vis trading partners has eroded since end-2004, on account of a strong real exchange rate appreciation, some undervaluation still remains. Furthermore, evidence suggests that the recent weak output and export performance in some of the traditional exporting sectors mainly reflects the transition toward higher value-added products.

I. Competitiveness1

1. This paper assesses Romania’s external competitiveness, by reviewing recent developments in a range of standard indicators and estimating equilibrium real exchange rates. The results suggest that, although Romania’s historical cost advantage vis-à-vis trading partners has eroded since end-2004, on account of a strong real exchange rate appreciation, some undervaluation still remains. Furthermore, the evidence suggests that the recent weak output and export performance in some of the traditional exporting sectors mainly reflects the transition towards higher value-added products. And strong import growth is partly driven by the rapid process of capital accumulation, over improved prospects of economic growth. Going forward, further real appreciation is expected, as part of the convergence process to EU living standards and continued strong capital inflows. In this context, the ability of Romania’s traditional export sectors to cope with the new environment will depend on Romania’s capacity to boost productivity gains, and contain inflationary pressure, and the speed of real appreciation. These findings point also to the need for further enterprise restructuring, and policies to promote reform and a business-friendly environment.

A. Background

2. The widening of the current account deficit, and the sharp appreciation of the real exchange rate since end-2004 have raised concerns about Romania’s external competitiveness. While Romania has historically benefited from a competitive edge vis-à-vis neighboring countries, the recent capital account liberalization and the exchange rate policy shift at end-2004 led to a strong real appreciation in a reduced period of time, driven mostly by a sharp nominal appreciation and a slowdown in disinflation. The appreciation of the leu has been accompanied by a widening of the trade and current account deficit. As a result, the issue of external competitiveness has presented a challenge for policy makers. The authorities perceive a strong trade-off between tightening monetary policy, aimed at resuming disinflation, and preserving external competitiveness, as higher domestic interest rates could exacerbate capital inflows and put further pressure on the exchange rate.

Figure 1.
Figure 1.

Romania: Exchange Rate, Inflation and Real Exchange Rate, 2002-05

(12-month growth rate, percent)

Citation: IMF Staff Country Reports 2006, 169; 10.5089/9781451832860.002.A001

1/ 3-month moving average.
Figure 2.
Figure 2.

Romania: Exports, Imports and Trade Balance, 2002-05

(In million Euros, 12-month moving average)

Citation: IMF Staff Country Reports 2006, 169; 10.5089/9781451832860.002.A001

3. Assessing Romania’s external competitiveness, like in other transition economies, is challenging. Besides the well-known difficulties of estimating equilibrium exchange rates, several factors have recently affected Romania’s external balances. Disentangling their effect from a potential exchange rate misalignment is not trivial. Some of these factors are:

  • Capital account liberalization and consumption smoothing: Romania’s capital account liberalization in 2005 was followed by strong capital inflows and coincided with a rapid domestic credit expansion. The later contributed to a pick up in investment and a sharp acceleration of consumption growth, leading to a strong increase in imports of both capital and consumption goods. While large imports of capital goods arguably reflect the normal process of convergence through capital accumulation, abundant imports of consumption goods could result from intertemporal consumption smoothing over improved growth prospects (due to the upcoming EU accession) and easing credit constraints, but also could be driven by a potential exchange rate misalignment. Disentangling both effects presents a challenge.

  • Climbing the quality and technological ladder: As in other transition economies, the process of capital accumulation has led to a marked transformation of Romania’s production and exporting structure, shifting away from production of traditional low-tech products towards higher valued-added goods. The underperformance of traditional exports can, thus, be partially explained by the re-allocation of resources associated to this transformation process.

  • Productivity gains: Increasing relative prices of non-tradable goods have been partially the result of strong productivity gains in the tradable sector, a phenomenon previously observed in other transition economies (Balassa-Samuelson effect). In this context, standard measures of the real exchange rate based on consumer prices do not reflect changes in external competitiveness but the effect of differential productivity gains across sectors on relative prices.

  • Changing International Environment: Simultaneous to this transformation process, Romania’s external trade has been affected by fast growing commodity prices (minerals and fuels) in recent years, and by the abolition of textiles quotas at end-2004.

B. Stylized Facts

4. Following a period of relative stability in the external accounts, Romania’s trade deficit started to widen in 2003. After the 1998-99 exchange rate adjustment – engineered to correct an exchange rate misalignment – trade and current account deficits fluctuated around 6 percent and 5 percent of GDP respectively until 2003. Since then, however, import growth has outpaced exports growth – 24 percent and 19 percent on average respectively- leading to a trade deficit of 10 percent of GDP and a current account deficit of 8.7 percent of GDP in 2005. External imbalances were financed by large capital inflows, which also allowed for large reserve accumulation and a sharp appreciation of the currency since end-2004. The latter has contributed to containing the current account balance (measured against GDP) despite the fact that the deficit increased by 20 percent in euro terms during 2005.

Figure 3.
Figure 3.

Romania: Current account balance and financing, 2001-05

(In billion Euros)

Citation: IMF Staff Country Reports 2006, 169; 10.5089/9781451832860.002.A001

5. The widening trade deficit is mainly explained by accelerating imports of machinery and mineral products. Despite the abolition of global textile quotas in 2004, the recent severe floods and the shock of energy prices, 73 percent of the trade balance deterioration since 2002 is explained by non-textile manufactures, of which, 31 percent is the effect of fast growing imports of machinery and equipment (Figure 5). Transport means account for another 31 percent of the trade balance deterioration, proving that imports of durable goods—including a strong contribution of car imports—have played a central role in the widening of external imbalances. The worsening of the trade deficit was also helped by minerals and fuels, mostly driven by high international prices, which accounted for 27 percent of the widening balance. Interestingly, the latter suggests that, despite the strong export growth of minerals and fuels, there is no ‘Dutch disease’ phenomenon in Romania, as the economy is a net importer of minerals and fuels. The analysis of trade balances alone, however, conceals significant differences in import and export performance across sectors.

Figure 4.
Figure 4.

Romania: Composition of Trade Balance, 1999-2005

(12-month moving average, Million Euros)

Citation: IMF Staff Country Reports 2006, 169; 10.5089/9781451832860.002.A001

Figure 5.
Figure 5.

Romania: Contributions to trade balance deterioration, 2002-05 1/

(million Euros and percent)

Citation: IMF Staff Country Reports 2006, 169; 10.5089/9781451832860.002.A001

1/ For trade balance of goods.

6. A shift toward higher-quality exports and lower imports of intermediate goods have offset the impact of the abolition of global quotas on textiles trade. While the latter led to a marked contraction of textile output, the value of net textile exports only suffered a slowdown during 2005 (Figure 5). The limited impact is explained by the large import component of inputs for textile production, as well as a quality upgrading of exported goods. The value of imports of intermediate goods for inward-processing industries (which account for most of the sector production) fell by 5 percent, more than offsetting the 1 percent fall in exports during 2005. Although part of this gap was covered by a reduction of inventories, the latter suggests that any further contraction of the textile industry will have limited effect on the external accounts. In addition, an increase in export prices—mainly explained by a quality improvement of exported goods—helped to offset the 4 percent fall in export volumes.

Figure 6.
Figure 6.

Romania: Light industry Trade Balance, 2002-05

(million Euros, Jan-Nov)

Citation: IMF Staff Country Reports 2006, 169; 10.5089/9781451832860.002.A001

Source: National Comission for Prognosis and Fund Staff estimates.

7. While imports of machinery and equipment have been strong, they have been outpaced by imports of cars and mineral products. Imports of machinery grew by 20 percent, driven by acceleration in private sector investment, while imports of transportation means grew by 45 percent, and mineral imports grew by 29 percent on average, since 2002. When compared to other transitions economies, the share of machinery in Romania’s total imports remains low at about 25 percent, while other transition economies have seen shares increased to 40-45 percent in the years preceding EU accession (Table 1). Imports of wood products and furniture also experienced a considerable expansion in the last years, mainly driven by the pick up in construction activity.

Table 1.

Imports of Machinery 1/

(Percent of total imports)

article image
Source: COMTRADE

Excluding cars.

Romania’s share was about 25 percent in 2005.

8. Turning to exports, performance has been mixed across sectors, and the composition has shifted away from low-and medium-tech products. Among main exported goods, the following performances are most noticeable:

  • Exports of mineral products and common metals—representing ¼ of total exports of goods—grew by 30 percent and 21 percent respectively, on average, during 2002-05, mostly driven by high international prices. However, while the volume growth of mineral products has accelerated during 2005, metals have fallen sharply despite continuously increasing prices.

  • Exports of transport means and machinery also showed healthy growth rates of 30 percent and 20 percent respectively, on average during 2002-05. While the latter have slowed down to 19 percent, the former has accelerated to 49 percent during 2005. This strong export performance in high-tech products has taken place despite strong domestic demand for cars and machinery.

  • Similarly, exports of food products grew by 20 percent during 2005, after underperforming for several years, and exports of agriculture products grew by a healthy 33 percent despite the severe floods of last year.

  • Among the underperformers, textiles continued the declining trend during 2005. Exports of wood products, on the other hand, had nil growth last year, although industrial production remained strong, pointing to sustained domestic demand growth.

Table 2.

Romania: Export performance of main products, 2002-05

article image
Source: National Bank of Romania

In Euros.

  • The mixed performance across sectors resulted in a shift in the structure of exports from low-medium to high tech products. This shift resembles the experience of other transition economies,2 although in the case of Romania this pattern has been accompanied by a simultaneous shift towards resource-intensive products, on account of high international commodity prices. While low-medium tech exports accounted for 47 percent of total exports in 2003, their share fell to 39 percent in 2005. Meanwhile, the share of high tech products increased from 23 percent to 27 percent in the same period.

  • The slow-down in Romania’s export growth from 2004, however, seems to be in line with developments in other transition economies (Table 3). With the exception of Latvia, most transition economies have experienced a substantial slowdown in non-oil exports, both in value and volumes, suggesting that Romania’s export slowdown may not relate to the recent real exchange rate (RER) appreciation but to other exogenous factors. Despite this common pattern, however, Romania’s penetration in the EU market has slowed-down significantly since end-2004, while other transition economies have shown continued growth in the share of EU imports, pointing to a deterioration of Romania’s competitive position relative to neighboring countries.

Table 3.

Export performance in selected transition economies, 1995-2005

(annual average growth rates)

article image
Source: World Economic Outlook and Fund staff estimates.

In US dollars.

  • Finally, exports of services—accounting for 15 percent of total exports—grew by 35 percent in euro terms during 2005, after several years of growing at about 8 percent. The impressive performance of exports, however, was outpaced by imports of services, which grew by 40 percent last year. The result was a doubling of the trade deficit in services from 2004. Still the service balance only accounted for 5 percent of the total trade deficit in 2005.

9. The evidence of mixed export performance across sectors makes the assessment of Romania’s competitiveness particularly challenging. While traditional export sectors—mostly specialized in low-tech products—have seen a marked deterioration, production and exports of higher value-added goods have showed healthy growth. In addition, large imports of durable goods (capital and consumption goods) partially reflect the catch-up process. The following section looks into traditional indicators of external competitiveness, in search for further evidence on external competitiveness.

C. Competitiveness Indicators

10. External competitiveness is difficult to define. By definition, exchange rate misalignments are not possible in the long run, and therefore a competitiveness problem simply refers to the country’s ability to sustain a certain level of income. In the short-run, however, an appropriate level of competitiveness is associated with the value of the real exchange rate, which, in conjunction with other domestic policies, ensures adequate profitability in the production of tradable goods and, thus, ensures both internal and external balance. However, market distortions that temporarily push the exchange rate away from its equilibrium value can create macroeconomic imbalances in the short-run that lead to undesired boom-bust cycles. As the paper is mostly concerned with this form of short-term external imbalances, we focus on recent developments of the real exchange rate (RER), and indicators of profitability in the tradable sector.

11. Romania’s RER has appreciated sharply since end-2004, after a prolonged period of stability. Following the 1998-99 currency adjustment, and up until end-2004, the NBR used the exchange rate as an implicit nominal anchor, guiding the rate of depreciation to broadly match its disinflation goals, while allowing some real appreciation to reflect productivity gains. However, since the exchange rate policy shift at end-2004—the NBR has allowed greater exchange rate flexibility—the appreciation of the RER has largely exceeded productivity gains (Figure 7). The trade-weighted CPI-based RER (also called real effective exchange rate) appreciated by 23 percent from September 2004 to September 2005, allowing the real exchange rate to reach the levels prevailing before the 1998-99 currency crisis. This sharp appreciation reverted somewhat at end-2005, before renewed pressure on the exchange rate in early 2006.

Figure 7.
Figure 7.

Romania: Export by type of product, 2003-05

(in million Euros, Jan-Nov)

Citation: IMF Staff Country Reports 2006, 169; 10.5089/9781451832860.002.A001

Source: National Comission for Prognosis and Fund staff estimates.

12. When compared to other transition economies, Romania’s real exchange rate shows a relative improvement during 1999-2004, on account of faster appreciation in neighboring countries (Figure 8). Between 1999 and 2004, Romania’s RER remained fairly stable, while other EU-transition economies saw their currencies appreciate by 10-25 percent in real terms. However, the sharp appreciation of the leu since end-2004 has offset most of the previous relative improvement, except against the Slovak currency. CPI-based measures of the real exchange rate, however, tend to overestimate the degree of erosion in competitiveness as the basket of goods and services used includes non-tradable goods and thus does not control for the Balassa-Samuelson effect. Furthermore, comparing CPI-based RERs across countries may be misleading to the extent that the degree of openness varied across them as the size of the non-tradable sector would determine the magnitude of the Balassa-Samuelson effect. A refined measure of competitiveness is the manufacturing unit labor cost (ULC), a proxy for the costs of producing tradable goods in the economy.

Figure 8.
Figure 8.

Transition Economies: Share in EU Imports, 2001-05

(January 2001=100; 12-month rolling average)

Citation: IMF Staff Country Reports 2006, 169; 10.5089/9781451832860.002.A001

13. Manufacturing ULCs have behaved similar to the CPI-based RER, confirming an erosion of Romania’s competitive margins. ULCs remained fairly stable during 1999-2004. Since then, however, they have increased sharply both in Euro and US dollar terms, exceeding the levels of pre-1999 currency crisis (Figure 9). The ULC-based real effective exchange rate—Romania’s ULC relative to weighted average of ULC in trading partner countries—shows a similar pattern, although the degree of appreciation is somewhat smaller and Romania’s relative ULC remains below the 1998-99 pick level. When compared to potential competitors for the EU market, the evidence also shows that much of the cost advantage has eroded, on account of the recent sharp appreciation (Figure 10). Furthermore, Romania’s ULC displays the sharpest movement in a short period of time, comparable only to developments in Czech Republic during 2001-02. However, while manufacturing ULCs provide a refined measure of competitiveness, they do not account for output price effects. Increasing unit labor costs may result from pass-through of increasing export prices. In such case, ULCs would not reflect an erosion of competitiveness.

Figure 9.
Figure 9.

Romania: Labor Productivity and Real Effective Exchange Rate, 2000-05

(12-month growth rate, 3-month m.a.)

Citation: IMF Staff Country Reports 2006, 169; 10.5089/9781451832860.002.A001

Source: INS and Fund Staff estimates.
Figure 10.
Figure 10.

Transition Economies: CPI-based RER, 2000-05

(2001=100)

Citation: IMF Staff Country Reports 2006, 169; 10.5089/9781451832860.002.A001

Source: Eurostat

14. Romania’s external profitability deteriorated during 2005, on account of high real wage growth and lower productivity gains. The external profitability index—a refined measure of profitability in the export sector—is defined as total revenues over total labor costs of the manufacturing sector, using export prices and wages in foreign currency.3 Variations of the index can be decomposed in productivity gains, external price effects and real (foreign currency) wage growth. The index for Romania shows that the profitability of the manufacturing sector has deteriorated since end-2004 on account of high real wage growth (both nominal growth and exchange rate appreciation) and lower productivity gains, although the trend has reverted partly due to the currency depreciation at end-2005 (Figure 11). The deterioration of the profitability indicator is worrisome, as this measure tends to overestimate profitability when capital/labor ratios are increasing, as it is expected in any transition economy. However, the sharp increase in real wages and the slowdown in productivity gains have been offset by fast growing export prices suggesting a quality upgrading of exported goods. This pattern is visible across most manufactured products, and particularly strong in the textile industry. Nonetheless, there seems to be evidence of a recent slowdown in export price growth (Figure 12), suggesting that, should high real wage growth and low productivity gains continue, external profitability could deteriorate rapidly.

Figure 11.
Figure 11.

Romania: Unit Labor Costs, 1997-2005

(3-month moving average)

Citation: IMF Staff Country Reports 2006, 169; 10.5089/9781451832860.002.A001

Source: Romania National Institute of Statistics and Fund staff estimates.
Figure 12.
Figure 12.

Transition Economies: Unit Labor Costs, 2000-05

(In Euros, 12-month moving average, 2001=100)

Citation: IMF Staff Country Reports 2006, 169; 10.5089/9781451832860.002.A001

Figure 13.
Figure 13.

Romania: External Profitability Indicator, 2001-05

(12-month growth rate, contributions)

Citation: IMF Staff Country Reports 2006, 169; 10.5089/9781451832860.002.A001

Figure 14.
Figure 14.

Romania: Main Manufacturing Products Export Prices, 2000-05

(In Euros, 12-month growth rate)

Citation: IMF Staff Country Reports 2006, 169; 10.5089/9781451832860.002.A001

15. While recent trends in competitiveness indicators suggest that Romania has lost some of its historical advantage, this evidence should be interpreted with caution. The discussion so far has focused on variations of several indexes over time, only providing information on recent trends but no information on levels. In the next section, we investigate estimates of comparable measures of competitiveness across countries, to assess Romania’s exchange rate level.

D. Equilibrium Real Exchange Rates

16. Presenting a precise estimate of a country’s equilibrium real exchange rate is somewhat challenging. This is particularly the case for transition economies, which are subject to substantial and continuing structural changes, as well as strong transitory capital inflows and market rigidities. As a result, researchers have opted for various forms of equilibrium RER estimations. As a first step, we can look at simple price-indicators, such as implicit purchasing-power-parity (PPP) exchange rates and relative wages.

17. Simple price-based measures suggest that Romania’s exchange rate remains undervalued. Looking at Romania’s implicit PPP exchange rate, and similar indicators such as the Big Mac index, the currency appears to be undervalued by as much as 24-47 percent in real terms. However, neighboring transition economies are also generally undervalued, and often show more pronounced undervaluations: Bulgaria’s currency is 38-64 percent undervalued, while Ukraine’s Hrv is undervalued by 53-76 percent. While PPP-indicators constitute the simplest method to estimate the equilibrium RER, there exists considerable literature suggesting that such measures do not perform well in estimating the degree of misalignment for most countries, owing to the slow reversion of the actual RER to a constant level (as implied by the PPP assumption).4 Alternatively, we can compare relative wages as a proxy for competitiveness. Romania’s wages remain very low compared to other transition economies, although the gap has been reduced recently. Simple wage comparisons, however, can be misleading as productivity levels and factor intensities differ across countries.

Figure 15.
Figure 15.

Manufacturing Sector Euro Wages in Selected Countries, 2002-05

(in percent of Romanian Wages)

Citation: IMF Staff Country Reports 2006, 169; 10.5089/9781451832860.002.A001

18. An alternative way to assess the degree of exchange-rate misalignment is to use cointegration techniques. By estimating the long-term relationship between the real exchange rate and an economy’s fundamentals, and then projecting the equilibrium values for those fundamentals, we can arrive at an estimate of the equilibrium real RER. However, cointegration analysis is based on the premise that a stable long-term relationship between those fundamentals and the exchange rate actually exists, and that this relationship can be derived from historical data. Unfortunately such an assumption is somewhat heroic for transition economies where structural shifts reduce the predictive power of historical data, and undermine the robustness of econometric results.

19. An alternative approach, based on a cross-country framework, is used in this paper. Drawing from the previous work by Halpern and Wyplosz (1997), Krajnyak and Zettlemeyer (1998), and Tiffin (2004), we estimate equilibrium exchange rates using a large cross-country panel. Following their methodology, U.S. dollar wages in the manufacturing sector serve as a proxy for real exchange rate—these data are easily available and, unlike RER indices, have the advantage of being comparable across countries.

20. Although cross-country panel-data analysis has advantages over a time-series analysis for transition countries, such results should still be interpreted with caution. Since countries within the sample are likely to be heterogeneous, and some country-specific factors cannot be controlled for, any estimated relationship can best be seen as outlining the average relationship across countries. In other words, the estimated equilibrium exchange rate for a given country is the best available prediction, assuming that the countries in the sample are, on average, in equilibrium and that the country in question is “typical” in all dimensions except for those that are controlled for.

21. The model estimates the equilibrium level of dollar wages as a function of various income and productivity measures. The equilibrium wage, therefore, represents the dollar wage that is consistent with internal and external macroeconomic balance. If the actual dollar wage were less than the estimated equilibrium level, it would suggest that the wage rate is “overly” competitive and that, by extension, the real exchange rate is undervalued. Our approach allows us to control for differences in the level of development and productivity across countries, as measures of the real exchange rate are typically affected by income as well as productivity differentials (Balassa-Samuelson effect). As an identifying assumption, again, we assume that the countries in our large cross-country sample are on, average, in equilibrium. The regression, therefore, provides an estimate of the equilibrium wage that a country can “afford” given its fundamentals.

22. The data cover the period 1990-2002, and extend across 85 countries. For the dependent variable, we use the average monthly wage in the manufacturing sector. Wage data in local currencies were obtained from the ILO International Statistics Yearbook, and then converted into US dollars using the annual average exchange rate from the IFS. For independent variables, the model follows Krajnyák and Zettlemeyer (1998) and includes data for: purchasing-power-parity-adjusted GDP per capita, obtained from the WEO; the share of agriculture in GDP as a general measure of development, taken from the World Bank’s World Development Indicators (WDI) database; and the gross secondary-school enrollment rate as an indicator of human capital, also from the WDI. To test for robustness, we also include various institutional indicators, such as: the rule of law; the level of corruption; the degree of government effectiveness; and the quality of regulation—all obtained from the World Bank’s Governance Database.

23. The estimated equation is written below as (1). Individual countries are represented by the index i = 1…N, whereas the time dimension is represented by t = 1…T. The independent variables x j, j = 1…3, denote the economic determinants of equilibrium wages, and OECD is a dummy variable that is included as a further indicator of overall development. The error term includes μi, which captures any unmeasured country-specific effects. The variables cec and fsu are time-varying dummy variables that identify Central European transition countries, and members of the former Soviet Union, respectively.

wagei,t=a0+∑j=13ajxji,t+a4OECD+∑k=1Tbkceci,t+∑l=1Tc1fsui,t+μi+∊i,t(1)

24. The independent variables are generally significant and have the expected sign—higher levels of per-capita GDP are associated with higher dollar wages (i.e., real exchange rates), whereas less-developed countries with a higher agricultural share typically have lower dollar wages. Our results also show that, for much of the 1990s, the transition countries were out of equilibrium with wages below what we estimate that they could afford, given their underlying characteristics. However, the extent of undervaluation seems to have been falling throughout most of the period, as the countries slowly moved toward equilibrium.

Figure 16.
Figure 16.

Equilibrium and Actual Dollar Wages, 1992-2002

(in logs)

Citation: IMF Staff Country Reports 2006, 169; 10.5089/9781451832860.002.A001

25. For Romania, the results suggest that the leu’s undervaluation has been significantly reduced in recent years. While Romania’s wages stood below 40 percent of their equilibrium value during most of the 1990s, much of the gap has been reduced in recent years, with US dollar wages reaching about 74 percent of equilibrium. Therefore, the results suggest that, even after controlling for income and productivity differentials, Romania’s exchange rate still remains undervalued.

Figure 17.
Figure 17.

Romania: Equilibrium US-dollar Wages and actual wages, 1991-2005

(Manufacturing sector)

Citation: IMF Staff Country Reports 2006, 169; 10.5089/9781451832860.002.A001

26. As an alternative approach, the robustness of the findings can be checked by using the gap between the actual and implicit PPP exchange rates as a measure of misalignment. Using data from 133 countries over 2000-05, the exchange-rate gap (measured against the EU average) is regressed against a PPP-adjusted measure of per capita income (again compared to the EU average). Conceptually, this exercise is analogous to the equilibrium wage regression above, in that it is again regressing a measure of the real exchange rate against an indicator of productivity and development. As before, the identifying assumption is that, on average, the countries from the worldwide sample are in equilibrium. The regression line, therefore, represents a country’s expected (equilibrium) exchange rate gap, given its income and productivity.

27. The results suggest, once again, that Romania’s currency is still somewhat undervalued. Figure 18 below plots the above regression line. As illustrated, most transition countries are undervalued when compared to the worldwide benchmark. This is similar to the wage-based finding, and suggests that transition countries may have specific features that tend to keep prices below international standards. One interpretation is that transition countries, as a legacy of communist central planning, suffer from persistent market-unfriendly institutions and barriers that prevent factor prices from reflecting their marginal product. Part of the undervaluation, therefore, may reflect an underlying structural disequilibrium, which will be unwound only slowly over time.

Figure 18.
Figure 18.

Real Exchange Rate Path for Transition Countries, 2000-2005

Citation: IMF Staff Country Reports 2006, 169; 10.5089/9781451832860.002.A001

28. To control for this transition effect, we consider a regression using a subset of countries that includes only transition countries and EU countries. The developed EU countries are included as they represent the relevant upper-end of the convergence process. The estimation provides the steeper regression line in the figure below, and can be interpreted as a equilibrium benchmark that is conditioned explicitly on a country’s degree of “transition”—i.e. it represents the exchange rate we would expect for a country engaged in slow, but fundamental, convergence with the European Union. For 2000-05, transition countries have generally moved along this line as they converged with the EU.

29. Romania and other transition economies show undervalued exchange rates relative to the world-wide benchmark. When compared to the EU-transition group, however, Romania’s exchange rate is greater than expected. One interpretation is that, compared to other transition countries with the same low level of income, especially the CIS countries, Romania has been relatively more successful in building the foundations of a modern market economy. If this is the case, there is little cause for alarm—the fact that Romania’s RER is close to the worldwide benchmark is an appropriate equilibrium outcome. Alternatively, if this is not the case, then the results suggest that Romania’s currency is perhaps slightly higher than we would expect given the country’s income and degree of transition. Under this interpretation, Romania may indeed face a competitiveness challenge from some of its lower-cost neighbors, indicating a pressing need for further productivity-enhancing structural reform.

E. Conclusions

30. On the basis of the above analysis, it appears that, on balance, while Romania’s cost advantage has eroded over the past two years, some real undervaluation remains. Recent evidence of widening external imbalances, output contraction in some manufacturing sectors, and a sharp real exchange rate appreciation during 2005 have raised concerns about Romania’s exchange rate level. Also rapidly-increasing labor costs point to a significant erosion of Romania’s historical cost advantage, mostly on account of rapid wage growth and slowing productivity gains—although some of this cost deterioration has been offset by a process of quality improvements that has resulted in higher export prices. Still, while Romania’s competitiveness seem to have deteriorated recently, estimates of potential exchange rate misalignment suggest that Romania’s currency remains undervalued relative to a world-wide benchmark.

31. Mixed export performance across sectors, on the other hand, point to a shift in the structure of output and exports away from low-tech products towards higher value-added goods. This suggests that the recent slowdown in overall exports reflects a structural change similar to the one observed in other transition economies. In addition, strong import growth is mostly driven by increased investment in durable goods, a typical and appropriate trend for a country in the process of catching with Western Europe. Thus, on balance, it appears that recent developments in Romania’s external sector have been mostly driven by a rapid transformation process, and not by an exchange rate misalignment—econometric evidence suggests that some undervaluation remains. Going forward, further real appreciation is expected, as part of the convergence process to EU living standards and reflecting also continued strong capital inflows. In this context, the ability of traditional exporting sectors to cope with the transition process will mainly depend on Romania’s capacity to boost productivity gains, and contain inflationary pressures and the speed of real appreciation. The former will require further enterprise restructuring and policies to promote a business-friendly environment, while the latter will require a consistent fiscal and monetary policy mix.

Table 4.

Romania. Industrial Output, 2000-05 1/

(growth rate, in percent)

article image
Source: National Institute of Statistics of Romania and Fund staff estimates.

Adjusted by working days.

Table 5.

Romania: Trade Composition, 2001-05

article image
Source: Romania National Institute of Statistics and Fund staff estimates.
Table 6.

Romania: Export and Import Performance, by product, 2002-05

(growth rates)

article image
Source: Romania National Institute of Statistics and Fund staff estimates.

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  • Rogoff, Kenneth, 1996, “The Purchasing Power Parity Puzzle,” Journal of Economic Literature, Vol. 34, pp. 647 –68.

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1

Prepared by Gustavo Adler and Andrew Tiffin.

2

See Schadler and others (2006).

3

The profitability index is defined as (P/E)Y(W/E)L, where P is the non-domestic producer price index, E is an index tracking the leu/euro exchange rate, W is the index of gross wages, Y is the industrial output index—adjusted by working days—and L is labor employment. All variables refer to the manufacturing sector.

4

See Rogoff (1996).

Same Series

Other IMF Content

Other Publishers

Cover IMF Staff Country Reports
Romania: Selected Issues and Statistical Appendix
Author: International Monetary Fund
Volume/Issue:
Volume 2006: Issue 169
Publisher:
International Monetary Fund
ISBN:
9781451832860
ISSN:
1934-7685
Pages:
115
DOI:
https://doi.org/10.5089/9781451832860.002
  • View in gallery

    Romania: Exchange Rate, Inflation and Real Exchange Rate, 2002-05

    (12-month growth rate, percent)

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    Romania: Exports, Imports and Trade Balance, 2002-05

    (In million Euros, 12-month moving average)

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    Romania: Current account balance and financing, 2001-05

    (In billion Euros)

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    Romania: Composition of Trade Balance, 1999-2005

    (12-month moving average, Million Euros)

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    Romania: Contributions to trade balance deterioration, 2002-05 1/

    (million Euros and percent)

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    Romania: Light industry Trade Balance, 2002-05

    (million Euros, Jan-Nov)

  • View in gallery

    Romania: Export by type of product, 2003-05

    (in million Euros, Jan-Nov)

  • View in gallery

    Transition Economies: Share in EU Imports, 2001-05

    (January 2001=100; 12-month rolling average)

  • View in gallery

    Romania: Labor Productivity and Real Effective Exchange Rate, 2000-05

    (12-month growth rate, 3-month m.a.)

  • View in gallery

    Transition Economies: CPI-based RER, 2000-05

    (2001=100)

  • View in gallery

    Romania: Unit Labor Costs, 1997-2005

    (3-month moving average)

  • View in gallery

    Transition Economies: Unit Labor Costs, 2000-05

    (In Euros, 12-month moving average, 2001=100)

  • View in gallery

    Romania: External Profitability Indicator, 2001-05

    (12-month growth rate, contributions)