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A cautious approach

Mugur Isarescu, governor of the National Bank of Romania, tells Matei Paun why he decided to issue a set of regulations that limit retail banking growth.
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Q How would you assess the health of the banking system as well as its development in terms of sophistication of instruments being used and competition levels?

A The September 2003 IMF/World Bank report on the stability of the financial system contends that, under efficient supervision, the Romanian banking system is resilient to a range of market and credit risk shocks, enjoying a high degree of capitalisation and liquidity, as well as adequate provisioning. Although the rapid expansion of lending fuelled fears as to the risk of bank assets becoming impaired, prudential indicators remain at manageable levels.

At the end of 2003 the solvency ratio stood much above the 12% internationally accepted benchmark, whereas the share of bad loans in total loans dropped to 0.3%. The strengthening of the banking system over the past three to four years was largely bolstered by the rise in the share of foreign capital – two-thirds of the total capital in 2003 – which fostered corporate governance improvements.

Once Banca Comerciala Romana [BCR] is privatised, the share of foreign capital will exceed 80% of the total capital. A big step forward in this respect was the completion, in November 2003, of the negotiations with the European Bank for Reconstruction and Development and the International Finance Corporation regarding their acquisition of a 25% stake in BCR.

The competition among banks has accelerated, as shown by the steady reduction of the net interest margin to 6.4% in 2003, down from 8.8% in 2001. Traditional banking products still have the upper hand; even though the regulatory framework governing derivatives trading is in place, these markets are still in their infancy.

Q The current account deficit last year ballooned to e2.92bn, up some 80% year-on-year, or nearly 6% of the GDP. How do you think will this affect the macroeconomic policies/stability in 2004, particularly as this is an election year? What instruments is the central bank planning to use to rein in the current account deficit?

A We have actually acted proactively, having taken steps since last August towards limiting the deficit, which is why in the end it has not reached or exceeded 6% of the GDP.

In an economy that grew by almost 5% last year, one could expect a current account deficit of 5.8% of GDP. Therefore, it’s not the size per se that is worrisome, but rather the way this deficit is financed. In 2003, almost half of it was financed through foreign direct investment [FDI]. In other countries, and Bulgaria is a case in point, the current account deficit has exceeded 8% of GDP, but investors do not worry, because more than 80% of that deficit is financed through FDI.

We are hopeful that, with the large privatisation projects that are in the pipeline, Romania will be able to provide a similar financing of the deficit this year, when the current account deficit is projected to be 5.5% of GDP, and in the next couple of years.

On our side, we have already implemented the measures we have considered, namely the increase in the leading interest rate by three percentage points since last August, the tightening of the rules for consumer credit, effective since February 1, 2004, plus the moral suasion to banks to create a credit bureau, to which we will

contribute with our database. We are confident that, with a small time lag, these measures will start yielding results very soon.

Q Foreign exchange reserves are at an all-time high, although having fallen below four months of imports. What is the central bank’s policy in this respect for this year?

A The foreign exchange reserves of the National Bank of Romania [NBR] exceeded e6.4bn at end February. For 2004 the objective of the NBR in this field is to ensure the coverage of 3.5 months of imports through foreign exchange reserves, a level that is seen as optimal for our country. This value is within reach, as at end-2003 the coverage level stood at 3.4 months of imports.

In order to reach this coverage against the background of significantly rising imports, the NBR intervenes in the interbank forex market as a net buyer of euro, without jeopardising the process of sustainable real appreciation of the national currency against the euro-dollar basket.

In addition to this, the privatisation receipts and the bonds to be issued by the Ministry of Public Finances on the international capital markets are expected to help strengthen the NBR’s foreign exchange reserves.

Q This brings to mind older discussions and statements about whether the central bank shouldn’t move more aggressively into an inflation-targeting mode. Is this on the cards anytime soon?

A We are currently in a monetary targeting regime but, de facto, we are trying in our day-to-day decisions to mimic an inflation-targeting “plus” regime. The “plus” in the definition comes from the flexible role attributed to the exchange rate, which is not a hard anchor, but rather one instrument among many others.

What we need to put in place, apart from the existing elements, are two things – enhancing the independence of the central bank, through the new statute that hopefully will be passed by the Parliament in mid-2004, and improving our forecasting tools, an issue we are trying to correct in close cooperation with other central banks.

Of course, 2005 for the introduction of the inflation-targeting regime is subject to another constraint linked to the credibility of the central bank. It is crucially important for the bank, in the year previous to the introduction of inflation-targeting, to hit its annual inflation target. 2005 is also slightly complicated by the possible one-off inflation burst that might be caused by the re-denomination of the currency.

Q Speaking about the medium-term future, there have been official announcements regarding a possible re-denomination of the currency, possibly by 2005. Why is this necessary just a few years ahead of EU accession and the adoption of the euro. What is the timetable and how much would this operation cost?

A Currently, the highest denomination of the Romanian notes is roughly equivalent to e25, while it should be around e100. This obliges us to print many more banknotes than normal, and the public is subject to cumbersome handling of cash. But the largest cost is borne by banks when operating, transporting and depositing large amounts of banknotes. This is not mentioning the IT and accounting costs related to a currency expressed with many zeros.

Concerning the adoption of the euro, looking to the difficulties that other accession countries have in this respect, with their best-case scenario being 2008-2009, but also looking to the real convergence criteria a country should fulfil before entering comfortably a common currency area, one could hardly contemplate Romania’s entering the eurozone before 2011-2013. So, this leaves us enough years to justify the re-denomination of 2005.

Q Which are the main challenges the country is facing this year and what do they mean in terms of central bank policies, such as the monetary policy?

A In 2004, macroeconomic policies will have to cope with the challenge of simultaneously achieving potentially conflicting objectives. On one hand, inflation is expected to reach, for the first time ever, single-digit levels, and the external imbalance is to be adjusted to 5.5% of the GDP. On the other hand, a steady growth rate, of 5.5%, is to be maintained.

In this context, monetary policy will stay within prudent coordinates. The resumption of the downward trend of interest rates will be conditional on the confirmation of the disinflationary trend. The exchange rate will act as a guide to disinflation.

Given the requirements of the convergence process, this policy will be pursued in the years ahead as well. The gradual weight increase of the euro in the currency basket and the characteristics of a direct inflation targeting strategy confine the possibility to use the exchange rate as a balance of payments adjuster.

Q Most leading banks operating in Romania have focused lately on the retail segment of the business, particularly on consumer lending and mortgage credits. The central bank stirred quite a little bit of discontent in the market by issuing a set of regulations that tend to limit growth in these areas. Could you comment on that?

A We are aware that the degree of banking intermediation in Romania is one of the lowest in the region, with non-governmental credit accounting for roughly 16% of GDP. This ratio should be increased at a fast pace.

On the other hand, the increase in consumer credit in 2003 was too rapid, at 50% in real terms. As a banker and economist, I start to worry when I see such exponential curves because, if unchecked, they could lead to troubles. I would point here to potentially non-performing loans, the share of which is very low, but we do not want to see it rising, and to the potential negative effects on the current account, as long as the domestic supply is slow to react.

The bottom line is that we would be very happy with a robust growth of non-governmental credit, say in the 20-25% range in real terms, but one that can be kept under control. This is the message that we have repeatedly sent and which makes some of the banks unhappy. But we are bound by our mandate to take a more cautious approach.

In association with Banca Comerciala Romana

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