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InterviewsDecember 3 2012

Governor vows to maintain flexibility of Romania's central bank

Mugur Isarescu, the governor of the National Bank of Romania, discusses Romania's tumultuous economic past, the health of its financial sector and pathways to future growth.
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Governor vows to maintain flexibility of Romania's central bank

Q: The Romanian economy has faced some significant challenges recently, how are things looking now?

A: We experienced a major adjustment, which started with the [2008 global economic] crisis. Romania switched from large capital inflows via all channels – from banking, foreign direct investment to portfolios, which up until 2008 almost flooded Romania, to a rapid slowdown (in inflows and growth) and a narrowing current account deficit. Alongside capital flows reversal, we also had a credit and banking adjustment towards what is going to be a new model of business.

Therefore, in 2010 there was no solution other than to severely cut public sector salaries. These necessary adjustments of incomes had social and political consequences. While inflation was also eroding nominal incomes, the unfavourable economic developments moved up the social ladder to the political world and, in 2012, Romania had three governments in six months and an attempted impeachment of the president.

Moreover, the severe drought this July caused poor agricultural output and, as a result, our forecast for 2012 gross domestic product growth is now below 1%. It seems now, however, that we are going to secure a kind of recovery, including in incomes, while purchasing power will increase gradually. We also had good progress in restoring fiscal and external sustainability.

Q: How did the National Bank of Romania respond to the crisis?

A: We have used all the tools at our disposal. Apart from the interest rate tool, we also let the exchange rate depreciate. As capital flows were so large from 2005 to 2008 we were almost flooded, and despite our best efforts the leu continued to appreciate. We risked the so-called Dutch disease [an adverse impact on a country's economy as a result of currency appreciation]. Appreciation was clearly not sustainable and also harmful for the industrial sector.

In a bid to avoid this we bought foreign exchange. So when the leu began to depreciate – a normal and necessary process in a bid to deal with the adjustment of a large current account deficit – we preferred to act like a pillar of stability, to boost further confidence and to avoid any panic. We never pegged the leu currency, but instead acted in a flexible manner, with a kind of constructive ambiguity.

Q: What sort of shape is the Romanian banking sector in and what sort of changes might we see in the future?

A: The banking sector remained very reliable throughout the crisis. I think resilience is the right word. All improvements in the capital base came from shareholders. With 85% of the Romanian banking sector having foreign ownership many of these inflows were international. And despite problems back home, the parent companies of Greek-owned Romanian banks behaved in an exemplary fashion. We worked very closely with them and with the Bank of Greece’s supervision department.

Perhaps now there are too many universal banks on the Romanian market considering the size of the country. But our preoccupation as the supervisory and regulatory authority is not to force them to consolidate. If a small bank has responsible, solid shareholders that increase capitalisation to reach adequacy ratios of 14% to 15%, then they obey the rules (although it is rather hard to say there is an optimum number).

Q: What sort of potential does the Romanian economy have for future growth?

A: A major source of potential is in unlocking resources of state-owned companies. However, the most recent privatisations have been delayed. Also, markets, in terms of investor sentiment, are not hugely favourable now. Nevertheless, structural reforms should not be delayed further. State-owned firms need private management, for example.

Infrastructure is another area. If we look at the highways, for example, most are currently underdeveloped and as a result potential sources of growth are blocked. All of the public benefits related to a highway, as well as from an economic point of view, such as service stations and motels, are stalled.

There are also the Black Sea oil and gas resources, and the energy sector could attract investment into renewables.

Q: Are these reforms the biggest economic challenges for Romania?

A: In my view there are two major problems facing the Romanian economy. The first is to continue the process of structural reforms. Romania has to do a lot in terms of reforming its healthcare, education systems and infrastructure, as well as the large state-owned firms, to give only a few examples.

The second is to improve the administration so we have a better absorption of available European funds. It is an area where we have performed very poorly, but we have the chance to raise huge amounts. I do hope we will perform better in the future and I am confident Romania will be a good place for investment. I look also to the experience of other eastern European countries, such as Poland. They also had a slow take-off, so I do expect a take-off in Romania too.

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