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From financial turmoil to financial crisis What began as a turmoil with the bursting of the US housing bubble and the first sub-prime credit induced losses in the summer of 2007 turned into a full-fledged crisis once Lehman Brothers went bankrupt in September 2008 Major changes in investors behaviour occurred amid increased risk aversion there has been a shift from global excess liquidity to liquidity crunch There are both direct and indirect effects of the crisis: Direct effects from banks exposure to toxic assets Indirect effects caused by changes in the availability of capital and liquidity conditions less external financing 2
Romania Overview of the Global Financial Crisis Effects 3
No direct effects The banking system is fundamentally sound Lack of exposure to toxic assets which lie at the root of the crisis Traditional banking products dominant due to their high profitability Prevalence of the originate and hold paradigm 4
yet the indirect effects are significant Availability and cost constraints of external financing Major impact on the availability of foreign-exchange denominated credit Decline in the volume of FDI inflows Increased likelihood of profit repatriation, in the context of an ongoing process of international deleveraging Negative impact on foreign demand, affecting Romania s exports Increased exchange-rate volatility amid the significant decrease in investors appetite for risk on emerging markets 5
However, there are some alleviating factors NBR s prudent policies provided a cushion for the banking system: High level of reserve requirements allows for the gradual adjustment of banking system liquidity, depending on the evolution of market conditions Prudential and administrative measures slowed down the expansion of credit to the private sector supported lending in domestic currency to the detriment of forex credit limited overall risk exposure Low share of overdue and doubtful loans in total loan portfolio (1.1 percent as of September 2008) Confidence boosting measures: Starting 15 October 2008, the guaranteed level for bank deposits (per individual and per credit institution) is EUR 50,000 from EUR 20,000 previously Continental-type financial system, dominated by banks Moderate impact of declining stock prices on corporate financing 6
Analysis Ratios for the Banking System 3.5 percent overdue and doubtful loans of non-bank clients/total loan portfolio percent 35 3.0 solvency ratio* (>8%); rhs ROE (net income / total equity); rhs 30 2.5 2.0 1.5 1.0 20.6 21.1 15.6 12.7 18.1 10.2 13.8 9.4 16.5 13.0 15.8 12.8 19.4 11.9 25 20 15 10 0.5 1.1 0.7 0.8 1.0 0.5 0.8 0.4 0.0 Dec.04 Dec.05 Dec.06 Dec.07 Mar.08 Jun.08 Sep.08 * Starting with 2007, according to Regulation No.13/2006 and Order No.12/2007; (>12%) until end-2006. Source: National Bank of Romania 5 0 7
Romania Macroeconomic Consequences of the Crisis 8
Wide external imbalances are no longer acceptable High economic growth in recent years and even disinflation have come at the price of an ever larger current account deficit There is a tight relationship between the fast expansion of domestic absorption, fuelled by rapidly growing personal incomes and credit, and the widening of the external gap The crisis will have an ambivalent impact on the magnitude of the current account deficit Exports will decelerate following the trend in external demand Imports will also decelerate, as a consequence of the decline in investment activity and exports The likely decrease in the FDI flow will make financing more expensive and significantly less available However, higher deposit rates should stimulate saving and would, therefore, reduce the gap between saving and investment There are mitigating factors with regard to the availability of financing resources: Alternative financing sources credit lines from international financial institutions such as EIB, EBRD, World Bank, etc. better absorption of EU structural funds Credit lines from parent banks to their local subsidiaries will not be discontinued a decrease in their generosity is however likely 9
Real GDP annual percentage change Inflation Rate and Current Account Balance 17.8 percent 5.1 5.2 8.5 4.2 7.9 6.0 8.0 14.1 9.3 current account balance/gdp inflation rate (Dec./Dec.) 8.6 6.6 6.7 4.9-3.3 2002 2003 2004 2005 2006 2007 2008f -5.8-8.4-8.7-10.4 2008 Q1: 8.2%; 2008 Q2: 9.3%; 2008 Q3: 9.1%; 2008 Jan.-Sep.: 8.9% -13.8-13.0 Source: National Institute of Statistics, National Bank of Romania 2002 2003* 2004* 2005* 2006* 2007* 2008f* *) including reinvested earnings f) NBR preliminary estimate 10
Domestic Demand and External Imbalance 16 real annual percentage change % of GDP, cumulative value for the last four quarters 16.0 14 current account deficit (right-side scale) 14.0 12 domestic demand 12.0 10 GDP 10.0 8 8.0 6 6.0 4 4.0 2 2.0 0 2002 I I 2003 I I 2004 I I 2005 I I 2006 I I 2007 I I 2008 I I 0.0 Source: National Institute of Statistics, National Bank of Romania calculations 11
Correlation between Current Account Deficit and Credit Flow 16 percent, cumulative values for the last four quarters percent 16 14 current account deficit/gdp 14 12 credit flow/gdp* (right-side scale) 12 10 10 8 8 6 6 4 4 2 2 0 0 2002 I I 2003 I I 2004 I I 2005 I I 2006 I I 2007 I I 2008 I I *) Credit flow represents the difference between Q stock and Q-4 stock. Source: National Institute of Statistics, National Bank of Romania 12
Current Account Deficit Financing via FDI 10 EUR billion EUR billion 10 5 2.2 0.7 6.5 7.0 0.3 5.7 0.4 7.2 5 0 0-5 -10-10.2-0.03-16.7-11.1-12.7-5 -10-15 -20 capital transfers BCR privatization non-privatization FDI current account balance 2006 2007 Current account financing via FDI (including capital transfers) amounted to 46.4% in 2007 vs 85.6% in 2006. In 2007, net FDI decreased by 19% yoy. Source: National Bank of Romania capital transfers foreign direct investment current account balance Jan.- Sep. 2007 Jan.- Sep. 2008 Current account financing via FDI (including capital transfers) amounted to 59.4% in Jan.- Sep. 2008 vs 54.9% in Jan.-Sep. 2007. In Jan. - Sep. 2008, net FDI increased 25.5% yoy. -15-20 13
Economic activity will decelerate, but inflationary pressures will persist Contracting external demand and subdued investment render a slowdown in economic growth unavoidable Economic growth is sure to decelerate in 2009, but it will remain in positive territory A rise in unemployment will follow Hardly a critical macroeconomic issue, given the very low current level The added slack in the labour market will prove useful in curbing excessive wage increase demands A more flexible labour market would facilitate the absorption of the recently unemployed Inflationary pressures are not likely to subside next year Excess demand will still be there, fuelled by the recent hikes in personal incomes 14
1,400 thousand Unemployment and Unemployment Rate in Economy percent 14 1,200 unemployment in economy unemployment rate (right-side scale) 12 1,000 10 800 8 600 6 400 4 200 2 0 0 Jan.02 Jul.02 Jan.03 Jul.03 Jan.04 Jul.04 Jan.05 Jul.05 Jan.06 Jul.06 Jan.07 Jul.07 Jan.08 Jul.08 Source: National Institute of Statistics 15
while the fiscal position is likely to deteriorate in the absence of corrective action Decelerating economic activity will affect revenue collection in the context of recently legislated permanent hikes in current expenditures In the absence of timely measures, there is a high risk of breaching the Stability and Growth Pact (SGP) 3 percent of GDP threshold in both 2008 and 2009 16
percent General Government Deficit /GDP (adjusted to ESA 95 methodology) -1.5-1.2-1.2-2.0-2.2-2.6-3.4-4.1 2002 2003 2004 2005 2006 2007 2008* 2009* Source: Ministry of Economy and Finance, National Institute of Statistics, European Commission Autumn 2008 Economic Forecast *) forecast 17
75 70 65 60 55 50 45 40 35 30 25 20 15 10 5 0 EUR billion 1.2 2.0 Total External Debt 15.0 15.9 18.3 24.6 2002 ST debt (majority private debt) MLT debt 2003 3.2 2004 6.3 2005 12.5 28.5 2006 20.2 38.4 2007 22.0 48.1 2008* Source: National Bank of Romania, Ministry of Economy and Finance MLT External Debt 10.2 10.6 75 70 65 60 55 50 45 40 35 30 25 11.0 31.5 11.3 20 25.0 9.2 9.7 10.0 15 5.6 6.0 7.9 12.4 16.6 10 5 0.2 0.4 0.9 1.0 3.2 6.0 0.2 0 2002 public and publicly guaranteed debt private debt deposits of non-residents 2003 2004 2005 2006 EUR billion 2007 2008* *) September 18
What Needs to be Done? 19
The current account deficit must be brought down through adequate policy measures There is no alternative to an adjustment of internal absorption able to significantly narrow the external imbalance While Romania still enjoys significant economic growth there is room for a relatively smooth correction A restrictive monetary policy alone cannot accomplish this task only a comprehensive and coherent policy mix will do The adjustment burden must be borne by both private and public sectors Structural reforms are needed in order to: Add more flexibility to the labour market Boost productivity Stimulate external competitiveness 20
A large budget deficit must be avoided Large deficits will be penalized by both the EC and financial markets: Entry into Excessive Deficit Procedure, which may lead to: financial penalties restricted access to EU funds More expensive or even rationed access to financing Fiscal policy should: Avoid further expenditure expansion Focus on public investment Aim at increasing the efficiency of public spending Be designed with a view to the medium to long-term consequences (multiannual budgeting) 21
In the absence of an adequate adjustment program a disorderly adjustment will occur and it will be neither smooth, nor reasonably sized a massive drop in foreign capital inflows is likely to follow Reduction in international reserves Loss of international credibility 22
Summing up An accurate macroeconomic diagnosis is required: An emotional approach of the crisis may lead to inadequate measures giving rise to an unwarranted stimulus to domestic demand A coherent policy mix is essential for a smooth restoration of macroeconomic equilibria 23