Rising local currency not enough to cool inflation

Romania’s local currency the leu has appreciated against both the Euro and the dollar at a one year low of 4.088 RON to the Euro

April 2011 - From the Print Edition

As we went to press, the Euro has not fared so poorly against the RON in the official exchange rate since the beginning of April 2010.
However two advisors to the central bank Governor recently characterised the RON appreciation as “insignificant”, and not enough to cool inflation.
Deputy Governor Cristi Popa reportedly stated that the RON appreciation versus the Euro is “market-driven”.
However an ING Bank analyst says the rise of the RON is most likely due to the Romania central bank selling 500 to 700 million Euro in February, to counterbalance a sharp rise in inflation and to keep the RON even.
The central bank had to keep the RON high against the Euro due to the larger than expected inflation rate of 7.6 per cent at the end of 2010, argue experts.
Romania’s inflation rose in the second half of 2010 partly due to the hike in VAT from 19 to 24 per cent.
The 7.6 per cent rate was over double the central bank’s target rate of 3.5 per cent. The central bank estimates that inflation for the first three months of the year will be 6.8 per cent.
ING experts say bringing inflation inside the bank’s target band would require a balance of 3.80 RON per Euro or lower and no RON weakening afterwards.
The central bank has a target rate of three per cent inflation for 2011.
The Euro/RON balance may drop lower or remain stable until the second half of 2011, due to rising inflation, according to ING.
However, even if this balance will fall to 3.9 to four RON per Euro in the second quarter, inflation could grow, which would require a much stronger RON for the central bank to bring inflation down to reach its target.
An appreciating RON could also hurt Romania’s export potential. In the last year Romania has narrowed its trade deficit and increased its proportion of exports, in part due to the depreciation of the local currency against the Euro.