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As in other centrally planned economies, most consumer prices in Romania were fixed before the 1989 revolution. However, with the liberalization of economic policy dramatic changes occurred and high inflation was, and still is, expected to remain one of Romania¡¦s key short-term economic concerns.
The evolution of Romania¡¦s annual inflation rate (year-end to year end or one year inflation) after 1989 started with a relatively moderate figure in 1990 (37.6%), but was very high during 1991 to 1993 (205.5% in 1991, 199.5% in 1992 and 295.5% in 1993).
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From 1994 to 1997 there was a period of repressed inflation. Many of the prices (energy, gas, fuel, etc.) were not true, in the sense that consumers were paying less than the related costs to producers. The difference was found in the growth of the deficit in the balance of payments, in the budgetary deficit and in the huge losses reported by large state-owned companies.
Source: National Institute of Statistics
The exchange rate liberalization and the energy price adjustments of the first half of 1997 resulted in a steep increase (100%) of the price level. After this price explosion, under the effect of budgetary constraints and tight monetary policy, inflation seemed to calm down, but not at reassuring levels. The initial forecast of 90% inflation for the whole year was exceeded by June 30, 1997, and the resulting year-end rate of inflation was 151.4%.
The impact of restrictive monetary and fiscal policies throughout 1998 brought the year-end inflation to 40.7%, in line with expectations. The main cause of the persistently high inflation levels over the last years was the general inefficiency of the economy. The underperformance of large state-owned firms (some 150 of them accounted in 1998 for more than 90% of the losses in the economy), made them unable to pay debts to suppliers and to the state budget. The situation changed for the better as several money-losing businesses (especially in the metallurgy, heavy industry and oil processing sectors) were closed or privatized in recent years.
The dropping trend in inflation started since 2000 has continued over the following years (Chart 2), with 2004 being the first year with a single-digit inflation rate forecast (9%).
Source: National Institute of Statistics
The factors that lead to the reduction in the inflation rate between 2001-2005
In the following we will concentrate on the interval 2001-2005 and the factors that influenced the evolution of the inflation rate in this period.
In 2001 the objective of reduction of CPI inflation rate to 25% (December/December) proved to be a too ambitious goal to achieve, being revised to 29%. Although the inflation outcome in 2001 (30.3%) was slightly higher than envisaged, it reflected the progress in disinflation, as consumer price growth rate was more than 25% below that of 2000. This development appeared consistent with the pace of real economy adjustment.
Behind the higher-than-targeted inflation stood the following factors:
X prices of some services and public utilities underwent higher-than-expected adjustments, as some of these prices had remained unchanged from September 2000. Thus, railway transport prices rose by 117.2% while those of natural gas and heating went up by 99.6% and 57.2% respectively. The price of electricity was raised by 35.6% during 2001;
X arrears and insufficient adjustment in the real economy also contributed to protracted inflation.
1999 2000 2001 2002 2003 2004 2005
Inflation rate (Dec on Dec) 54.8% 40.7% 30.3% 17.8% 14.1% 9.3% 8.6%
Inflation rate (annual average) 45.8% 45.7% 34.5% 22.5% 15.3% 11.9% 9%
Source: National Bank of Romania, National Institute of Statistics
In 2002 the inflation rate (December/December), as measured by the consumer price index, came in at 17.8%, undershooting the 22% target.
This good performance can be attributed to the following factors:
X abatement of cost-push inflation pressure owing to the slower pace of nominal depreciation of the domestic currency against the implicit EUR/USD basket (real appreciation averaged 4.4% in 2002 compared with 2% in 2001) and to the moderate increase in gross wages (3.9% on average in real terms as against 10.7% a year earlier);
X sluggish consumption, which can be attributed to the cautious fiscal policy via spending control, but also to the slowdown in household demand for non-durables as a result of the joint action of the following factors: (i) the alteration of consumer behavior, with the focus shifting to durables (because the decrease of interest rates and increase of consumer loans); (ii) the hike in utility expenses induced by swift rise in the price of heating; (iii) stepped-up saving caused by deposit rates staying in real positive territory over most of the year under review;
X smaller adjustment of administered prices (from 43% in 2001 to 23.5% in 2002), due widely to the capping of increase in prices of electricity and natural gas and to the delay in raising the price of railway transport;
X imported disinflation, as inflation touched rock bottom in many European countries, the USA and Japan.
In 2003 the inflation rate, as measured by the consumer price index (December/December), reached 14.1 %, very close to the 14% target.
The reduction of the inflation rate carried on in 2003 for the fourth straight year. This was the result of the interplay of several factors, some of them entailing positive effects and other negative effects. Among these factors, the following deserve mention:
X slowdown in nominal depreciation of the domestic currency against the implicit EUR/USD basket;
X lower magnitude of adjustment of administered prices, from 23.5% in 2002 to 17.4% in 2003. As a result of such rates of increase, administered prices contributed 3.8 percentage points to inflation, compared with 4.6 percentage points a year earlier;
X stable taxation. The small package of tax measures (such as the upping of excise duties on tobacco, alcoholic beverages and liquid fuel) had only a limited impact on inflation;
X positive developments in import prices of consumer and industrial goods, sending the unit value of imports down by 3.3% compared to 2002.
By contrast, a number of factors put pressure on prices:
X the raise in the gross average wage by 23.6% in nominal terms and 7.2% in real terms. Pay rises were reported by loss-making industries as well. Such developments bring about inflationary pressures both directly, as the ensuing demand cannot be matched by aggregate supply, and indirectly, as it stirs confusion on the progress of reform;
X the increase in consumer demand, driven by larger household incomes and the policy of rapid household credit expansion promoted by most commercial banks. With a view to purchasing consumer goods, households proceeded to make borrowings and even cut back on their savings. As a result, household savings (in ROL) subsided by a real 1.8% at end-2003 compared to end- 2002;
X continued build-up of arrears. This drove inflation up both directly, leading to an artificial rise in aggregate demand, and indirectly entailing adverse selection and moral hazard.
In 2004 the inflation rate declined for the fifth year in a row, touching 9.3%, slightly higher than the 9% end-year target, yet within a fluctuation band compatible with the requirements of the inflation targeting regime to be introduced in the latter half of 2005. It is noteworthy that, for the first time in 14 years, Romania recorded a single-digit inflation rate.
Among the factors that lead to a reduction of the inflation rate, the following deserve mention:
X the real 5.8% strengthening of the domestic currency against the implicit EUR/USD basket (annual averages), compared with 2.9% a year earlier;
X lower magnitude of administered price adjustment, from 17.4% in 2003 to 9.9% in 2004;
X recovery of the propensity towards saving due to the National Bank of Romania¡¦s prudent monetary policy stance, the real annual growth of ROL denominated household savings reaching 25.1% in December 2004, compared with -1.8% in December 2003;
X tight fiscal policy, as illustrated by the narrowing of the budget deficit to 1.1% of GDP, far below the projected level of 3%.
By contrast, a number of factors fuelled inflationary pressures, as follows:
X the hike in the gross average wage (22.5% in nominal terms and 9.5% in real terms, annual averages), which was hardly matched by labor productivity gains in all sectors of the economy;
X the increase in consumer demand, driven mainly by the developments in wages, but also as a result of the expansion in lending, especially in foreign exchange loans;
X the continued build-up of arrears.
In 2005 the reduction in the inflation rate continued, with the 12-month inflation rate dropping at year-end to 8.6%, 0.7 percentage points below the year-earlier reading. The progress in disinflation was much more visible in the case of the annual average of inflation (down 2.9 percentage points to 9%) which entered the single-digit region for the first time in 15 years.
Among disinflation boosting factors, the following deserve mention:
X cautious monetary policy stance, with further restrictive monetary conditions, as illustrated primarily by the nominal 6% strengthening of the domestic currency against the euro (December/December) and the prudential and administrative measures taken with a view to slowing foreign-currency-denominated credit growth;
X tight fiscal policy for most of the year under review (the government budget showed a surplus of one percent at end-November);
X stronger competition in the retail sector, which although the monetary, prudential and administrative measures taken by the National Bank of Romania during 2005 caused the annual growth rate of medium and short term new household loans to decelerate, it topped in real terms 44% and 27% in case of RON-denominated and EUR-denominated loans respectively.
Nevertheless, the joint effect of supply-side shocks and protracted excess demand caused inflation rate (December/December) to overshoot marginally the ¡Ó1% point band around the 7.5% target.
On the supply side, the following factors concurred to the slowdown in the pace of disinflation:
X adjustments of administered prices, the annual change of which rose to 14.2%, far above the average rise in consumer prices and the year earlier increase in administered prices. At the root of these hikes lay the adjustment of electricity, heating and natural gas prices brought about by the need to ensure cost recovery, a commitment the Romanian authorities assumed to the European Commission to gradually bring the price of domestically-produced gas into line with import price, as well as by the soaring external prices of energy products;
X ahead-of-schedule implementation of the calendar on upping excise duties to bring them to the minimum level in the European Union;
X sizeable increase in volatile prices (13.7%) induced by short supply of foodstuffs within this category ¡V i.e. vegetables, fruit, and eggs ¡V and disturbances due to bird flu towards the end of the year, as well as, in the case of fuel, by the soaring oil prices worldwide;
X half-hearted economic restructuring, which prevented domestic supply to meet demand.
In addition, household consumer demand put further pressure on prices, with larger financial resources paving the way for faster-growing purchases of goods and services than a year earlier.
In 2006 inflationary pressure persists due to international energy price hikes, as well as further increasing wages without a correlation to improvements in productivity. The increase in consumer prices was less than anticipated, due to the fact that the newly introduced "tax on vice", similar to an excise on alcoholic beverages and tobacco, was not fully passed to the end-user prices by producers and retailers. Inflation moved up to 7.3% y/y in Q1 2006 in line with central bank's expectations.
1. Anuarul Statistic 2004, www.insse.ro
2. Annual Report 1998, National Bank of Romania, www.bnr.ro
3. Annual Report 1999, National Bank of Romania, www.bnr.ro
4. Annual Report 2000, National Bank of Romania, www.bnr.ro
5. Annual Report 2001, National Bank of Romania, www.bnr.ro
6. Annual Report 2002, National Bank of Romania, www.bnr.ro
7. Annual Report 2003, National Bank of Romania, www.bnr.ro
8. Annual Report 2004, National Bank of Romania, www.bnr.ro
9. Annual Report 2005, National Bank of Romania, www.bnr.ro
10. Inflation Reports 2002-2006, National Bank of Romania, www.bnr.ro
11. Romanian Business Digest, issues September 2004, March 2005, September 2005, March 2006 and September 2006, http://rbd.doingbusiness.ro/home.htm