Economic overview Romania. Highlights. November Nicolae Covrig, PhD Financial Analyst Phone:

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1 Economic overview Romania Exchange rates Highlights November EUR/RON USD/RON (rhs) 8-Sep-1 8-Sep-1 18-Oct-1 7-Nov-1 7-Nov-1 Source: National Bank of Romania Monetary policy rate NBR key interest rate 6.5% Source: National Bank of Romania Money market interest rates Data as of: 5-M ay-1 1 M 3 M 6 M 1 M ROBID 3.51% 5.8% 6.5% 6.3% ROBOR.1% 6.3% 7.% 7.5% Data as of: 9 December 1 Source: National Bank of Romania Exchange rate outlook Current Dec-1 M ar-11 Jun-11 Sep-11 EUR/RON USD/RON EUR/USD Data as of: 9 December 1 Source: Raiffeisen RESEARCH Analysts Raiffeisen BANK Romania Ionut Dumitru, PhD Chief-economist Phone: Nicolae Covrig, PhD Financial Analyst Phone: Mircea Romulus, CFA Financial Analyst Phone: Gabriel Bobeica Financial Analyst Phone: Raiffeisen RESEARCH Vienna Martin Stelzeneder, CEFA Phone: This report was completed on 1 December 1. The government survived the no-confidence vote at the end of October. Agreements with the IMF and the European Commission have remained on track, but disbursement of new funds was delayed until Romanian authorities would approve the new unitary wage law for public sector, the new pension law and the budget plan for 11. So, Romanian could receive the next tranches from the IMF and the EC in January next year, at the earliest. Inflation rate climbed to 7.7% yoy at the end of November. Advance in food prices was again the main driver of the inflation rate in last months. We think that food prices dynamics raises the main risks for inflation rate in the next period. As expected, the real GDP fell in Q3 (-.7% qoq). However, the contraction pace was lower than we and market expected. Moreover, most of recent data (in August and September) came in on the positive side, lowering the chances for a new contraction in real GDP in Q. On the contrary, a quarterly growth rate close to zero or slightly positive seems now more likely for Q. Following a better than expected GDP dynamics in Q3, we have revised upward the forecast for this year to -1.9% yoy from -3% yoy. A better figure is not completely excluded. NBR remained on hold at the last monetary policy meeting at the beginning of November, keeping the monetary policy rate unchanged at 6.5%. Short-term interbank rates continued to trade below the level of the monetary policy rate, helped by the liquidity excess in the market. Interest rates for longer tenors remained high due to high risk premium. In recent months, the government succeeded to rollover all maturing government securities, while keeping also a strong control over the public budget deficit (.6% of GDP at the end of October). Credit ratings (FCY long-term) S&P Moody's Fitch Rating / Outlook BB+ / Stable Baa3 / Stable BB+ / Stable Key economic figures 8 9 Aug-1 Sep-1 Oct-1 1f 11f Real GDP (%, yoy) 7.3 (7.1) (.5) (1.9). Industrial output (%, yoy).5 (5.5) CPI eop (%, yoy) CPI avg (%, yoy) Unemployment (%, eop) Budget balance (% of GDP)* (.8) (7.) (.) (.6) (.6) (6.8) (5.) Trade balance (EUR bn, ytd) (19.1) (6.8) (3.9) (.3) (.8) (6.8) (8.6) CA balance (EUR bn, ytd) (16.) (5.) (.1) (.) (6.8) (8.) FDI (EUR bn, ytd) Official FX reserves (EUR bn) * national methodology Source: National Bank of Romania, National Institute of Statistics, Raiffeisen RESEARCH 1

2 Key events of the month Unemployment is falling Recorded unemployment rate and the number of peoples officially recorded as being unemployed was decreasing in the last six months. Recorded unemployment rate stood at 7.3% in October, down from a peak of 8% in April. As we pointed out in our previous reports, the dynamics is rather strange given than unemployment is a lagging indicator (it should start to decrease only after the economic activity starts to pick up). Surveys on enterprises with a least employees show they are still laying-off people. The situation is the same in the public sector. Given these circumstances, we see several factors which might explain why the unemployment rate is falling: More and more people gave up renewing papers with the National Agency for Employment as they are not more eligible for receiving unemployment benefits. The companies laid-off fewer people in the last months, as they saw an improvement in their activities; Most likely, the number of people working without official papers has increased; Decline in unemployment rate might suggest that economic activity is about to bottoming up in short term. Agreements with the IMF and the EC have remained on track, but disbursement of additional tranches was delayed At the beginning of November, technical missions from the IMF and the European Commission ended their sixth review of the policies pursued by Romanian authorities in the context of the international financial package agreed in 9. Technical missions from the IMF and the EC said that an agreement was reached with the Romanian authorities regarding the disbursement of the additional instalments. Basically, the disbursements of the seventh instalment from the IMF (around EUR 9 mn) and of the third instalment form the EC (EUR 1.15 bn) were delayed and they are conditional on the capacity of Romanian authorities to enforce several key laws by the end of December: the Parliament should approve the new unitary wage low for the public sector; the Parliament should approve the new pension law; the Parliament should approve the budget plan for 11 with a budget deficit target of.% of GDP; The government pledged to act in order to enforce the above laws in time, by the end of December. The IMF and the EC would approve the disbursement of money only if the above prior measures would be taken. This could happen the earliest in January Oct-7 Oct-8 Oct-9 Oct-1 Recorded unemployment (thous. Seas. Adjusted) Employees (thous., seas adjusted, RHS) Source: National Institute of Statistics, Raiffeisen RESEARCH Calendar for key events and economic indicators Date Indicator/ Event Next release Recent developments Ref. date Expect/ Efective Oct-1 Sep-1 Aug-1 Jul-1 Jun-1 -Nov-1 Non-government credit, % yoy Oct Nov-1 Economic Sentiment Index (ESI) Nov Dec-1 GDP, % yoy Q Dec-1 FX official reserves, EUR bn Nov Dec-1 PPI, % yoy Oct Dec-1 Retail sales, % yoy Oct Dec-1 Gross wages in economy, % yoy Oct Dec-1 Gross wages in industry, % yoy Oct Dec-1 Output in construction, % yoy Oct Dec-1 Industrial output, % yoy Oct Dec-1 FOB/FOB foreign trade deficit, EUR bn, last 1 M Oct Dec-1 CPI, % yoy Nov Dec-1 Current account deficit, EUR bn, last 1 months Oct Dec-1 FDI inflows, EUR bn, last 1 months Oct Dec-1 Total external debt, EUR bn Oct Dec-1 Non-government credit, % yoy Nov Source: National Institute of Statistics, National Bank of Romania, Eurostat

3 Good performance of industry and exports Driven by external demand Focus on Industry recovered on the back of external demand Industrial output is on an upward trend starting the beginning of 9. In fact, industry was the only sector which expanded over the last quarters, having a positive contribution to GDP growth. Recovery of the industrial output was exclusively helped by reviving of the external demand. A closer look at the industrial sectors shows that the sectors more depended on the external markets (where exports accounts for a large part of the total production) had a stronger performance than sectors less depended on the external demand. Activity in sectors highly dependent on the domestic demand (i.e. foods and beverages) was negatively impacted by decline in domestic consumption and investments and it still suffers. Outstanding performance for automotive industry and manufacturing of telecommunication equipment (mobile phones) The pattern of the recovery in industrial output in the sectors highly depended on the external demand was different from industry to industry. There are several sectors where the recovery was fast, while the performance over the last year was also impressive: production of passenger cars, production of part and accessories for automotive industry, and production of mobile phone. The good performance of these sectors has been explained by two key factors: (1) governmental programs on the external markets aimed at helping the automotive sectors, and () the price competitiveness of the Romanian products. The crisis pushed many foreigners to favour cheaper cars (with incentives offered by foreign governments making such cars even more attractive). Much more, Romanian producer of passenger cars Dacia Renault went one step before, improving the offer of cars. For instance, when the car scraping programs on the external markets ended, Dacia started the production of a SUV, which was very appreciated by foreign markets. Recovery of demand for passenger cars thanks to governmental programs increased also the demand for parts and accessories for passenger cars (electrical equipment for cars, rubber tyres, and other accessories for transport means). There are a lot of players in these sectors which established their activities in Romania in order to benefit from low labour costs and which faced an increase in the demand for their products. Not in the last, the external demand for mobile phones produced in Romania by Nokia was also very high due to their low price. Accordingly, the exports of passenger cars, of parts and accessories for passenger cars and of telecommunication equipments increased sharply over the last two years. Exports of road vehicles (passenger cars) and telecommunication equipments (mobile phones) amounted for 19.% of the total exports in Jan-Aug 1. Based on our calculus, exports of parts and accessories for transport means (electrical equipment, rubber tyres) might have accounted for another 1% of total exports in Jan-Aug. In 9, exports related to automotive industry (passenger cars, part and accessories) and to telecommunications sector (mobile phones) increased by 1%, while the exports for the other exported goods plunged by.5%. Dynamics of industrial output in CEE countries Sep-7 Mar-8 Sep-8 Mar-9 Sep-9 Mar-1 Sep-1 Romania Baltic countries Note: 3 months moving average Source: Eurostat, Raiffeisen RESEARCH CEE Countries Euro area Industrial turnover for domestic and external market % yoy 3. yoy 6.9% yoy 1.% yoy Sep-7 Mar-8 Sep-8 Mar-9 Sep-9 Mar-1 Sep-1 Deflated turnover for manufactuing - Total (8 H1=1) +19% yoy +3.% yoy.1% yoy Deflated turnover for manufactuing - Domestic market (8 H1=1) Deflated turnover for manufactuing - External market (8 H1=1) Note: 3 months moving average Source: Eurostat, Raiffeisen RESEARCH Dynamics of exports in CEE countries Mar-8 Sep-8 Mar-9 Sep-9 Mar-1 Sep-1 7% yoy 37% yoy 1% yoy Romania CEE Countries Baltic countries Note: 3 months moving average; CEE countries = Poland, Czech Republic, Slovakia, Hungary; Baltic Countries = Estonia, Latvia, Lithuania Source: Eurostat, Raiffeisen RESEARCH 3

4 Focus on Main categories of exports (SITC classification), Jan-Aug 1 SITC code Category (% of total exports) 78 Road vehicles Eelctrical machinery and aparatus, and electrical parts thereof Telecommunications equipments Clothing articles Iron and steel Petroleum and petroleum products 5. 7 Industrial machinery and equipments.7 79 Other transport equipment 3.3 Rubber manufactures (I.e rubber 6 tyres) 3. 8 Furniture and parts thereof 3.1 TOTAL 61. Note: Exports in SITC 77 category are mainly related to the automotive industry (parts and accesories) Source: Eurostat, Raiffeisen RESEARCH Main drivers of exports 3 1 Aug- Aug- Aug- Aug Aug-8 Aug-1 Source: Eurostat, Raiffeisen RESEARCH Telecommunication equipment (EUR mn) Rubber tyres (EUR mn) Electical equipments (EUR mn) Road vehicles (EUR mn) In January-August 1, exports of passenger cars, part and accessories for road vehicles and telecommunications equipments surged by % yoy (based on euro equivalent), while exports of all other goods increased only by % yoy. Strengthening of activity of the external demand helped also the metallurgical sector Recent crisis had a strong negative impact on the activity in the metallurgical sector. Output in section NACE Basic metals fell by % in 9. But once activity started to strengthen on the external market, demand for metallurgical products rebounded. After a sharp fall in 9, the output of the metallurgical sector is now increasing at a very fast pace. Output for NACE section increased by 33% yoy in January- September 1, which is the highest growth rate among all industrial sectors. However, the output is still substantially below its level prevailing before the crisis (by around 5%). Industry to remain a key driver of economic growth in the next period We think that industry would continue to expand in the next period, being helped primarily by the external demand. Economic activity would continue to expand on the external markets, although at a slower pace. Moreover, Germany, the main trading partner for Romania, continues to surprise on the positive side (confidence indicators are further trending higher). At the same time, domestic demand should start to recover in the coming quarters (although slowly). Food and beverage industry, which accounts for a large share of total industrial output, should benefit from this recovery of domestic demand. Not in the last, it seems that the current level of the exchange rate is also helping exporters. Decline in output in sectors likes textiles, clothing and footwear curbed in last year. We think that output dynamics in these sectors could reflect also a favourable impact from the exchange rate. Industry: top 5 performers during the crisis (8-1) The data show that confidence at the level of companies in the manufacturing sector improved both in October and in November. The confidence index increased from -7.7 in September to -5.7 in October and to -5. in November. This suggests that industrial output remains on an upward trend Mar-8 Sep-8 Mar-9 Sep-9 Mar-1 Sep-1 Wood and wooden products 8H1=1) Pharmaceuticals (8H1=1) Rubber and plastic products (8H1=1) Electrical equipments (8H1=1) Motor vehicles (8H1=1) Source: National Institute of Statistics, Raiffeisen RESEARCH Note: 3 months moving average

5 Trends in real sector Better than expected GDP figure in Q3 Is the economic activity about to bottom out? More details regarding dynamics of the GDP components are available in our new Chartbook National accounts data publication attached at the end of the report. Better than expected GDP figure in Q3 1, but domestic demand remains very weak The real GDP fell again in the third quarter (-.7% qoq). In annual terms, the real GDP fell by.5% from Q3 9, at a faster pace than in the second quarter (-.5% yoy). The market did expect to see a decline in real GDP in the third quarter, but the effective pace of contraction was lower than expected. For instance, we expected a decline of -1.5% qoq and of -3.5% yoy. In a Reuters survey, the expectations were for a decline of 1.3% qoq and of -.6% yoy. The better-than-expected figures were the result of a smaller-thanexpected contraction in household and government expenditure, and a strong increase in inventories. The figures for consumption expenditure in the national accounts were better than we expected. Consumption expenditure decreased by only 1.% qoq, although all other monthly indicators (retail sales, sales of new passenger cars, and turnover for market services rendered to the population) declined much faster in Q3. For instance turnover for retail sales (in real terms) fell by.3% qoq in Q3. Retail sales of food products fell by.% qoq (in real terms), while retail sales of non-food products fell by 7.9% qoq as spending with households appliances, computers and IT equipments was the most affected. Sales of new passenger cars fell also by around % qoq. The turnover for market services rendered to the population fell by.7% qoq in Q3 1. Also, the imports of consumer goods were in July-August by.7% below the average level in Q based on quantities. In this context, an increase in consumption in the informal segment might explain the overall better statistical figure from the national accounts. The decline in real government expenditure was also lower than expected (-3.% yoy), as the largest part of the decline in nominal public expenses (-8.% yoy) was reflected in a price decrease (-5.5% yoy) rather than a quantity decline. We expected a larger decline, as the government seems to have laid-off more people in Q3 and to have bought less goods and services in order to meet the budget deficit targets. Gross fixed capital formation fell by 5.% qoq in Q3. While the decline in construction output was not a surprise, the decline in the investment in machinery and equipments seems to have been large also in Q3, which is a bad news. Inventories continued to increase rapidly in Q3, consolidating the trend from the previous quarter. We think the increase in inventories is due mainly to the stronger activity in industry (+.% qoq) driven by external demand. Inventories had again a large positive contribution to the annual GDP growth rate in Q3 (.7 percentage points). Retail sales of durable consumer goods (real terms) Oct-7 Apr-8 Oct-8 Apr-9 Oct-9 Apr-1 Oct-1 Food, beverages and tobacco (7=1, 3M average) Computers, telecommunications equipment (7=1, 3M avg) Audio-video and electrical household appliances (7=1, 3M avg) New passenger cars (7=1, 3M avg) Source: National Institute of Statistics, Raiffeisen RESEARCH Dynamics of construction output Sep-5 Sep Sep-7 Sep-8 Sep-9 Sep-1 Construction output - effective level Construction output - Medium-term trend Source: Eurostat, Raiffeisen RESEARCH Volumes of imports, by categories of goods Aug- Aug-5 Aug Aug-7 Aug-8 Aug-9 Aug-1 Volume of imports of capital goods (=1, 3M average) Volume of imports of consumption goods (=1, 3M average) Volume of imports of intermediate goods (=1, 3M average) Source: Eurostat, Raiffeisen RESEARCH 5

6 Trends in real sector Foreign trade deficit and current account deficit Sep- Sep-5 Sep Sep-7 Sep-8 Sep-9 Sep-1 Balace for foreign trade in goods and services (EUR mn, 3M average) Current account balance (EUR mn, 3M average) Source: National Bank of Romania, Raiffeisen RESEARCH Gross and net inflows of foreign private capitals Sep-5 Sep Sep-7 Sep-8 Sep-9 Sep-1 Net inflows of foreign private capitals (EUR bn, 3 months cumulated) Gross inflows of foreign private capitals (EUR bn, 3 months cumulated) Source: National Institute of Statistics Raiffeisen RESEARCH Short-term indicators, % yoy Q-9 Q3-9 Q-9 Q1-1 Q-1 Q3-1 Oct -1 Industrial output M anufacturing Construction Services - population Retail sales Unemployment* Sales of new passenger cars Source: National Institute of Statistics, Eurostat, Raiffeisen RESEARCH Short-term indicators, % qoq (or % mom) Q-9 Q3-9 Q-9 Q1-1 Q-1 Q3-1 Oct -1 Industrial output M anufacturing Construction Services - population Retail sales Sales of new passenger cars Source: National Institute of Statistics, Eurostat, Raiffeisen RESEARCH Strong improvement in foreign trade deficit helped the GDP Net exports contribution to the annual GDP growth rate improved substantially in Q3 compared with Q. Net exports contribution to the annual GDP growth rate (-.5% yoy) stood at +. percentage points in Q3 compared with -.6 percentage in Q. Exports were weak both in July and August, but they improved unexpectedly in September (6.7% mom based on euro equivalent). Overall, the valued of exports of goods increased by 3.9% qoq in Q3 based on euro equivalent, while total exports of goods and services advanced by.6% qoq. On the other hand, total imports of goods and services fell by 5.7% qoq in Q3. Increase in the exports and plunge in the imports resulted in a strong improvement in the foreign trade balance in the third quarter. Net exports (difference between exports of goods and services and imports of goods and services) amounted to only EUR 991 mn in Q3 (seasonally adjusted data), being less than half of the amounts recorded in Q 1 (EUR. bn) and in Q1 1 (EUR. bn), and also substantially below the amount recorded in in Q3 9 (EUR 1.7 bn). Improvement in the foreign trade deficit helped also the current account deficit to reach a very low level in Q3 (EUR 57 mn or only around 1% of GDP based on our preliminary estimations). Is the economic activity about to bottom out? After a strong negative performance in July, most of the data came on the positive side in August and September, suggesting that the negative impact of the austerity measures was already been passed through to a large extent. The premises for the fourth quarter are rather for an improvement in the economic activity than for additional deterioration. However, the risks still exist. Retail sales figures for October came in on the negative side, with all three components decreasing rapidly (foods, non-foods, and fuels). So, while a new slight negative quarterly GDP growth rate should not be excluded in Q, the chances for a zero or a slightly positive figure have increased. We think that the economy is about to bottom out and to re-enter on an upward trend. However, we are looking only for a slow pace of the recovery in the next quarters. Domestic demand would remain weak. While consumption decreased less than expected in Q3, it might surprise on the negative side in Q. The investments in construction would decrease in Q, while investments in equipments might be also weak in Q. Net exports cannot offer too much support to the economic growth. The foreign trade deficit is already at a low level and a further decrease (which means positive contribution to the GDP) could be achieved only by a decrease in consumption and investments (which means negative contribution to the GDP). Public expenditure cannot help the economic growth as well, given that the government should keep a tight control on spending in order to reach the budget deficit targets. But more importantly, net inflows of foreign private capitals (the main drivers of private consumption and investment in the previous years) are still low for the time being and we think they would not improve strongly in short-term. Moreover, without good governmental policies and political stability, they can remain low even for a long period of time. 6

7 Inflation Growth rate of food prices accelerated Fuelling the advance in the overall CPI Dynamics of inflation by components 16 CPI (% yoy) Foods (% yoy) Non-foods (% yoy) 1 Services (% yoy) Advance in food prices the main driver of the inflation rate in last months In spite of the weak consumption demand, the inflation rate remained at high levels in last months. Monthly inflation rate was close to.55% in each of the last three months (September-November), while the annual rate of inflation climbed to 7.9% yoy in October before decreasing to 7.7% yoy in November. Food prices increased by around.85% mom, in each of the last three months (September-November), having the highest contribution to the total inflation rate. - Nov-7 May-8 Nov-8 May-9 Nov-9 May-1 Nov-1 Source: National Institute of Statistics Raiffeisen RESEARCH Dynamics of inflation by components Nov-3 Nov- Nov-5 Nov Nov-7 Nov-8 Nov-9 Nov-1 CPI (% yoy) Fruits, vegetables, eggs (% yoy) Food prices (% yoy) Source: National Institute of Statistics, Raiffeisen RESEARCH CORE measures of inflation Oct-5 Oct Oct-7 Oct-8 Oct-9 Oct-1 CORE 3 inflation (% yoy) CORE weighted median (% yoy) CORE % trim mean (% yoy) Source: Eurostat, Raiffeisen RESEARCH Some of the risks we talked about in our previous reports started to materialize. Increases in food prices were the main driver of inflation rate between September and November. In fact, the advance in food prices over the last months was much higher than the advance in overall CPI. The annual rate of inflation for food prices climbed by 6.1 percentage points between end-june and end-november (from -.1% yoy in Jun to 6.1% yoy in Nov) while the increase in the overall CPI was only of.3 percentage points during the same period (from.% yoy in Jun to 7.7% yoy in November). Volatile prices of vegetables increased the most in the last months reflecting the weak vegetable output. Moreover, the risks are for additional increases in food prices in the coming months. Upside pressures on prices are expected to persist not only in case of vegetables, but also in case of bakery products (given the recent strong increase in wheat price), or in case of meat. However, underlying inflationary pressures remained low, coming below our expectations. Our statistical core measures of the inflation rate (the cumulated % symmetric trim mean and the weighted median) have remained at a low level in recent months (after excluding the one-off upward move in July due to hike in VAT). Risk stemming from supply side shocks are important At the moment, there is a strong belief among analysts (including the central bank) that the weak domestic demand would act in order to limit the increase in prices in the coming period. We agree with this. But we think that risks to see large supply side shocks in the next quarters are important and we prefer to put more weigh on these risks and to remain further on the pessimistic side. While the central bank expects the inflation rate to be at 3.% yoy at the end of next year, we still look for a higher figure (.5% yoy in the baseline scenario). Past data show that dynamics of the inflation rate in Romania is highly sensitive to supply side shocks (increase in food prices, increase in administered prices, increase in excises, increase in oil price, etc.). We think that most of these shocks have large chances to materialize in the coming period. Commodity prices are trending upward worldwide, the governmental agency for energy regulation has postponed the increase in natural gas prices several times, while the government pledged to remove subsidies for thermal heating next year. 7

8 Interest rates and yields Tensions on the domestic and external markets Had no impact on the local interest rates and yields NBR remained on hold at the last monetary policy meeting Central bank remained on hold at the last monetary policy meeting on November, keeping the monetary policy rate unchanged at 6.5%. Also, ratios for minimum reserve requirements were left unchanged at 15% for RON and 5% for FCY. Much more, we have not perceived any significant change in central bank s rhetoric compared with the previous two meetings ( August and 9 September). Central bank said it still has concerns regarding the second round effects from the hike in VAT at the beginning of July, the potential higher than expected increases in administered prices, and the uncertainty raised by the tense political and social climate at the address of the fiscal consolidation process. The NBR raised its inflation forecast for the end of the year to 8.% yoy from 7.8% yoy previously, mainly based on the larger than expected increases in food prices. Also, the inflation forecast for end of 11 was raised to 3.% yoy from 3.1% yoy previously. In order to anchor the inflation expectations, the NBR said that inflation target for 1 will be hold unchanged at 3% with a variation band of +/- 1%, while starting with 13 onwards the inflation target is.5% with a variation band of +/-1%. Low short-term interbank interest rates, but high risk premium for longer tenors Central bank is going forward with its policy, letting more liquidity in the money market. As a result, short-term interebank interest rates (up to one month maturity) continued to trade at a low level over the last month. For instance, the average interest rate for all transaction in the money market stood only at.7% in October, down from 5.1% in September, and substantially below the level of the monetary policy rate (6.5%). ROBOR 1M traded at 5.3% in October, down from 5.8% in September (monthly averages). These rates traded at even lower levels in November (i.e. effective money market interested rate fell to.3%, while ROBOR 1M stood only at.7%). Risk premia for medium and long tenors remain very high. 1-month ROBOR was quoted almost unchanged at 7.1% in October-November. RON lending and deposit interest rates are still substantially above the level of the short-term interbank interest rates and of the monetary policy rate, while the pace of decline is extremely slow. Lending and deposit interest rates (for outstanding amounts) decreased only marginally in the last months. We think that high uncertainty related to politics and governmental policies is the main reason for the high risk premium. Accordingly, as long as the uncertainty remains high, medium and long term interest rates are expected to remain high, and to converge only extremely slowly towards the lower levels of the short-term interbank interest rates. At this moment, the monetary policy transmission mechanism is strongly negatively impacted by the uncertainty regarding future developments in politics and in the economy. NBR s key interest rate and market interest rates 1% 9% 6% 3% Nov-9 Feb-1 May-1 Aug-1 Nov-1 Money market effective interest rate ROBOR 1 month NBR key rate Source: National Bank of Romania, Raiffeisen RESEARCH Excess of liquidity in the banking system Nov-5 Nov Nov-7 Nov-8 Nov-9 Nov-1 Excess of liquiditity in banking system (RON bn, daily average, outstanding) Liquidity injected by the NBR (RON bn, daily average, outstanding) 6.5% NBR's net position in open market operations and permanent facilities (RON bn) Source: National Bank of Romania, Raiffeisen RESEARCH RON lending and deposit interest rates Apr-7 Oct-7 Apr-8 Oct-8 Apr-9 Oct-9 Apr-1 Oct-1 Loans to companies (%) Loans to households (%) Deposits from companies (%) Deposits from households (%) Money market effective interest rate (%) Note: Interest rates for outstanding amounts Source: National Bank of Romania, Raiffeisen RESEARCH.% 8

9 Interest rates and yields Interest rate and yields outlook Current Dec-1 Mar-11 Jun-11 NBR key rate ROBOR 1 month ROBOR 3 months T-bonds 3 years (ask) T-bonds 5 years (ask) T-bonds 1 years (ask) Source: Raiffeisen RESEARCH Foreign interest rate outlook Current Dec-1 Mar-11 Jun-11 ECB key rate EURIBOR 1 month FED key rate LIBOR USD 1 month Source: Raiffeisen RESEARCH Market yields for RON bonds, (%, monthly avg., ask) 1% The Finance Ministry gave up the 7% cap on yields IMF and the European Commission s decision to delay the disbursement of additional instalments from the external loans agreed in 9 until the beginning of the next year, as well as the delay in the implementation of the Euro Medium Term Notes programme pushed the Finance Ministry to give up the 7% cap on yields and to pay more to raise debt on the local market. For instance, the Finance Ministry paid up to 7.3% in the last 1- year T-bills auctions. The move allowed the government to issue more debt on local market in November. At the same time, the move had no impact on the yields in the secondary markets which remained unchanged. The liquidity excess in the money market allowed the government to rollover easily the maturing debt, but only on short-term basis. On the positive side, the Finance Ministry succeeded to rollover a 1-year T-bill reaching maturity at the end of the month (amounting to EUR 1. bn) by a 3-year T-bond auction (amounting to 1.3 EUR ). The issue can be considered a success given the longer maturity of the new bond. We think local banks were the main investors, renewing their exposure towards the government. Given that lending to the private sector is still fragile due to weak demand for loans and weak economic perspectives, the banks prefer to invest further their excess of liquidity in government bonds. Risk premium and interest rates to remain high in short-term 9% 8% 7% 6% 5% Nov-9 Feb-1 May-1 Aug-1 Nov-1 1 Year (%, ask) 3 Years (%, ask) 5 Years (%, ask) 1 Years (%, ask) In our baseline scenario, we have looked for a slight increase in the interbank interest and yield in the last quarter of the year based on tensions on the local market. Such tensions have materialized (a new noconfidence vote against the government, delays for instalments to be received from the IMF and the EC), but their impact on the interest rates and yields was rather limited. Given the high uncertainty at the moment, we prefer to keep a prudent view for the time being. Accordingly, we think that central bank will keep the monetary policy rate unchanged in the coming months. Also, the RON lending and deposit interest rates, as well the yields for the governmental bonds will continue to trade close to their current levels. Source: Reuters, Raiffeisen RESEARCH For the time being, we maintain our view on RON bonds (neutral), given that uncertainty remains high. Auctions in RON Government securities Auction date Tenor (M onths) Amount (RON mn) Cupon (%) Amount (RON mn) Average Maximum Tenor Intended Effective Yield yield Auction date (years) Intended Effective 1-Nov % 7.% -Nov % % 7.1% 8-Nov % 7.3% 18-Nov % Nov % 7.% -Nov % 7.9% 6-Dec % 6.95% 16-Dec % 5 13-Dec Dec % 3 -Dec Dec Discount T-Bills Benchmark T-Bonds Average Yield Maximum yield * the amounts for the next period are only indicative. Source: Ministry of Public Finance 9

10 Budget deficit Lower than expected budget deficit Good performance of public revenues The increase in consolidated budget deficit slowed down rapidly in the second half of the year. While the government struggles to meet the budget deficit targets agreed with the IMF for Q1 and Q, the effective level of the budget deficit (cash basis) at the end of Q3 (.6% of GDP) was much lower that the target (5.5% of GDP). Also, the consolidated budget deficit was unchanged in October (.6% of projected GDP). The still high level of the public arrears is one reason for which the consolidated budget deficit has not increased to much in the last months. But there seems to be also other factors behind the slower deterioration of the budget deficit in the last months. The cut by 5% in the public wages and by 15% in case of social transfers (other than pensions) starting July allowed the government to reduce spending with personnel and social assistance. For instance, expenses with personnel have decreased by 6.7% yoy in January- October (after they had decreased by.5% yoy in January-June), while the growth rate of social transfers decelerated to 8% yoy in January- October from 1.3% yoy in January-June. Expenses with subsidies fell by 5.7% yoy in January-October, decelerating also substantially from the first part of the year (+6.3% yoy in January-June). Capital expenses remained also at a low level (-.9% yoy in January-October). By limiting spending with personnel and social transfers, the government had room to increase the spending with goods and services in the third quarter. Expenditure with goods and services increased by.3% yoy in January- October after they had decreased by 1.7% yoy in January-June. The increase in spending with goods and services seems to be related to the payment of some arrears of the public sector (e.g. in healthcare sector). Growth rate of public revenues accelerated also in the second half of the year, being helped by the increase in the value added tax (VAT) and improved collection of excises. It seems that government s additional revenues due to the hike in VAT from 19% to % on 1 July were better than expected. Following the better than expected performance of public revenues in July-October, there are large chances for the government to meet this year s target for public revenues. As a result, the chances for the government to meet this year s the budget deficit target of 6.8% of GDP (or around RON 35 bn) have also increased. It rest only on government to keep in check the spending in November and December. Almost always there were excesses in public spending in the last two months of the year. But fulfilling the budget deficit target agreed with the IMF could be a strong incentive for the government to refrain from exuberant spending at the end of this year. The budget plan for 11 made known recently sets a budget deficit target of.% of GDP, in line with the agreements with the IMF and the EC. There would be no major changes in taxation the next year. The public revenues are planned to increase in 11 by around 6.8% in nominal terms, while public expenditures are planned to remain close to their level this year. We think that next year s budget deficit target is challenging, but it is achievable. The main challenge for government would be to keep the public spending in check, which is not easy. Consolidated public budget deficit (cash basis) % % -% -% % -8% -5.5% -.6% Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec -.8%.8% -7.% targets agreed with IMF Source: Ministry of Public Finances, Raiffeisen RESEARCH Dynamics of public revenues and public expenses (% yoy) Oct-8 Apr-9 Oct-9 Apr-1 Oct-1 Total public revenues (% yoy, 3M moving average) Total public expenses (% yoy, 3M moving average) Source: Ministry of Public Finances, Raiffeisen RESEARCH Net debt raised by government in local securities Aug-8 Feb-9 Aug-9 Feb-1 Aug-1 Feb-11 Aug-11 Goverment securities reaching maturity (RON mn) Total goverment securities issued (RON mn) Effective new funds raised by government (RON mn) Note: Both RON and EUR government securities are taken into account Source: Raiffeisen RESEARCH 1

11 Exchange rate Stable exchange rate in last months In spite of tensions on local and external markets In the recent months, the leu exchange rate performed slightly better than we expected. We have looked for a temporary depreciation of the leu in September-October due to some tensions on the local market related to politics and to negotiations with the international institutions (the IMF and the European Commission). Such tensions did materialized, but they had no material impact on the exchange rate. The opposition parties introduced a new no-confidence vote at the end of the October, putting in danger the government s position. Despite the animosities within the ruling coalition (and even inside the parties in the ruling coalition), it continued to function and backed the government by its vote. The result of negotiations with the IMF and the EC was mixed. The agreements with the IMF and the EC remained on track (which is good news), but disbursements of additional funds was delayed until the beginning of the next year, being conditional on the capacity of the government to enforce several key laws. There were protests from the part of the labour unions in the public sector, but they had a low intensity. The leu remained immune to the tensions on the external markets as well. We think that one factor which might explain the low sensitivity of the leu exchange rate over the last months is the low interest of non-resident players in RON assets (including here a reluctance to bet on a move of the leu exchange rate in one or another direction). Exchange rate dynamics over the last months was shaped mainly by local players. We think that capacity of the government to keep the agreements with the IMF and the EC on track (and to renew them as well) will be the main factor which will shape the exchange rate dynamics in the coming period. This depends on the developments in the political field. Given that we see some risks to have new tensions in the first quarter of the next year on the domestic and also on the external markets, we are expecting a slightly weaker leu in the coming months. Regional exchange rates EUR/HUF EUR/PLN EUR/CZK EUR/RON Dec-7 Mar-8 Jun-8 Sep-8 Dec-8 Mar-9 Jun-9 Sep-9 Dec-9 Mar-1 Jun-1 Note: Fixed base index, 9 Dec 7=1 Source: National Bank of Romania, Raiffeisen RESEARCH 5-year CDS quotations (USD segment) Jan-9 May-9 Sep-9 Jan-1 May-1 Sep-1 Romania Bulgaria Hungary Poland Czech Republic Source: Bloomberg, Raiffeisen RESEARCH Exchange rate outlook Current Dec-1 Mar-11 Jun-11 Sep-11 EUR/RON USD/RON CHF/RON EUR/USD EUR/CHF Source: Raiffeisen RESEARCH 11

12 Main indicators F 11F Economic activity Nominal GDP (EUR bn) GDP per capita (in EUR) Real GDP (%, yoy) Household expenditures (% yoy) Fixed investments (% yoy) Industrial production (%, yoy) Unemployment rate (%, avg.) Unemployment rate (%, eop) ILO unemployment rate (%, avg.) Wages M onthly average gross wage (EUR) Gross nominal wages - economy (% yoy) Gross nominal wages - industry (% yoy) Prices CPI (%, yoy, eop) CPI (% yoy, avg) PPI (%, yoy, avg) GDP deflator (%, yoy) Non-government credit Non-government credit (%, yoy) n.a n.a. Non-government credit (% of GDP) n.a n.a. Credit in foreign currencies (% of total) n.a n.a. Public sector Public budget balance (% of GDP) Public budget balance (ESA95, % of GDP) Public revenues (ESA95, % of GDP) Public spending (ESA95, % of GDP) Public debt (ESA 95, % of GDP) Public debt (national definition, % of GDP) External sector External debt (EUR bn) External debt (% of GDP) Short-term external debt (% of total debt) External debt service (% of GDP) External debt service (% of C/A receipts) Current account balance (EUR bn) Current account balance (% of GDP) Current account + FDIs (% of GDP) Trade balance (FOB/FOB, EUR bn) Trade balance (FOB /FOB, % of GDP ) FOB exports (%, yoy) FOB imports (%, yoy) Net FDI inflo ws (EUR bn) FX official reserves (EUR bn) FX oficial reserves (months of imports) Interest rates NBR key rate (%, avg) n.a NBR key rate (%, eop) n.a ROBOR 1 month (%, avg.) year T-Bonds (%, avg., ask prices) n.a. n.a. n.a. n.a Exchange rates EUR/RON (eo p) EUR/RON (avg) USD/RON (eo p) USD/RON (avg) Source: NBR, NIS, EUROSTAT, Raiffeisen RESEARCH 1

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14 Chartbook ROMANIA: National accounts data Methodological notes: Most of the comments in the report are based on the trend of seasonally adjusted data. See the end of the report for the methodology used to derive the indicator. 1. Dynamics of GDP components at quarterly frequency Annual changes (% yoy, gross data) 9 Q 9 Q3 9 Q 1 Q1 1 Q 1 Q3 9 Q 9 Q3 9 Q 1 Q1 1 Q 1 Q3 Real GDP Real GDP without agriculture Domestic demand excl. inventories Household expenditures Government expenditures Gross fixed capital formation Domestic demand with inventories Inventories's contribuion to GDP (%) Exports Imports Net exports' contribution to GDP (%) Gross value added (GVA) agriculture industry construction services Gross value added excl. agriculture Source: National Institute of Statistics (NIS), Raiffeisen RESEARCH. Real GDP excluding agriculture Quarterly changes (% qoq, seasonally adjusted) We think that real GDP excluding agriculture is a better indicator of the dynamics of the economic activity because of high volatility of agriculture and its large contribution to the total GDP. Our calculus show that real GDP excluding agriculture is on a downward trend for 9 quarters already. After real GDP excluding agriculture was almost flat in Q 1, the pace of decline accelerated again in Q3 1 following the introduction of the austerity measures Q3 7Q1 7Q3 8Q1 8Q3 9Q1 9Q3 1Q1 1Q3 Real GDP (% qoq) - NIS Real GDP(% qoq, tendency) - Raiffeisen 6Q3 7Q1 7Q3 8Q1 8Q3 9Q1 9Q3 1Q1 1Q3 Real GDP (% qoq) - NIS Real GDP exluding agriculture (% qoq, tendency) - Raiffeisen Page 1