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Wednesday, November 03, 2004

Romania relaxes forex regime, leu jumps

source: REUTERS

EU-candidate Romania relaxed its currency regime on Tuesday by allowing its leu to fluctuate in line with market trends, a milestone step towards opening up to short-term foreign capital inflows.

The country's central bank (BNR) said in a statement accompanying a decision to cut interest rates that it would no longer announce exchange rate targets for the leu and would limit intervention on the domestic foreign exchange market.

The new system will create flexibility on the threshold of EU membership and allow the bank to focus solely on inflation, it said.

"Greater flexibility of the exchage rate is complementary with the new monetary policy framework of inflation targeting and with the next steps in the capital account liberalisation," the statement, which caused the leu to jump against the euro, said.

The new regime replaces a rigid system under which the bank was steering the leu along a gradual, pre-announced appreciation course through frequent intervention.

Analysts said the decision was a milestone because it prepared the poor Balkan country for free flows of foreign capital next year. It was a testimony to Romania's progress with market reforms.

"It is a turning point for the Romanian financial market," ABN Amro senior analyst Radu Craciun said. "It marks the crossing of the border between an indirect exchange rate targeting policy...and a flow-driven rate."

The leu moved to 40,320/340 against the euro from 40,740/770 as traders tested whether the new "hands-off" policy was already in place.

CAPITAL FLOWING

With more capital flowing into Romania on the back of robust economic growth and in anticipation that the country will be allowed into the EU in 2007, the central bank has found it hard to fight inflation while managing the leu, analysts say.

It forced the bank to target both inflation and the exchange rate -- a combination most central banks in other ex-communist countries that are now part of the EU have shunned in favour of inflation targeting.

The shift in Romania's policy reflects similar steps taken by Poland, Hungary and Czech Republic in late 1990s.

As part of similar EU-linked liberalisation, the BNR plans to allow foreigners to hold leu-denominated deposits early next year.

Officials have estimated short-term foreign inflows into Romania at around 1.0 billion euros this year, a figure set to triple once the market opens up and investors rush in to take advantage of still high interest rates.

Analysts say the authorities are set to allow the leu to appreciate in line with greater inflows, using the stronger currency, which makes imports cheaper, to limit inflation.

Inflation in Romania runs at 11 percent, and the central bank wants to push it below 10 percent by the end of the year.

Falling inflation would in turn allow the bank to lower interest rates. To drive the point home, the bank said it was cutting its main interest rate to 18.25 percent from 18.75 on Tuesday.

The rate cut was the latest move in a monetary easing cycle which began in June when the rate was at 21.25 percent.

Posted by Mihai : 11/03/2004 11:45:00 am