Foreign investors turned on by Romania

Anlysis By James Thornhill

LONDON, Dec 7 (Reuters) - It's difficult for foreign investors to get exposure to Romania's soaring currency, but that hasn't stopped some of them and the attraction of high yields and EU entry in 2007 means more are likely to follow.

The leu is up around six percent against the euro since November 3 -- when the central bank announced a shift to a flexible managed float currency regime -- driven, at least in part, by speculative foreign inflows.

Romania's central bank intervened aggressively on Monday to stem the leu's charge, but analysts say it can probably only slow the pace of gains, given the growth of interest in Romania.

Romania's benchmark Eurobond maturing in 2012 also underlines the strength of interest, with the risk premium having dropped to 4.0 percent, from 6.285 percent in May.

Investors' confidence that Romania will remain on track for EU entry has insulated markets against a bout of political turbulence in the wake of last month's inconclusive parliamentary elections.

"In spite of capital restrictions, Romania has benefited from the plentiful global liquidity chasing yield and, with better macro policies, approaching EU membership and high domestic rates, money has moved in," said Erik Nielsen, head of new European markets research at Goldman Sachs.

The central bank's reduced participation in the market since November has encouraged leu bulls, salivating at the prospect of Romania's high yields -- the key deposit rate is at 17.75 percent -- and the convergence anchor of European Union entry in 2007.

"People are looking for vehicles to express their bullish leu view. Interest rates are only a couple of percent below Turkey, but Romania is a lot closer to EU entry. From that perspective it's very attractive," said Koon Chow, emerging markets currency strategist at CSFB.

Domestic traders corroborate the view from outside: "Foreign inflows are picking up and are set to grow on expectations of further liberalisation of capital flows, maintaining upward pressure on the leu," said one senior dealer in Bucharest.

STRICT DOOR POLICY

The attraction of Romanian markets to foreign investors are obvious. The trouble is, as Chow at CSFB puts it, it's still "hard as hell" for foreigners to buy leu assets and get in and out of the market easily.

"It's definitely nowhere near as liquid as other parts of central Europe, there is an NDF (non-deliverable forward) market, but investors tend to take very small positions," said Ivailo Vesselinov, emerging markets analyst at Dresdner Kleinwort Wasserstein.

NDF markets allow investors to take forward positions in non-convertible or thinly traded currencies, like the leu, with contracts settled in hard currency.

"They're still testing the waters, but we expect the market to develop quite rapidly over the next year," Vesselinov added.

That development should be enhanced by the gradual lifting capital controls, in line with EU entry requirements.

Romania has promised to allow foreigners access to leu deposits starting next April, with the full liberalisation of the capital account to take effect in time for EU membership in 2007.

Bankers in London say hedge fund involvement in leu markets so far has been very limited, but that could change if these markets are opened up.

"If these opportunities were there with an open market, people would be a lot more interested," said Goldman's Nielsen.