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Minutes of the monetary policy meeting of the BNR Board on 29 May 2020
12 June 2020
On 29 May 2020, the Board of the National Bank of Romania held a meeting in which the following members took part: Mugur Is?rescu, Chairman of the Board and Governor of the National Bank of Romania; Florin Georgescu, Vice Chairman of the Board and First Deputy Governor of the National Bank of Romania; Leonardo Badea, Board member and Deputy Governor of the National Bank of Romania; Eugen Nicol?escu, Board member and Deputy Governor of the National Bank of Romania; Csaba Bálint, Board member; Gheorghe Gherghina, Board member; Cristian Popa, Board member; and Dan-Radu Ru?anu, Board member.
During the meeting, the Board discussed and adopted the monetary policy decisions, based on the data on and analyses of the recent characteristics and the medium-term macroeconomic outlook submitted by the specialised departments, as well as on other available domestic and external information.
Looking at the latest relevant statistical data, Board members agreed that the main macroeconomic developments had started to reflect the adverse effects of the coronavirus pandemic and the restrictive containment measures taken worldwide and countrywide. It was shown that the annual inflation rate had dropped in April to 2.68 percent, after staying flat at 3.05 percent in March, and that its significant downward correction versus December 2019 had owed to disinflationary base effects and particularly to the plunge in the oil price, which had triggered, alongside the removal of the special excise duty, a deep fall of the fuel price dynamics into negative territory.
By contrast, the annual adjusted CORE2 inflation rate had tended to increase mildly, contrary to forecasts, standing at 3.7 percent in April from 3.66 percent in December 2019. It was noted that behind that trend had stood developments in the processed food segment, reflecting to a large extent the strong pick-up in demand for food products before and during the state of emergency declared on 16 March 2020, associated also with probable disruptions and cost increases in production and supply chains. At the same time, the slowdown in the dynamics of services prices, which had nearly offset the impact of the rise in processed food prices, was attributable to disinflationary base effects, as well as to the lockdown on market services and the drastic contraction of household demand amid social distancing measures, consequently causing an adaptation of the statistical method to compile the consumer price index. Apart from those influences, it was deemed that the evolution of core inflation continued to reflect significant inflationary pressures from the cyclical position of the economy and labour costs, alongside short-term inflation expectations that had been still high or even revised upwards in recent months in the case of some categories of economic agents, likely to fuel the persistence of that inflation component.
The adverse impact of the pandemic crisis and the associated measures had been stronger for economic activity and labour market, Board members showed. Thus, according to preliminary data, economic growth had recorded a sizeable deceleration in 2020 Q1, even if in the first two months of the current year it had remained particularly robust; in quarterly terms, economic growth had remained however in positive territory, translating only into a slight shrinking of the significant excess aggregate demand. It was remarked that net exports had probably made a marked negative contribution to the GDP dynamics, given that the trade deficit had seen again a considerably faster widening in Q1, amid a more pronounced decline in exports than in imports of goods and services. Consequently, the dynamics of the current account deficit had regained momentum, despite the improvement in the evolution of the primary and secondary income balances, a context in which its coverage by foreign direct investment and capital transfers had posted a steeper decline.
Moreover, it was noted that the widespread lockdown on activity in numerous economic sectors starting with the second part of March, in an effort to contain the spread of the COVID-19 pandemic, and the pronounced drop in consumer demand, in parallel with the fall in external demand, were likely to trigger a severe contraction of the Romanian economy in Q2 and implicitly a sudden shift in its cyclical position from a significantly positive value to a strongly negative one.
The magnitude of the contraction was however difficult to anticipate, Board members repeatedly underlined, given the extremely high uncertainties about the evolution of the pandemic and of physical mobility restrictions, likely to have an unpredictable impact on the activity of various sectors/sub-sectors of the economy, as well as entail major changes in macroeconomic behaviours, especially consumer behaviour. In their assessments, Board members referred to the characteristics of the decline in the Romanian economy in the context of the global financial crisis, as well as to the sudden lockdown on companies and activities at the current juncture – particularly in areas such as transport, tourism, accommodation and food service activities, recreational activities, industry and trade –, also touching upon the national measures/programmes designed to support firms and households, but limited by the existing fiscal space. A special focus was placed on the implications of the external environment amid the fast-paced worsening of the evolution and prospects of global, euro area and EU economies – with disinflationary or even deflationary effects in certain countries –, alongside the sizeable contraction of international trade, owing, inter alia, to the major disruptions in global production and distribution chains. In that context, many central banks in advanced and emerging economies, including the ECB and central banks in the region, had continued to ease the monetary policy stance by way of unconventional approaches or by additional cuts in key policy rates.
Board members also pointed out the particularly high uncertainties associated with labour market developments, which had seen a sudden worsening in mid-March, mitigated however by employers’ wide resort to government furlough schemes. Nevertheless, the number of labour contracts terminated had recently risen and the evolution could become more pronounced starting 1 June, some Board members warned, inter alia in the context of a lower support to furloughed employees in areas where restrictions would be kept in place. It was concluded that labour demand would probably continue to fall overall, on the short time horizon, yet amid uneven or even opposite developments across sectors, as shown by the hiring intentions expressed in April by companies in the food industry, trade in essential goods, freight transport and the ICT sub-sector. Against that background, a mild slowdown in the growth rate of wages was to be expected in the near term, accompanied however by further elevated dynamics of unit wage costs in industry, in the context of notable labour productivity losses.
Board members noted that financial market conditions had improved considerably after the adoption of the monetary policy decisions on 20 March and after overcoming at end-March the peak of tensions generated by the COVID-19 crisis. Key interbank money market rates had witnessed a significant downward adjustment in the closing 10-day period of March and had afterwards continued to decline gradually, while interest rates on leu-denominated government securities had gone down progressively, amid the increased volume of liquidity injected by the NBR through bilateral repo operations and purchases of leu-denominated government securities on the secondary market, given the liquidity shortfall on the money market. Moreover, the average lending rate on new business had almost entirely corrected in March the rise witnessed during the first two months of the year, mainly on account of the interest rate on loans to non-financial corporations, more closely correlated with developments in ROBOR rates. Board members concluded that the slight increase in the IRCC level in Q2 and the characteristics of the index, but also the draft legal acts – currently in various stages of the legislative process – regarding the banking sector compounded, however, the uncertainties about the functioning of the monetary policy transmission mechanism in the context of the pandemic crisis and of the associated measures.
At the same time, it was shown that the EUR/RON exchange rate had seen lower fluctuations, under the influence of the relative improvement in global financial market sentiment, as well as amid liquidity conditions on the money market and the interest rate differential. Several members cautioned that changes in those parameters or an additional worsening of the risk perception vis-à-vis the domestic economy and the local financial market, entailed by a potential more severe deterioration of the fiscal position and its outlook, would however be conducive to renewed heightened pressures on the leu’s exchange rate. These would have adverse implications, inter alia, for the confidence in the domestic currency, external vulnerability indicators and, ultimately, for financing costs and the pace of economic recovery following the downturn.
Furthermore, it was remarked that lending growth had moderated only slightly in March, before coming under the influence of the pandemic crisis in April and slowing to 5.7 percent from 6.9 percent a month earlier. The share of domestic currency loans in total private sector credit had narrowed slightly at the end of that period, to 67.1 percent against 67.6 percent in December 2019. At the same time, broad money dynamics had accelerated considerably in March and afterwards had consolidated at double-digit readings, some members noted, amid the sizeable widening of the budget deficit, owing to public health-related expenditures and the containment measures during the pandemic.
When discussing the outlook for macroeconomic developments, Board members repeatedly pointed out that the multiple unknowns concerning the evolution of the pandemic and the related measures, as well as the unprecedented nature of such an economic shock domestically and internationally, rendered the forecasting process highly difficult, taking the uncertainty associated with the current forecast scenario to extreme levels.
It was observed that, in light of that scenario, the anticipated inflation pattern was different from the previous projection, especially in the latter part of the forecast horizon, when it was seen standing visibly below the levels envisaged earlier. Thus, after a moderate decline in Q2, followed by a slight pick-up in Q3, the annual inflation rate was expected to fluctuate temporarily around 2.8 percent, before falling to the midpoint of the target in mid-2021 and staying there afterwards, whereas the previous projection had seen it at 3 percent in December 2020 and 3.2 percent at end-2021.
It was shown that the return of the annual inflation rate to slightly higher readings in 2020 H2 was entirely attributable to supply-side factors. Their action would probably turn somewhat more inflationary than previously forecasted over the short term, as the impact of the decline in oil prices was anticipated to be more than counterbalanced by that of the increase in prices for vegetables/fruit, but also for some essential goods and processed food items, owing, inter alia, to persistent disruptions in domestic and global production and distribution chains.
According to some Board members, influences in the same direction might also come from the unfavourable weather conditions in the first months of the year – likely to affect agricultural performance and hence the prices of some agri-foodstuffs –, as well as from some economic agents’ price-setting behaviour. Moreover, administered price developments remained uncertain, amid the prospective liberalisation of natural gas and electricity markets, but also the potential implications of reference market prices, while CPI accuracy could be affected over the very short term by the difficulties in collecting statistical data and compiling that index.
At the same time, Board members remarked that pressures from fundamentals were expected to become strongly disinflationary only in 2021. That outlook was based on a number of assumptions and explanations: i) the lag of the disinflationary effects exerted by the negative output gap – anticipated to open markedly in 2020 Q2 and witness a partial correction in the following period; ii) the likely pick-up in the dynamics of unit wage costs in 2020, amid large productivity losses; and iii) the potential persistence, in the near future, of changes in consumer demand composition due to the pandemic and social distancing, conducive to temporary disequilibria between demand for and supply of certain consumer goods, food items in particular. However, reference was also made to the significant disinflationary base effects affecting core inflation in 2020 Q2 and 2021 Q1, associated with the introduction of the telecom sector tax and with the costlier pigmeat and hike in prices for other agri-food commodities respectively.
Under the circumstances, the annual adjusted CORE2 inflation rate was expected to stay above 3 percent during 2020, even after a visible decline in Q2, but to fall in 2021 H1 and afterwards fluctuate very slightly around 2.2 percent, compared with the previous 3.4 percent projection for the end of the forecast horizon. Nevertheless, Board members pointed out the unusually high uncertainty surrounding the size and profile of the economy’s cyclical position, but also the potential response of consumer prices thereto.
As regards the prospects for the cyclical position, it was observed that in the current scenario the Romanian economy was foreseen to witness a significant contraction in 2020, followed by a moderate recovery in 2021, as the severe economic decline in 2020 Q2 would probably be corrected partially in the following quarter and somewhat more gradually afterwards, amid the progressive easing of restrictive measures associated with the pandemic crisis. The outlook, relatively synchronised with that anticipated for the euro area/EU, implied a major turnaround in the output gap pattern. Specifically, after having reached a peak of the current business cycle at end-2019, the output gap was expected to fall markedly into negative territory in 2020 Q2, before closing progressively until 2022.
Board members agreed that the pace of recovery in the near run of both the economy and the major aggregate demand components was, however, very difficult to anticipate, depending on movement restrictions and the characteristics of their lifting, and implicitly on the evolution of the pandemic, which might even see a renewed spike over the short time horizon. In relation thereto, the determinant behind private consumption recovery was the growth rate of real disposable income, itself dependent on labour market conditions, but also on the cost of households’ bank debt and on inflation developments. Also essential was consumer confidence, which might be affected over the short term by households’ pandemic-related fears – in the absence of an effective vaccine/treatment –, but also by concerns about the prospects for their workplaces and financial standing, conducive to a stronger propensity for saving and to the preservation of recent changes in consumption structure.
Board members deemed that very high uncertainty also surrounded the outlook for investment, anticipated to post a massive decline in Q2, which would practically fully explain the economic contraction in 2020, but would also affect the future potential of the economy. It was mentioned that the recovery in investment starting with 2020 H2 – in line with expectations – was conditional on developments in consumer demand and external demand, as well as on investor confidence and the pace of recovery in the home countries of foreign investment, but also on firms’ revenues/profits and their access to finance at reasonable costs, also dependent on the risk premium. It was considered that, given the very narrow fiscal space, a significant contribution to supporting the relaunch of investment and of the economy overall would be made by the EU recovery package to counter the COVID-19 crisis, alongside the probable improvement in the absorption of European funds, amid the flexibilisation measures regarding their use recently adopted at a European level. Positive influences were also expected from the government-backed IMM Invest programme targeting SMEs, as well as from the measures taken by the central bank to render more flexible the prudential regulatory framework applicable to credit institutions.
Board members discussed at length the current and future stance of both fiscal and income policies, considered as generating much higher uncertainties and risks to macroeconomic developments and stability, over a longer time horizon. Focus was placed on the unusually large widening of the budget deficit in recent months, under the impact of the pandemic crisis and of the associated measures – worrisome, inter alia, in terms of financing costs and challenges, but also of the potential impact on next years’ budget execution, especially in view of the election calendar and the provisions of the new pension law. Moreover, special reference was made to the requirement for a start of fiscal consolidation in the short run, amid the European Commission’s excessive deficit procedure, still in force, the temporary suspension of the Stability and Growth Pact notwithstanding. Arguments were again brought up in favour of a well-calibrated fiscal correction, with a focus on current expenditures, to minimise the adverse effects on economic recovery and the medium-term growth potential and at the same time to prevent the worsening of domestic and external imbalances.
A matter of particular concern was also considered the prospective further deterioration of the current account deficit in 2020, as a share in GDP, followed only by a probable marginal improvement in 2021. It was observed that net exports were however expected to diminish considerably their contractionary impact on the economy in 2020 – amid the sizeable narrowing of the differential between the dynamics of domestic absorption and those of the economies of major trading partners, but also owing to price competitiveness losses in the economy; at the same time, mention was made of the increasing uncertainties and risks stemming from the euro area and world economy contraction, in the context of the coronavirus pandemic crisis.
Given also the package of measures adopted in March, Board members were of the unanimous opinion that the overall context under review warranted a prudent cut in the monetary policy rate. This should help achieve fast-track economic recovery after the coronavirus-induced contraction, with a view to ensuring price stability over the medium term in line with the 2.5 percent ±1 percentage point inflation target, while preserving financial stability.
Under the circumstances, the NBR Board unanimously decided to cut the monetary policy rate to 1.75 percent from 2.0 percent; moreover, it decided to lower the deposit facility rate to 1.25 percent from 1.50 percent and the lending (Lombard) facility rate to 2.25 percent from 2.50 percent. Furthermore, the NBR Board unanimously decided to maintain the existing levels of minimum reserve requirement ratios on both leu- and foreign currency-denominated liabilities of credit institutions. Given the liquidity shortfall on the money market, the Board unanimously decided to further conduct repo transactions and continue to purchase leu-denominated government securities on the secondary market, keeping financial market stability.
In addition, given the elevated uncertainty surrounding economic and financial developments, the NBR Board decision to suspend the previously announced calendar of monetary policy meetings was kept in place, with monetary policy meetings to be held whenever necessary.