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Minutes of the monetary policy meeting of the National Bank of Romania Board on 15 March 2021

On 15 March 2021, 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; Dan-Radu Ru?anu, Board member; Virgiliu-Jorj Stoenescu, Board member.


During the meeting, the Board discussed and adopted the monetary policy decisions, based on the data on and analyses of 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 recent inflation developments, Board members showed that the annual inflation rate had risen way above expectations in the first two months of 2021, i.e. to 2.99 percent in January and to 3.16 percent in February, from 2.06 percent in December 2020. It was noted that the evolution had been driven by the transitory impact of the liberalisation of the electricity market for household consumers and by the rise in fuel prices, amid higher oil prices, only to a small extent counterbalanced by the disinflationary influences from the VFE and tobacco product segments, as well as from core inflation deceleration.


It was remarked that the annual adjusted CORE2 inflation rate had decreased at a slower pace over that period, going down to 3.1 percent in January 2021, from 3.3 percent in December 2020, and remaining flat in February. Board members shared the view that the downtrend had been further underpinned by the disinflationary base effects associated with the developments in some processed food prices, as well as by the modest impact of the aggregate demand deficit, alongside that of the weak demand on the services segment, whereas small opposite influences had stemmed from the rebound in purchases of some goods, but also from supply-side disruptions and costs linked with the pandemic and with the measures to prevent the coronavirus spread. At the same time, the dynamics of the component were still marked by the pre-pandemic underlying inflationary pressures, reflecting, inter alia, the associated inflation expectations.


As for the cyclical position of the economy, Board members showed that the economic activity had further seen a particularly fast recovery in 2020 Q4 – the pace had exceeded by far the forecast and had lagged only slightly behind that seen in Q3 –, with the annual GDP decline slowing to -1.4 percent from -5.6 percent in the previous quarter, given the 4.8 percent quarterly increase after the 5.6 percent pick-up in Q3. It was remarked that the economy had thus reversed another significant part of the loss seen in Q2 and that the economic decline had stood at only -3.9 percent in 2020 as a whole. At the same time, some Board members pointed out that excluding the effect of agriculture – due to unfavourable weather conditions –, the economic contraction would have come in at -3.3 percent, among the lowest values in Europe. It was deemed that the upturn made it likely for the aggregate demand deficit opened in Q2 to close to a very large extent at end-2020, which ran somewhat counter the previous forecasts that had indicated a significant deficit halting its closing in 2020 Q4.


Relative to the drivers of the recovery, Board members underlined the decisive contributions made over that period – in contrast to the strong contractionary impact in Q3 – by the change in inventories and the private consumption sub-components, other than households’ purchases. It was noticed that the renewed contraction of the latter had been attributable mainly to the drop in services, in the context of the resurgence of the pandemic, while the segment of goods had seen relative resilience. Moreover, gross fixed capital formation had played an important part in view of the significant acceleration in its annual dynamics amid the markedly faster growth in new construction works, with the contribution, inter alia, from public investment and government programmes – likely boosting the growth potential of the economy in the future.


It was remarked that the recovery had owed entirely to domestic demand, whereas the negative contribution of net exports to annual GDP dynamics had almost doubled amid a slightly more visible step-up in the dynamics of imports than in those of exports of goods and services, triggering also a renewed increase in the trade deficit versus the same period of the previous year. Under the circumstances, as well as following a more pronounced worsening of the primary income balance owing to dividend distribution flows, the current account deficit had seen a larger advance in annual terms, in spite of rising inflows of EU funds to the current account. Thus, the current account deficit to GDP ratio had expanded during the year overall to 5.0 percent from 4.7 percent in 2019.


For the near run, Board members were of the same view that the upturn in the economic activity would probably see a strong deceleration in 2021 H1, following the much faster-than-expected pace in 2020 Q4, also visibly slowing compared to the previous forecast, yet with annual dynamics exceeding previous forecasts. Against that background, Board members emphasised that, in mid-2021, the GDP loss caused by the pandemic could be largely recouped and the negative output gap could fully close. The assessments were, however, surrounded by high uncertainty, in the context of the third pandemic wave spreading across the country and the difficulties in collecting statistical data.


On the labour market, the impact of the resurgence of the pandemic and of the mobility restrictions implemented in 2020 Q4 had also been below expectations, Board members noted. The number of employees in the economy had continued to pick up mildly November through December, the same as its annual dynamics, which had nevertheless remained negative, while the ILO unemployment rate had reported further a slow deceleration compared to the previous quarter’s average. The job vacancy rate had shed however the marginal advance recorded in Q3, with labour market looseness remaining thus relatively unchanged, yet in the context of heterogeneous developments across the sector. Under the circumstances, the average gross nominal wage earnings had consolidated their relatively strong annual dynamics over the last months of 2020, mainly on account of private sector developments. Unit labour costs had, however, posted a visibly slower annual growth both across the economy as a whole and across industry amid the pronounced advance in labour productivity.


Looking ahead, labour market developments remained marked by elevated uncertainties, especially in the longer run, Board members deemed, citing the third pandemic wave and the associated restrictions, alongside the dynamics of vaccination, as well as the transitory nature of government support measures, which could later on entail the restructuring/bankruptcy of some firms. Reference was also made to possible future actions to enhance the efficiency of public spending, likely affecting developments on this market, in addition to capping public sector wages, as well as to the high degree to which firms had adapted to the epidemiological situation, as well as to the slight improvement in employment intentions in the very short run as shown by some surveys in the first months of 2021.


Relative to financial market conditions, Board members underlined the new significant declines in the interbank money market rates and government securities yields following the January 2021 policy rate cut, as well as their partial or full corrections later on. These corrections had come under the impact of the heightening of international financial market volatility, to which had added influences from the tightening of money market liquidity conditions and from much better-than-expected macroeconomic developments, as revealed by statistical data.


On the government securities market, the movements had been relatively abrupt – similarly to global developments –, Board members noticed, with the yield on the 10-year maturity climbing for a very short while in the vicinity of the levels prevailing in 2020 Q3, from the new historical low seen at the onset of February. The EUR/RON exchange rate had also witnessed a slight upward adjustment, more modest than those in the region, after having remained relatively stable in the first two months of the year, inter alia amid the interest rate differential. Lending rates on the main types of new business had continued to go down December 2020 through January 2021 or had consolidated at their previous low readings, reflecting also the renewed decline in the IRCC level at the beginning of the current year, whose downward trend was expected to persist in the following two quarters, some members noted.

It was deemed that the global financial market would remain a source of heightened risks to developments on the domestic front, but also at a regional and European level, amid investors’ increased inflation expectations and concerns about the outlook for the Fed’s monetary policy stance. That would likely cause a protraction of the ongoing tensions or new episodes of weakening global risk appetite, and hence would entail major portfolio shifts worldwide, with a potential adverse impact on emerging markets in particular.


It was remarked that the annual dynamics of credit to the private sector had witnessed a sharper pick-up in December 2020 – averaging out at 4.7 percent in Q4, only marginally lower than the Q2 average – and had edged down in January 2021. The leu-denominated component had seen its growth rate step up further during the entire period, its flow hitting a historical high in December, amid the recovery of economic activity and as result of government programmes and downtrend in interest rates; thus, in January, its share in total had widened to 69.6 percent, a record high for the post-January 1996 period. It was observed that, in the 2020 specific context, the share of private sector credit in GDP had widened to 26.8 percent, from 25.3 percent in 2019, after eight consecutive years of decline. Against that background, reference was also made to loan moratoria, with favourable implications for the credit stock, but also for the real disposable income, during the suspension of payment obligations to credit institutions, yet with contrary effects subsequently.


Mention was also made of the particularly swift and accelerating growth rates of broad money in recent months – primarily correlated with the budget execution and the dynamics of using European funds –, as well as of the 2020 leap in the economy’s degree of monetisation, expressed as a share of M3 in GDP, which had reached a historical high of 46.3 percent.


As for future macroeconomic developments, Board members highlighted the visibly changed inflation outlook, showing that the annual inflation rate would probably continue to pick up gradually during 2021, until nearing the upper bound of the variation band of the target, and hence considerably exceed the 2.5 percent level previously anticipated for the second half of the year. At the same time, after the foreseeable sizeable downward correction at the beginning of next year, it was expected to climb again above the mid-point of the target and reach 2.8 percent at the end of the forecast horizon – higher than the previously-projected 2.4 percent.

It was observed that the higher and mildly rising values of the inflation rate in the current year, but also their downward adjustment at the onset of 2022 owed entirely to the action of supply-side factors, especially to the transitory impact of costlier electricity – amid the liberalisation of the relevant market – and its disinflationary base effect afterwards. Significant influences, in both ways across different time horizons, also stemmed from the likely developments in fuel prices, as well as from the rise in international agri-food commodity prices, affecting core inflation in particular.

The inflationary impact of those factors could, however, be stronger and lengthier, inter alia via their indirect effects, Board members repeatedly underlined, mentioning the sharp increase in oil prices, but especially the almost broad-based uptrend that global commodity prices had recently embarked on, compounded by bottlenecks in production and supply chains, with an impact on associated costs. A potential materialisation of such a risk would, nevertheless, have a low likelihood of generating second-round effects by means of affecting medium-term inflation expectations, Board members deemed, especially in light of the persistent slack in the labour market, but also in the goods market, given inter alia the opposite influences exerted by such shocks on households’ real disposable income, implicitly on consumer demand in the period ahead.


Board members pointed out that underlying pressures were expected to gradually become mildly inflationary in the latter part of the projection horizon as opposed to their being slightly disinflationary at present. The major premises and assumptions for that evolution were: (i) the delayed pass-through of the disinflationary effects from the negative output gap, as well as of the inflationary ones from the aggregate demand surplus, anticipated to reopen in 2021 Q3 and to widen slowly afterwards, (ii) the relative improvement in the composition of aggregate demand in terms of its inflationary potential, through a higher share of investment to the detriment of private consumption, with implications also for the future evolution of potential GDP, as well as (iii) the likely steep deceleration in the growth rate of unit wage costs over the projection horizon, amid the persistence of labour underutilisation and hence of loose labour market conditions.


Conversely, import price dynamics emerged over the short term as a source of inflationary influences, contrary to previous forecasts, Board members remarked. Mild transitory inflationary effects would likely stem also from the abrupt rise in demand for services after the removal of current restrictions, possibly amid supply-side constraints, as well as from persistent disruptions in production and supply chains.


Under the joint impact of fundamentals and of supply-side factors, the annual adjusted CORE2 inflation rate was expected to continue its slight decline for several months, before seeing it come to a halt and remaining thereafter in the vicinity of 2.7 percent, visibly above the previously-anticipated values.


As for the future of the cyclical position of the economy, Board members showed that the economy would advance at a probably swifter pace in 2021 than envisaged earlier, due to its recovery way above expectations in 2020 Q4, before returning to more moderate dynamics in 2022, amid quarterly growth rates picking up as of the latter part of the current year – against the background of vaccination progress and the easing of restrictive measures –, albeit remaining below those in the pre-pandemic years. It was observed that those developments rendered likely a renewed reversal in the cyclical position of the economy as soon as 2021 Q3, significantly earlier than in the prior projection, but also a slow subsequent rise in excess aggregate demand.

At the same time, it was remarked that, while decisive for economic growth across the forecast horizon, private consumption dynamics would probably trail way behind those prevailing in the pre-pandemic years – excluding this year’s major statistical effect –, in the context of the fiscal consolidation measures taken and the presumed labour market conditions, likely to affect, alongside the inflation rate, the dynamics of households’ real disposable income. By contrast, in the case of gross fixed capital formation, Board members pointed out that faster dynamics than in the 2016-2018 period were expected, and hence a relatively stronger contribution to economic advance, amid the increase in public investment expenditures and the stimulative effect on the private sector, as well as with the support, temporary at least, of government programmes/measures. In turn, net exports would probably see their contractionary impact diminish in the current year, given the hefty recovery of external demand, alongside the solid pick-up in domestic absorption. The favourable implications would also feed through to the economy’s external position, Board members noted, referring to the marginal correction in the current account deficit as a share of GDP anticipated for 2021, accompanied also by a likely slight improvement in its financing structure.


The uncertainties about the new outlook continued, however, to be very elevated, Board members agreed, mentioning the evolution of the pandemic and the associated restrictive measures – amid the third pandemic wave gaining momentum –, as well as the vaccination dynamics across Europe, with potential adverse effects on households’ and companies’ confidence and incomes, but also on the labour market, which might deteriorate further as a result of unwinding government support measures.


It was shown that the investment outlook was further conditional on both consumer and external demand, implicitly on the functioning of global production chains, as well as on the speed of recovery of the home countries of foreign investment – all potentially hit more severely by the resurgence of the pandemic. At the same time, it was observed that accessing the European funds allocated to Romania via the Recovery and Resilience Facility, alongside the increase in absorption and effective use of funds under the Multiannual Financial Framework 2021-2027, would likely boost investment beyond expectations over the longer term. Such an outlook might be consolidated also by the possible relocation to Romania of European companies’ production facilities from other continents – in the context of plans to shorten production chains –, conditional, however, on domestic improvements in infrastructure, legal framework predictability and digitalisation of the economy, Board members reiterated.


As for the future stance of fiscal policy, Board members showed that the recently enacted 2021 budget programme confirmed the start of budget consolidation in the current year, with favourable implications for macroeconomic stability and the sovereign risk premium, and hence for financing costs. Nevertheless, uncertainties lingered with regard to the pace of budget consolidation – presumed to be gradual over the medium term –, as well as to the instruments potentially resorted to further ahead. In that context, reference was made both to the characteristics of budget execution in the early months of 2021 – marked by the renewed impetus of the pandemic and by the vaccination effort, but also by the large share of permanent expenditures – and to the changed prospects for some real and nominal variables in the economy, conducive to an improvement in the short-term developments of budget revenues.


In the Board members’ unanimous opinion, the analysed context warranted leaving unchanged the monetary policy rate and the interest rates on the NBR’s standing facilities. Such a calibration of the monetary policy conduct aimed to preserve price stability over the medium term in line with the 2.5 percent ±1 percentage point flat inflation target, in a manner supportive of the recovery of economic activity in the context of fiscal consolidation, while safeguarding financial stability.

Under the circumstances, the NBR Board unanimously decided to keep the monetary policy rate at 1.25 percent per annum; moreover, it decided to leave unchanged the deposit facility rate at 0.75 percent per annum and the lending (Lombard) facility rate at 1.75 percent per annum. 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.