More pain on foreign exchange as local currency is expected to hit RON 4.4/EUR

The unstable fiscal environment, political climate and a dire need for financing continue to put pressure on the currency exchange rate. Both international and local dealers see it reaching RON 4.4/EUR by the end of the year.

Dana Ciuraru

On the first day of this month the RON reached its highest level in the past five weeks, RON 4.2636/EUR – making the chance of a stable and reasonable RON/EUR rate even more remote.

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Win Thin, a senior currency strategist at Brown Brothers Harriman & Co. (BBH), said on September 2 – the day of the Romanian government reshuffle – that, “Developments in Romania support our recent bearish call on the RON. The EUR/RON has risen since we went long on August 30 around 4.24. We still target the record high of 4.40 from June and expect this pair to creep upwards in the coming weeks. The 4.23 area represents the 50 percent retracement level of the big March-June rise, and is providing a strong base for the euro right now. Intermediate targets are retracement levels around 4.29, 4.31, and 4.33 from the June-August drop.”

Local market dealers confirm BBH’s market analysis, saying that a rate of RON 4.4/EUR would correctly reflect economic fundamentals. “In this case, our predictions coincide with those made by the BBH specialists. We could expect RON 4.4/EUR in the next period,” said a market dealer.

Meanwhile, reports from Raiffeisen Bank see the euro at a rate of RON 4.4 for September, while Unicredit specialists are talking about a level of RON 4.35/EUR for the end of the current year.

The rate is expected to strongly influence the commercial balance as over 70 percent of Romania’s trade takes place with entities on EU territory.

FX comes under pressure

According to the BBH senior currency strategist, the political instability is likely to get worse in Romania, which could influence the exchange rate. He points out that the minority government barely survived a vote of no confidence in June over plans to cut pensions and salaries, and another such motion is likely to be called by the opposition this fall, as the popularity of the government has plunged to all-time lows.

Andrei Ciubotaru, head of brokerage at Tradeville, told Business Review that the contraction of the Romanian economic environment is showing no sign of reversal. Quite the contrary, the pace of shrinkage could accelerate in response to measures to increase tax. According to him, from the several possible explanations, the most important is that the Romanian economic environment’s solvability is insufficient to cause an increase in lending, as, for instance, there are more borrowers in the banking system than there are workers with employment contracts.

“The horizontal evolution trend of the EUR/RON may suddenly be disrupted by events such as the political crisis, an interruption of the grant agreement with the IMF or failure to achieve the macroeconomic targets agreed by the Romanian government. These events may act only in terms of currency depreciation,” said Ciubotaru.

“The RON has experienced depreciation pressures, amid concerns about the return to global growth. We believe that the BNR will not prevent the depreciation pressures, if they are not aggressive, so as not to lead to more restrictive financial conditions,” said Vlad Muscalu, ING economist, recently.

USD and CHF sees clouds ahead

Since the beginning of year the EUR has also depreciated against the USD and Swiss Franc (CHF). The Tradeville specialist points out that the international markets have started to include in the price of financial assets the possibility of the global economy going back into recession. The EUR will not be able to strengthen against the USD and CHF until the financial markets are convinced that there will be no double dip in the short term.

“So the Romanian currency is exposed to further depreciation against the USD and CHF in the foreseeable future. In the event of further depreciation of the RON against the EUR because of an internal shock then depreciation in relation to the CHF and USD will be much greater. If the percentage of nonperforming loans increases, then the Romanian banking system will need to seek additional resources from outside Romania for refinancing. This will exert even greater pressure in terms of currency depreciation,” said Ciubotaru.

The pressure to seek additional resources is already showing. Recently there was yet another failed bond auction, as the Finance Ministry rejected all bids for the RON 300 million five-year paper offered. Officials continue to try and put a 7 percent ceiling on borrowing rates, but there are simply no takers in this risk-averse environment.

“The more auctions that fail now, the more trouble Romania will be in down the road. Indeed, one of the assumptions behind any debt sustainability framework centers on getting borrowing rates back to ‘normal’ levels,” said Thin.

Making matters worse, the international specialist says, the unpopular government is undertaking a cabinet reshuffle that saw the finance minister, Sebastian Vladescu, replaced. “If the new finance minister shows less commitment to the austerity plans, then the IMF package will be at risk. It did just receive approval in its fifth review under the current program, but the 24-month stand-by arrangement expires in May 2011. There is no way Romania can stand without IMF aid, and so the markets should watch closely for signals by the new minister,” said Thin.

But the RON’s rough ride will not be indefinite. Less troubled times for the exchange rate should come in 2011, said Rozalia Pal, chief economist for UniCredit. “The RON will register some appreciation in 2011, but especially in the second half of 2011.”