May 18, 2004
Talking up the leu
A commentor on the last post mentioned the external debt issue.
Romania's external debt has been rising and rising, which should cause the leu to fall at some point. But this hasn't happened yet. In fact, the leu has risen a little bit. (Against the euro. It's risen a lot against the dollar, but so has everyone else.)
I think the reason for this is that the National Bank is talking tough on inflation. That is, they are LOUDLY saying that they won't allow inflation above 9% next year.
What this means -- and what they're really telling the world -- is that if the leu falls, they will raise interest rates to defend it.
Now, as long as investors believe this, they will tend to keep their money in lei. This, in turn, tends to keep the leu strong. In other words, the Bank is "talking up the leu".
The only problem with this is that sooner or later, if the external debt continues to rise, people will stop believing that the Bank will defend the leu. The only think that will convince them will be if the Bank starts to *really* defend the leu -- like, by raising interest rates.
For what it's worth, though, I think that the Bank is doing the right thing. An interest rate increase will tend to slow business activity and growth. So you want to delay it as long as possible. So "talking up the leu" is a good, rational short-term strategy.
As I mentioned a while back, the National Bank of Hungary didn't do this last year. They sent mixed messages. Sometimes they said reducing inflation was their top priority. That's how a National Bank says "we will raise interest rates to defend the currency". But then sometimes they said growth was the most important thing, which sounds more like "we will accept some inflation for better growth, so we probably won't raise interest rates". So they ended up with the worst of both worlds -- speculators attacked the forint, and they had to very suddenly raise interest rates quite sharply (from 9.5% to 12.5% in less than a month).
The National Bank of Romania seems to have been paying attention to this. And that's good.
Of course, if the external debt continues to grow, eventually it won't matter. The leu will fall, and the NBR will have to choose between inflation or higher interest rates.
A cynic might suggest that "eventually" will arrive pretty soon after the election (late November). I guess we'll see.
Posted by douglas at May 18, 2004 11:08 AMDon't forget that the inflation rate of the forint is still around 7%. Compared to the U.S. dollar, the forint is still strong. In August 2002, the dollar was at 270-280 forints. Now it's at 204.
About the strategy of the Hungarian National Bank:
1. The govt. put the Bank under heavy pressure to do what they say; the Bank resisted. That's why govt. officials, the Secretary of Finance and the President of the National Bank said completely different things.
2. The Bank wanted to defend the forint, but the government has spent so much that they _needed_ correction in interest rates. This is our worst government since the Change...
Sniper
Posted by: Sniper at May 30, 2004 07:41 AMHi Sniper,
I'd expect the forint to be strong against the dollar, given its high interest rates. (Although I understand the Bank cut interest rates earlier this year.)
The forint seems to have come through the storm of last November pretty well. However, the combination of big government deficits and a large trade deficit is going to cause problems sooner or later.
There are stopgap measures that are possible -- restricting consumer credit, raising VAT on luxury goods that are imported -- but these two trends are going to put a lot of pressure on the forint. Unless Hungarian productivity grows VERY fast, eventually the government and the National Bank will have to choose between accelerating inflation, or higher interest rates and (probably) slower growth and higher unemployment.
Doug M.