The National Bank of Romania Board members present at the meeting: Mugur Isărescu, 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; Marin Dinu, Board member; Daniel Dăianu, Board member; Gheorghe Gherghina, Board member; Ágnes Nagy, Board member; and Virgiliu-Jorj Stoenescu, Board member.
During the meeting, the Board discussed and adopted the monetary policy decision, based on the data and analyses on recent features and the updated projection of macroeconomic developments over the medium term submitted by the specialised departments, as well as on other available domestic and external information.
In their addresses, Board members first examined the recent inflation developments. It was noted that the annual inflation rate had ceased to rise in March, staying relatively steady at 0.18 percent, but that in Q1 as a whole it had gone up in line with the projection. The first-quarter performance had been marked by the base effect associated with the standard VAT rate cut to 20 percent, whereas the lowering of the VAT rate to 19 percent and the removal of the special excise duty on fuels as of 1 January 2017, as well as the scrapping of non-tax fees and charges one month later had exerted a contrary impact that had partly offset the mentioned base effect. It was shown that, in terms of the main CPI components, the increase had been driven mostly by developments in core inflation. A modest contribution had also had the return to positive readings of the annual price dynamics for vegetables, fruit and eggs, while opposite influences had come from the slightly faster decline in administered prices and the slower growth of fuel prices in March, as a result of weaker oil prices.
Board members found that the increase in the annual adjusted CORE2 inflation rate – to 1.04 percent in March from 0.33 percent in December 2016 – had, however, largely been ascribable to the base effect associated with last year’s standard VAT rate cut. Of particular note was also the opposite effect on core inflation triggered by the drop in prices of compulsory motor third party liability insurance policies in January. It was assessed that, given the higher-than-expected pick-up in economic growth in 2016 Q4 and the increase in unit wage costs industry-wide, the recent developments in core inflation continued to point to the build-up of underlying inflationary pressures, amid its weakening sensitivity to the output gap.
Turning to economic activity, Board members underscored that the fourth-quarter pick-up in growth – leading to a wider-than-anticipated opening of the positive output gap – had been driven by net exports. By contrast, the contribution of domestic demand to GDP growth had remained unchanged, as developments in final consumption and the change in inventories had offset the impact of the sharp decline in gross fixed capital formation.
Some Board members observed that the contribution of gross fixed capital formation to GDP growth had fallen back into negative territory in 2016 as a whole, chiefly owing to the contraction in public investment, and emphasised the adverse implications on the economy’s growth potential, inter alia by potentially discouraging private-sector investment. On the other hand, private consumption growth – the driving force behind last year’s step-up in GDP dynamics to 4.8 percent – had climbed to a nine-year high of 7.3 percent, mainly on account of higher real disposable income. Furthermore, it was pointed out that, in terms of GDP formation, the key determinant of the pick-up in economic growth had been the services sector, trade included, whereas the agricultural sector had played a secondary part.
As for the latest developments, Board members assessed that the available statistical data pointed for 2017 Q1 to a slight deceleration in GDP growth, which was, however, seen running at a higher-than-previously-projected level and hence entailing a relatively wider opening of the positive output gap. At the same time, they indicated private consumption as the prime mover of economic growth, considering the ongoing brisk expansion in the turnover volume of retail trade, automotive trade, and services January through February. It was pointed out that the contribution of gross fixed capital formation to GDP growth could have stayed in negative territory, albeit at smaller values, given the protracted decline in civil engineering works and the notably faster dynamics of residential construction works, possibly fuelled by the rising trend in house prices. The contribution of net exports to GDP growth was also expected to revert to negative levels in 2017 Q1.
Board members remarked the further increase in the number of employees economy-wide, which had moderated only slightly in February, and the fall in the ILO unemployment rate to 5.3 percent in March. Some Board members voiced, under the circumstances, their concerns about the tightening labour market trend, enhanced by companies’ difficulties in hiring adequately skilled workforce. From this perspective, Board members mentioned the pick-up in the annual dynamics of the average net wage earnings and of the unit wage costs industry wide January through February, partly on the back of the hike in the whole-economy gross wage in February.
Board members discussed the real monetary conditions, which were deemed to have retained their stimulative nature. Mention was also made of the stronger growth of credit to the private sector over the past two months, upheld largely by a rebound in new loans to non financial corporations. It was pointed out that the private credit-to-GDP ratio, which had steadily declined in recent years, similarly to some countries in the region, would most likely bottom out later in the year, also on the back of a reduction in non-performing loan sales. Broad money had, in turn, seen its annual dynamics gather pace and revert to double digit growth rates in the February-March period.
At the start of discussions on future developments, Board members noted that the new medium-term forecast reconfirmed the outlook for the annual inflation rate to gain momentum over the following eight quarters, yet on a lower-than-previously-foreseen path. In particular, the same as in the previous projection, the annual inflation rate was expected to rise progressively during 2017, while remaining below the lower bound of the variation band of the target until towards end-Q4; however, the projected rate for December 2017 was 1.6 percent instead of 1.7 percent in the earlier forecast. Also in line with previous assessments, the annual inflation rate was seen witnessing a sizeable upward correction at the beginning of next year – mainly on account of base effects –, before climbing into the upper half of the target band at mid-2018 H1 and sticking to an upward path thereafter. Members observed that the downward revision of the anticipated inflation trajectory was more pronounced on that segment of the forecast horizon, with the projected annual rate coming in at 3.1 percent in December 2018 from the previously-forecasted figure of 3.4 percent; nevertheless, it was seen climbing to 3.4 percent in March 2019, a similar level to that indicated in the previous projection for the end of its horizon.
In their analysis, Board members pointed out the major role that supply-side factors continued to play in the configuration of the upward path of the forecasted annual inflation rate, especially over the short time horizon. It was shown that, while the base effects associated with the cuts/scrapping of indirect taxes/fees and charges were quasi-certain, projections were surrounded by uncertainties related to fuel prices, prices for vegetables, fruit and eggs, and administered prices, as well as to their indirect effects. It was deemed that the risks induced by the latter two price categories were relatively balanced, whereas the balance of risks associated with future developments in the international oil price was tilted to the downside.
Board members underlined that the anticipated behaviour of core inflation was the key determinant of the prospective pick-up in inflation, as well as of the downward revision of the inflation forecast. It was pinpointed that, similarly to the earlier projection, the forecasted path of the annual adjusted CORE2 inflation rate trended strongly upwards in 2017 H2, gaining considerable traction during 2018, albeit running below the previously-anticipated trajectory. It was noted that the repositioning of this measure to lower values was attributable to the weaker relationship between core inflation and the output gap, given that the opening of the positive output gap was expected to be relatively wider throughout the forecast horizon, amid the upward revision of economic growth projected for 2017 and 2018; moreover, rising inflationary pressures, or at least comparable to those in the previous forecast, were anticipated to stem from unit wage costs, prices of imports – against the backdrop of the likely increase in their volume –, as well as from the uptrend in short-term inflation expectations.
Turning to the economic growth foreseen for 2017 and 2018, Board members remarked that its slowdown compared with 2016 was visibly more moderate than that highlighted in the previous projection. It was indicated that the main assumption underlying the outlook was the relative strengthening of the pro-cyclical stance of the fiscal and income policies across the projection horizon; furthermore, it implied an accommodative nature of real monetary conditions comparable to that in the earlier forecast and sturdier economic growth in the euro area/EU and globally.
According to assessments, household consumption was seen to likely remain the driver of economic growth in the following two years as well, given the sustained rise in real disposable income. Gross fixed capital formation was anticipated to have a positive, albeit modest contribution. It was pointed out that the recovery in investment was conditional on the improvement in EU funds absorption and further favourable corporate financing conditions, including on account of profits – potentially affected, inter alia, by the increase in wage- and commodity-related costs –, as well as on strengthening investor confidence, also by reducing legislative uncertainty. Members highlighted the importance of carrying out the planned public investment, also in light of the potential stimulative effects on private investment.
Also from this perspective, Board members viewed the future fiscal and income policy stance and the likely composition of public spending as the main sources of uncertainties and risks to the medium-term inflation forecast, particularly in the context of the uncertainty regarding the new unified wage law and the possible corrective fiscal measures. Members underlined the adverse influences on inflation, as well as on the current account deficit, that would derive from an increase, against this backdrop, in the fiscal impulse and hence a widening of the positive output gap, but also from the possible rise in companies’ wage costs under the impact of a demonstration effect and the tightening of labour market conditions.
At the same time, however, reference was made to the authorities’ commitment to ensure compliance of the fiscal deficit with the 3 percent-of-GDP reference value in 2017, as well as to the likely implications on the final version of the unified wage law – pending adoption – and on the sources of budget revenues, possibly supplemented by new fiscal measures. Mention was also made of the characteristics of budget execution in the period from January to March 2017 – which had ended on a slight surplus –, as well as of the measure requiring state-owned companies to pay a larger share in profits, as dividends, to the budget; moreover, the risk of further weak EU funds absorption under the new Multiannual Financial Framework was pointed out.
In the Board members’ assessment, the external environment also continued to pose two-way risks to the inflation forecast. Members noted, on the one hand, the balancing trend of the risks to the outlook for economic growth and inflation in the euro area/EU and globally, inter alia amid the ongoing accommodative monetary policy stance, especially in developed countries, and the anticipated fiscal stimulus to the US economy. On the other hand, significant downside risks were seen to further arise from the elections scheduled in the euro area, the Brexit talks, as well as from the economic policies implemented by the new US Administration.
In light of the analyses, Board members judged it appropriate to leave the monetary policy stance unchanged, with a view to ensuring price stability over the medium term in a manner conducive to achieving sustainable economic growth. Specifically, the NBR Board unanimously decided to keep the monetary policy rate at 1.75 percent per annum; in addition, the Board unanimously decided to maintain at ±1.50 percentage points the symmetrical corridor defined by the interest rates on the standing facilities around the policy rate, to further pursue adequate liquidity management in the banking system, as well as to leave unchanged the minimum reserve requirement ratio on leu-denominated liabilities of credit institutions. At the same time, given the contraction in foreign currency credit, the consolidation of forex reserves above the adequate level and their improved composition, the NBR Board unanimously decided to cut the minimum reserve requirement ratio on foreign exchange-denominated liabilities of credit institutions to 8 percent from 10 percent starting with the 24 May – 23 June 2017 maintenance period. The measure aimed to continue the harmonisation of the minimum reserve requirements mechanism with the relevant standards and practices of the European Central Bank and the major central banks across the European Union.