February 2008

1. Romania: Recent Macroeconomic & Banking System Developments February 2008 NATIONAL BANK OF ROMANIA

2. CONTENTS • Recent Macroeconomic Developments………….....…………3 • Inflation Developments and Outlook……..………….....……..7 • Monetary Policy and Policy Mix…………………........……...22 • Real Sector Developments …………………….………….......28 • External Sector ………………………………………….….……34 • Exchange Rate Regime ………………………………………...41 • Fiscal Position ……………………………………………..….…56 • Monetary Data ……………………………………………….......59 • Financial System …………………………………….….…..…..71 • Euro Adoption ………………………………….…….…….…....76 • Economic Relations with the USA………….……....…..84

3. Recent Macroeconomic Developments

4. Recent Macroeconomic Developments (1) • CPI inflation: • Annual rate: 6.57% (Dec. 2007/Dec. 2006) 7.26% (Jan. 2008 /Jan. 2007) • Average annual rate: 4.84% in 2007 5.11% :(Feb. 2007-Jan. 2008)/( Feb. 2006-Jan. 2007) • GDP growth: 2006: 7.9% based on increases in final consumption by 9.3% (private consumption grew 11.4%) and in investment by 19.3% Jan.-Sep. 2007: 5.8% based on increases in final consumption by 9.7% (private consumption grew 9.9%) and in investment by 25.3% • Current account deficit: 2006: EUR 10.2 bn., up 47.4% yoy; (10.4% of GDP); 86% covered by FDI 2007: EUR 16.9 bn., up 66.1% yoy; (14.4% of GDP);42% covered by FDI • Foreign Direct Investment: • 2006: EUR 8.7 bn., up 66.6%yoy • 2007: EUR 7 bn., down 19% yoy

5. Recent Macroeconomic Developments (2) • Fiscal balance (IMF Methodology): 2006: -1.5% ofGDP 2007 (preliminary data): -2.4% of projected GDP • International reserves(foreign currency including gold): 2007: EUR 27.2 bn.; forex reserves EUR 25.3 bn. January 31, 2008: EUR 27.6 bn.; forex reserves EUR 25.6 bn. (covering about 4.8 months of prospective goods-and-services imports) • Financial intermediation 2007forecast: 37.9% of GDP • Real growth of loans to the private sector 2007: 50.5% (RON: 30.6% foreign currency: 72.6%)

7. Inflation Developments and Outlook

19. Wage increases overtakingproductivity gains Protraction or even worsening of the wage-productivity mismatch might lead to a dangerous wage-inflation spiral Implementing a looser budget policy, specific to an election year Failure to achieve the planned dynamics of budget revenues and making unforeseen public expenditures Financing current expenditures to the detriment of capital expenditures Faster deterioration of inflation expectations Higher oil prices Further increase in the oil price is a plausible scenario on international markets Good agricultural year Boosted by a favourable base effect, the larger-than-expected increase in agricultural output (the projection assumes an average agricultural year for 2008) would have a sizable impact on food prices The Government’s commitment on: Wage increases in line with productivity gains Narrowing of the budget deficit Improvement of public spending structure Potential Causes for Deviation of Inflation Ratefrom the Projected Path

20. Nature of risks and uncertainties associated with the current medium-term projection is generally similar to the previous one (November 2007) HOWEVER In the event of upside risks to inflation materialising – especially if occurring simultaneously, this could have more severe consequences given the tensions in the international and domestic environments The effects of the fiscal easing which in the previous years had allowed companies to absorb cost-related shocks without their having a major impact on inflation have faded External financing will be available at higher costs, at least for a period of time Consequences of Risks Associated with the Projection Materialising

21. Even though annual inflation rate is projected to exceed the upper limit of the annual variation band until 2009 Q1, the NBR has chosen to tighten its monetary policy stance instead of revising inflation targets Over a period marred by numerous uncertainties and exogenous shocks, it is of the essence to: Bring inflation as fast as possible back to the announced medium-term disinflation trajectory Ensure the sustainability of disinflation by avoiding a wider current account deficit Maintenance of Inflation Targets for 2008 and 2009

22. Monetary Policy and Policy Mix

23. Decisions of the NBR Board • To raise the monetary policy rate three times in the last 4 months (by 0.5 pp in November 2007, by 0.5 pp in January 2008, and by 1 pp in February 2008) to 9.0 percent p.a., from 7.0 percent • Proactive measures substantiated by: • worsening of the short-term inflation outlook • need for efficient anchoring of inflation expectations • boost in saving by ensuring a real positive interest rate, considering the need to reduce the savings/investment imbalance, aimed at correcting the external deficit • To continue to pursue a firm management of money market liquidity via open-market operations • Ensure efficient transmission of the monetary policy signal • Contain the volatility of short-term money market rates • To adopt additional prudential measures, including higher provisioning for foreign exchange-denominated loans to unhedged borrowers • To leave unchanged the existing minimum reserve requirement ratios on both RON- and foreign currency-denominated liabilities of credit institutions

24. Prudential Measures Adopted in the NBR Board Meeting of February 2008 • Separate recognition of the currency risk effects assumed by borrowers, natural entities,through additionalprovisioningof foreign currency-denominated loans to unhedged borrowers (individuals who do not earn incomes in the loan denomination currency) • Lenders must submit to the NBR their amended internal lending norms, within 30 days from publication of the new provisions in the Official Gazette, so that they comply with the recently adopted requirements

25. The economic policy mix is more important than any of its components  A restrictive monetary policy can offset only partly the lack of support from budget and fiscal policies and income policy in attaining the price stability objective: Usually, over the short term By taking the risk of persistent distortions, whose subsequent correction by the authorities is costly and lengthy, a spontaneous correction could be massive and disorderly  The outcome is suboptimal in terms of real convergence in the medium and long term Economic Policy Mix and Macro-stability (1)

26. Economic Policy Mix and Macro-stability (2) The economic policy mix needs to be reconsidered all the more so as: • Turbulence on world markets is persistent • The increasing international prices of agri-food items, energy and gold fuelled inflation • Romania’s external deficit has widened to unsustainable levels  need for gradual correction (to avoid disorderly correction) • Domestic currency appreciation is unlikely to be a major contributor to disinflation • Wage pressures will remain high in the context of EU integration

27. Optimal Economic Policy Mix • Continuation of structural reforms so as to boost the growth of productivity and external competitiveness of Romanian products • High monetary policy restrictiveness • Tighter-than-expected fiscal policy, likely to help narrowing macroeconomic imbalances • Containment of public spending growth and its channelling mainly towards public investment meant to foster the production potential of the economy • Improved budget planning by approving multiannual budgets and ensuring a uniform and predictable budget execution • An income policy matching productivity gains

28. Real Sector Developments

34. External Sector

41. Exchange Rate Regime

42. Liberalization of International Flows • 1998: Current account operations(Art. VIII of IMF Articles of Agreement) • 1999: Medium- and long-term capital inflows • 2001-2002: Capital flows with low impact on the balance of payments • 2003-2004: Capital flows with significant impact on the real sector • 2005-2006: Capital flows with significant impact on the balance of payments • September 2006: Full convertibility of the national currency

43. Exchange Rate: implications of full convertibility • Full convertibility of the RON renders monetary policy conduct difficult • Massive inflows of speculative capital put downward pressure on the exchange rate of the RON • Support disinflation in the short term BUT • Imply risks to financial stability • great likelihood of a reversal in speculative flows • keener interest in forex borrowings  increase in external indebtedness of domestic companies, particularly in the short term  currency risk overexposure • Foster excess demand

47. Exchange Rate – Recent Developments and Outlook • The nominal appreciation trend manifest over the past three years came to a halt • The RON exchange rate reverted to a trajectory compatible with macroeconomic fundamentals, following the overappreciation at mid-2007 • The correction was faster and larger due to the increased risk aversion of investors, caused by the US sub-prime mortgage crisis • In spite of the unfavourable short-term impact on inflation, exchange rate flexibility is an advantage, as it: • Allows the avoidance of excessive accumulation of macroeconomic imbalances which may generate crises • Operates as a self-correcting mechanism of current imbalances, alleviating the impact of external shocks • Return to a nominal appreciation trend is sustainable only in the context of productivity gains able of improving external competitiveness

48. Daily Nominal Exchange Rates (local currency/EUR) Source: Eurostat, National Bank of Romania