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					Romania

                                                                                                Nicolaie Alexandru-Chidesciuc


Weekly update
                                                                                                Senior Economist
                                                                                                Vlad Muscalu
                                                                                                Economist



Growth could fall like a rock

                                                                                           __




                                                                                                Key policy rate and CPI
   We always talked about 2009 as an adjustment year, and now
   we see growth at about 2%. The RON should depreciate
                                                                                                15
   gradually during 2009 so, although disinflation started in                                                                            F'cast

   August, the NBR risks missing the inflation target again.                                    11



                                                                                                 7


   Recent developments                                                                           3

   •   3Q08 GDP growth above expectations. Nonetheless, the breakdown                            Jan-05    Jan-06   Jan-07
                                                                                                          Poli cy rate (%)
                                                                                                                             Jan-08   Jan-09
                                                                                                                                 CPI (%YoY)
       reveals highly worrying developments as services contracted sharply.
                                                                                           Source: NBR, NIS, ING estimates

   •   Finance minister says budget deficit widened to 2.9% of GDP in                      __




       November.

   •   Industrial production contracts 3% YoY in October. Industrial output                     Romanian leu (eop)

       growth turned negative, in line with our expectations.
                                                                                                4.1              IN G EU R/R ON
                                                                                                                 forecast
   •   Wage growth softens up in October. The net average nominal wage                          3.9              Im pli cit EUR/RON
       increased by 22.4% compared to 24.6% YoY in September.
                                                                                                3.7


   The week ahead                                                                               3.5


   •   On Friday, we expect Romania’s CPI to drop to 7% in November due to                      3.3

       sharply lower crude prices and a favourable base effect. With regards to                 3.1

       external trade, we expect a slight widening because of seasonal imports                   Jan-05 Jan-06 Jan-07 Jan-08 Jan-09

       and less demand from abroad. At the same time, we do not exclude                    Source: Reuters and ING estimates
       another sharp increase in the C/A deficit as profit repatriation most likely        _




       was stronger in October than in September.
                                                                                           Core projections
                                                                                                                                  2007    2008F

                                                                                           Real GDP (%YoY)                         6.0       8.0
                                                                                           Current account (% of GDP)            -13.9     -14.2
                                                                                           Inflation (%YoY, avg)                   4.8       7.9
                                                                                           Key policy rate (%)                    7.50     10.25

                                                                                           Source: ING estimates




  This publication has already been published under the ING Bank Wholesale Banking brand
                                                             Romania Weekly Update              8 December 2008



                            Assessment
                           The dismal industrial output, along with the weak data on construction activity released
                           on Friday (which suddenly fell from 28.3% to 19.1% YoY), implies our 4Q08 GDP
                           forecast carries a sizeable downside risk. The outlook remains dire for the industrial
                           sector for the rest of the year and especially in 2009, which is negative for next year’s
                           growth prospects, though our 2009 GDP forecast is already at 1.7%. Given our bleak
                           view on economic activity, we expect a considerable decrease in wage growth in the
                           following year. We do not exclude growth in real wages turning negative, chiefly in the
                           private sector. The public sector is likely to have a different development if the hike in
                           teachers’ wages is actually implemented. However, this will not be enough to
                           compensate for the expected fall in incomes of workers in other sectors, thus we
                           expect consumption growth to fall substantially in 2009. The acceleration in private
                           consumption in 3Q08 is explained by self-consumption and by possible issues in
                           estimating deflators (this view is supported by the fact that inventories – which have no
                           substantial economic meaning – contributed -7.7ppt to third quarter growth). The
                           inventories impact is striking by any measure.

                           On the election front, the PSD (social democrats) just announced they will start
                           negotiations with the PD-L (democrat liberals, the president’s party), but they
                           conditioned such an alliance on excluding the UDMR (ethnic Hungarians).
                           Nonetheless, talks with the PNL (ruling liberal party) cannot be excluded as PSD
                           members are divided between an alliance with the PD-L or the PNL. Therefore,
                           although some steps in the right direction were taken, we still have to wait for a final
                           outcome. Romania needs the approval of a new government as soon as possible
                           given current and expected fiscal developments.

                           We want to point out that Romania also needs a government to implement harsh
                           measures with short-term costs, but medium-term benefits. Otherwise, we are afraid
                           that, in the medium term, we may end up with sluggish economic growth for several
                           years. It seems that political parties have become more aware about the impact the
                           global crisis is having on Romania, but did not announce any important measures yet
                           as they remain focused on negotiations.

                           The news is positive as the move came faster than expected and since the two parties
                           have 70% of the seats. However, we think the measures to be announced by any new
                           government are of utmost importance.


                            Data releases
                           3Q08 GDP growth above expectations


                              Nonetheless, the breakdown reveals highly worrying developments as services
                              contracted sharply.


Agriculture expanded at    GDP increased by about 9.1% YoY in 3Q08, slightly above our forecast (8.7%) and
    a fierce pace of 35%   market consensus (Bloomberg: 8.7%, Reuters: 8.9%). The explanation of the still
        YoY but services   strong expansion comes from agriculture, which grew by about 35% YoY vs our
   slowed down sharply     forecast of 15%, which means agriculture added 4ppt to 3Q08 growth. We advised that
 from 7.6% to 2.6% YoY     agriculture output could bring positive surprises, but farming output growth was so
                                                                                            Romania Weekly Update                8 December 2008


                                             strong that it even more than compensated the sharp slowdown in services from 7.6%
                                             to about 2.6% YoY in the third quarter of 2008.

     This should sound                       The contraction in services was faster and stronger than we expected (we had 6.2%
      alarm bells as the                     YoY) and this should sound alarm bells as this component accounts for about 50% of
    services component                       GDP. We had forecasted similar numbers only in 1Q09 and afterward as we thought
 accounts for about 50%                      services should show some persistence by looking at historical developments. Looking
                 of GDP                      at the structure, the biggest deceleration was registered in “Financial intermediation;
                                             real estate, renting and business activities” from 6.5% to 2% YoY, followed by public
                                             administration. The component “Wholesale and retail activities, personal and
                                             household goods, hotels and restaurants; transport, storage and communication”
                                             corrected as well quite sharply from about 9.5% to 4% YoY growth in 3Q08.

  GDP growth excluding                       As a result of the above developments, the growth of GDP excluding agriculture output
 agriculture fell abruptly                   fell abruptly from 9.6% to about 5.8% YoY, according to our calculations. If we exclude
  from 9.6% to 5.8% YoY                      net taxes besides farming, it fell to 5.6% YoY. Moreover, our forecast implies a further
                                             deceleration towards 4% in the fourth quarter, with risks for a lower number.

   The agriculture effect                    The sharp slowdown should become visible in 1Q09 as agriculture’s impact should
     should dissipate in                     dissipate. Furthermore, additional worsening of Eurozone growth along with a bad
 1Q09, revealing a sharp                     agricultural year – that we have not included in our forecast – could push GDP growth
              slowdown                       into negative territory in 2009.

 Fig 1     GDP growth and supply-side components’ contributions (pps)
 10                  9.8                                                                                                                     9.3   9.1
                                       9.5                                            7.9       8.4                                    8.2
                                                                                                      7.9                        6.6
  8            7.0                                                              7.0
        6.3
                                                   6.0                                                      6.1     5.7    5.7
  6
                                                            4.7
                                                                         4.3
  4
                                                                  2.6
  2

  0

  -2

  -4
       1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08
                           Industry              Services         Agriculture         Construction      Net Taxes         GDP Growth (%)

Source: NIS, Eurostat, ING estimates
                                             _




     Private consumption                     Also, we feel the need to highlight that most likely the private consumption acceleration
   less self-consumption                     in 3Q08 from 12.2% to 14.6% YoY is based on self-consumption – which is a very
             has probably                    important component and is highly dependent on agricultural output. Therefore, we
       decelerated, which                    believe that the exclusion of latter component from private consumption would reveal a
         translates to less                  deceleration, which means pressure on prices is decreasing. In addition, we stated
       pressure on prices                    previously that the National Institute of Statistics has issues in estimating deflators for
                                             imports and exports, thus consumption data could suffer as well as rendering private
                                             consumption growth numbers unreliable. We think this is the reason for the strong
                                             impact from inventories.

    Investments, mainly                      As regards fixed investments, more than 50% of it represents construction activity and
 driven by construction                      another significant part is cars. Both these are likely to decrease considerably in 4Q08.
         activity and car                    Moreover, 4Q04 data showed that elections had a terrible impact on investment
 purchases, are likely to
      decelerate in 4Q08
                                                                                                                                                                                                                                                                                                                                                                                   Romania Weekly Update        8 December 2008


                                                                                                                                                                                                                                                                                                     activity and we believe this is likely to repeat this year. This would imply lower imports
                                                                                                                                                                                                                                                                                                     as well.
As regards fixed investments, more than 50% of it represents construction activity and another significant part is cars. Both these are likely to decrease considerably in 4Q08. Moreover, 4Q04 data showed that elections had a terrible impact on investment activity and we believe this is likely to repeat this year. This would imply lower imports as well.




            Fig 2                                                                           GDP growth and expenditure components’ contributions (pps)

                 18

                 13

                            8

                            3

                      -2

                      -7

            -12
                                                         1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08
                                                                   Individual consumption      Public consumption         Gross Fixed Capital Formation
                                                                                                                                                                            Inventories                                                                                                                                                                              Net Exports               GDP Growth (%)

Source: NIS, Eurostat, ING estimates




                                                                                                                                                                                                                                                                                                     Finance minister says budget deficit widened to 2.9% of GDP in November
                                      Budget shortfall                                                                                                                                                                                                                                               The finance minister confirmed earlier speculation saying the budget shortfall
                                  expanded to 2.9% of                                                                                                                                                                                                                                                expanded to 2.9% of GDP in November. This is a sharp expansion past the latest-
                                 GDP according to the                                                                                                                                                                                                                                                available official data, which shows a 1.42% of GDP deficit was recorded at the end of
                                      finance minister                                                                                                                                                                                                                                               September, and, given December expectations, it could be above our year-end
                                                                                                                                                                                                                                                                                                     forecast of 3.5% of GDP (cash basis). There are significant risks that this turns out to
                                                                                                                                                                                                                                                                                                     be true.

                         A widening to 4% of                                                                                                                                                                                                                                                         A widening to 4% of GDP at the end of this year – as suggested by some other MoF
                        GDP is harmful for the                                                                                                                                                                                                                                                       officials – could prove very harmful for the RON. Moreover, it increases the chance the
                                         RON                                                                                                                                                                                                                                                         budget shortfall for 2009 will stand above our estimate of 5.5% of GDP, with negative
                                                                                                                                                                                                                                                                                                     implications for both economic growth and the local currency.



                                                                                                                                                                                                                                                                                                     Industrial production contracts 3% YoY in October


                                                                                                                                                                                                                                                                                                                                      Industrial output growth turned negative, in line with our expectations.


   Industrial production                                                                                                                                                                                                                                                                             Although the September headline figure showed a 3.8% YoY increase, the seasonally-
 registered the sharpest                                                                                                                                                                                                                                                                             adjusted rate was barely positive. In October, industrial production registered the
contraction in more than                                                                                                                                                                                                                                                                             sharpest contraction in more than three years and this may only be the beginning.
           three years…                                                                                                                                                                                                                                                                              Large chemicals-producer Oltchim has announced a 20-40% cut in output in
                                                                                                                                                                                                                                                                                                     November while Renault-owned carmaker Dacia has extended an almost three-week
                                                                                                                                                                                                                                                                                                     halt in production by another month.

                                                                           ...and the outlook                                                                                                                                                                                                        This should lead to a sharp contraction in November and the downtrend is likely to
                                                                                 remains dire                                                                                                                                                                                                        continue as Eurozone leading indicators point to a considerable deterioration in
                                                                                                                                                                                                                                                                                                     business activity. All these also imply sluggish profits and wages growth that could
                                                                                                                                                                                                                                                                                                     lead to a deterioration of consumer and business confidence. Therefore, at some point
                                                                                                                                                                                                                                                                                                     in future, policymakers' attention might shift away from inflation to the real economy.
                                                                              Romania Weekly Update             8 December 2008


                                      The industry breakdown shows the largest contraction took place in the manufacturing
                                      sector where output dropped by 4.7% YoY as this sector is most exposed to external
                                      demand. A softer deceleration took place in the energy sector while mining activity
                                      remained roughly unchanged. Among goods categories, the capital and intermediate
                                      goods contracted sharply, while energy and current goods proved more resilient.

 Fig 3     Industrial output (%YoY)

    25

    20

    15

    10

      5

      0

     -5

   -10
     Jan-06      Apr-06      Jul-06       Oct-06      Jan-07     Apr-07    Jul-07   Oct-07    Jan-08   Apr-08   Jul-08   Oct-08

                                                   Total       Mining     Manufacturing      Energy

Source: NIS, ING estimates
                                      _




                                      Wage growth softens up in October


                                           The net average nominal wage increased by 22.4% compared to 24.6% YoY in
                                           September.


        The pace of wage              We were expecting a mild slowdown, but the deceleration slightly surpassed our
     growth in the private            estimation. Although public sector wage growth decelerated less than our
  sector is likely to follow          expectations, the slowdown in the private sector more than compensated the former
   a decelerating trend…              soft deceleration. Workers are feeling the effects of the companies’ struggles to cope
                                      with falling demand and, since we expect economic activity to soften going further, the
                                      pace of wage growth in the private sector is likely to follow a decelerating trend.

 …but a sharp slowdown                A sharp slowdown seems unlikely as the dynamic of public sector wages is strong and
         seems unlikely               workers in this sector account for almost 25% of total employees. This could prevent
                                      sharp falls in annual growth rates in particular if the 50% increase in teachers’ wages is
                                      implemented.
                                                                              Romania Weekly Update               8 December 2008



 Fig 4     Average wage dynamics (%YoY)

                                                     74.8                                             52.6
   35
   30

   25
   20

   15
   10

     5

     0
    -5
    Jan-06       Apr-06      Jul-06       Oct-06   Jan-07       Apr-07    Jul-07    Oct-07   Jan-08      Apr-08   Jul-08   Oct-08

                                               Private Sector       Public Sector     Average wage

Source: NIS, ING estimates
                                      _




                                          FX and money market strategy

                                            The front end of the depo curve is likely to continue to soften as flows from the
                                            MoF return to the market around this time of the month. Sharp falls should not
                                            be expected as the central bank is likely to step in the money market absorbing
                                            excess liquidity.


                                            News that the budget deficit has almost reached 3% of GDP in November is
                                            likely to drive EUR/RON upwards. The 3.8500 resistance level has been broken
                                            and the pair seems to be biased to the upside as this is also supported by low
                                            interest rates.


                                      Money market and fixed income
                                      The increase in available liquidity, caused by the cut in RON reserve requirements,
                                      continued to drive interest rates lower. Short-term funding rates opened the week at
                                      15% and traded at the end of Friday’s session at 12%. As we anticipated, short-term
                                      funding rates slipped below the NBR credit facility and look likely to fall below the key
                                      policy rate of 10.25% during this week. Large falls below this level should not be
                                      expected as the central bank will probably hold open-market operations to prevent the
                                      building of cheaply funded large short-RON positions.

                                      On the primary debt market, the MoF sold RON612m in 3M T-bills and RON221m in
                                      5Y T-bonds at yields up to 14.25% and 13%, respectively. This week it plans to sell
                                      RON1bn in 6M T-bills for which it paid a maximum yield of 14.25% in the previous
                                      month. The MoF has repeatedly stated that it will not accept yields above the 14.25%
                                      credit facility level of the NBR, but demand below this level is turning thin as the
                                      average accepted yield have risen sharply and now stands at a maximum 2bp below
                                      14.25%. The news that the budget shortfall reached 2.9% of GDP in November could
                                      soften demand for MoF instruments, forcing the MoF to accept higher yields to access
                                      liquidity. When the 14.25% threshold is broken, yields are likely to jump in large steps
                                                                    Romania Weekly Update                     8 December 2008


                               after a period of one month and a half during which they should have strangely stalled
                               at this level.

Fig 5    Short-term rates – weekly assessment

                                Direction                                            Comment

NBR key policy rate path         ◄►           The central bank kept its powder dry at the last rate-setting meeting. The expected
                                              sharp adjustment in economic growth could turn the NBR’s attention away from
                                              inflation, which means a cut in the key rate during 1Q09 and more cuts in the MRR
                                              for both RON and FX should not be excluded.

NBR open-market operations       ◄►           If the central bank organises the usual Monday open market operation, it will probably
                                              not raise any significant interest as SW rates trade above the key policy rate. Since we
                                              expect the front end of the curve to slip below 10.25% in the following session, there is
                                              a possibility the NBR will drain excess liquidity from the market in the last trading
                                              sessions of the week.

Autonomous liquidity factors      ▼           Flows from the MoF return to the market around this time of the month, increasing market
                                              liquidity. Although flows to and from the MoF are very important from a liquidity-
                                              management point of view, they are hard to predict.

Offshore interest in RON          ▼           FX swap implied yields for RON stand about 2ppt below depo rates, signalling that local l
                                              demand for hard currency funding outweighs the offshore need for RON liquidity. We
                                              expect this tendency to become more pronounced in the future, thus increasing the
                                              likelihood of cuts in the MRR for FX. Furthermore, this should put upside pressure on the
                                              EUR/RON.

On balance                        ▼           The front end of the depo curve is likely to continue to soften as flows from the MoF
                                              return to the market around this time of the month. Sharp falls should not be
                                              expected as the central bank is likely to step in the money market absorbing excess
                                              liquidity.
Source: ING estimates


                               FX market
                               The Romanian currency weakened about 1.5% in the last week. Intraday trading has
                               been quiet and the RON seems to have somewhat decoupled from its regional peers,
                               which lost more ground against the euro. The 3.8500 support level was broken on
                               Friday and EUR/RON seems biased to the upside. The fall in short-term rates is likely
                               to induce a weakening trend, but a larger impact is likely to come from the statement of
                               the finance minister who said the budget shortfall expanded to 2.9% of GDP in
                               November. However, very large depreciation moves look less probable as profit taking
                               orders are likely to be triggered quickly since the low levels of liquidity amplify the
                               impact of a FX intervention.
                                                                                Romania Weekly Update                    8 December 2008



 Fig 6    EUR/RON weekly assessment

                                      Direction                                                Comment

 Current account deficit                  ▲           We look for a widening to slightly above 14% of GDP based on our view that the
                                                      Eurozone slowdown will negatively impact export growth.

 Short-term interest rate gap             ▲           Short-term interest rates have fallen to 12% and we expect they will weaken further, which
                                                      eases the cost of funding short RON positions.

 Remittances                              ◄►          Remittances flows should have a limited impact on exchange rate developments.

 Risk premium                             ▲           Regional currencies continued to follow a weakening trend and RON is likely to follow. As
                                                      Romania is the only EU member state rated below investment grade, the Romanian
                                                      currency may come under more pressure than its peers if the wave of selling orders
                                                      continues.

 Technical                                ▲           For the short term: Support 3.8000; Resistance 3.9500; upward bias.

 On balance                               ▲           News that the budget deficit has almost reached 3% of GDP in November is likely to
                                                      drive EUR/RON. The 3.8500 resistance level has been broken and the pair seems to be
                                                      biased to the upside as this is also supported by low interest rates.
 Source: ING estimates



  Economic outlook
 Fig 7 Economic forecast summary

                                          Current       1Q08      2Q08       3Q08    4Q08F       1Q09      2Q09       2007     2008F     2009F

 EUR/RON*                                      3.87    3.7216    3.6475    3.7336       3.90      3.95      4.05    3.3373      3.68       3.96
 5Y bond yield end period (%)*                13.25       9.4       9.6        10       14.8        15      14.3       7.5        11       14.1
 3m interest rate end period (%)*              15.9     10.96        12      13.7       19.3      19.8        16       7.9        14       15.6
 CPI (%YoY)*                                    7.4        8.6       8.6       7.3         7       6.6       6.1        4.8      7.9          7
 GDP (%YoY)*                                    9.1        8.2       9.3       9.1       5.4       2.5       1.6          6      8.1        1.7
 NBR key policy rate end period (%)           10.25       9.5        10     10.25      10.25      9.75       9.5       7.5     10.25          9
*Quarterly forecasts are eop; yearly forecasts are average over the year
                                      _
                                                           Romania Weekly Update               8 December 2008



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