The Evolution Of Inflation In Romania

The evolution of inflation between 1989-2000- short overview

As in other centrally planned economies, most consumer prices in Romania were fixed before the 1989 revolution. However, with the liberalization of economic policy dramatic changes occurred and high inflation was, and still is, expected to remain one of RomaniaÐŽ¦s key short-term economic concerns.

The evolution of RomaniaÐŽ¦s annual inflation rate (year-end to year end or one year inflation) after 1989 started with a relatively moderate figure in 1990 (37.6%), but was very high during 1991 to 1993 (205.5% in 1991, 199.5% in 1992 and 295.5% in 1993).

The reduction in inflation from 1991-1993 annual triple-digit rates to less than 33% in 1995 was the main achievement of the stabilization program of 1993-1994. However, the expansionary macro-economic policy pursued in 1995 led to a resurgence of inflationary pressures in the middle of 1996, which resulted in year-end inflation of 56.9% in 1996.

From 1994 to 1997 there was a period of repressed inflation. Many of the prices (energy, gas, fuel, etc.) were not true, in the sense that consumers were paying less than the related costs to producers. The difference was found in the growth of the deficit in the balance of payments, in the budgetary deficit and in the huge losses reported by large state-owned companies.

Chart 1

Source: National Institute of Statistics

The exchange rate liberalization and the energy price adjustments of the first half of 1997 resulted in a steep increase (100%) of the price level. After this price explosion, under the effect of budgetary constraints and tight monetary policy, inflation seemed to calm down, but not at reassuring levels. The initial forecast of 90% inflation for the whole year was exceeded by June 30, 1997, and the resulting year-end rate of inflation was 151.4%.

The impact of restrictive monetary and fiscal policies throughout 1998 brought the year-end inflation to 40.7%, in line with expectations. The main cause of the persistently high inflation levels over the last years was the general inefficiency of the economy. The underperformance of large state-owned firms (some 150 of them accounted in 1998 for more than 90% of the losses in the economy), made them unable to pay debts to suppliers and to the state budget. The situation changed for the better as several money-losing businesses (especially in the metallurgy, heavy industry and oil processing sectors) were closed or privatized in recent years.

The dropping trend in inflation started since 2000 has continued over the following years (Chart 2), with 2004 being the first year with a single-digit inflation rate forecast (9%).

Chart 2

Source: National Institute of Statistics

The factors that lead to the reduction in the inflation rate between 2001-2005

In the following we will concentrate on the interval 2001-2005 and the factors that influenced the evolution of the inflation rate in this period.

In 2001 the objective of reduction of CPI inflation rate to 25% (December/December) proved to be a too ambitious goal to achieve, being revised to 29%. Although the inflation outcome in 2001 (30.3%) was slightly higher than envisaged, it reflected the progress in disinflation, as consumer price growth rate was more than 25% below that of 2000. This development appeared consistent with the pace of real economy adjustment.

Behind the higher-than-targeted inflation stood the following factors:

„X prices of some services and public utilities underwent higher-than-expected adjustments, as some of these prices had remained unchanged from September 2000. Thus, railway transport prices rose by 117.2% while those of natural gas and heating went up by 99.6% and 57.2% respectively. The price of electricity was raised by 35.6% during 2001;

„X arrears and insufficient adjustment in the real economy also contributed to protracted inflation.

Inflation Rate

1999 2000 2001 2002 2003 2004 2005

Inflation rate (Dec on Dec) 54.8% 40.7% 30.3% 17.8% 14.1% 9.3% 8.6%

Inflation rate (annual average) 45.8% 45.7% 34.5% 22.5% 15.3% 11.9% 9%

Source: National Bank of Romania, National Institute of Statistics

In 2002 the inflation rate (December/December), as measured by the consumer price index, came in at 17.8%, undershooting the 22% target.

This good performance can be attributed to the following factors:

„X abatement of cost-push inflation pressure owing to the slower pace of nominal depreciation of the domestic currency against the implicit EUR/USD basket (real appreciation averaged 4.4% in 2002 compared with 2% in 2001) and to the moderate increase in gross wages (3.9% on average in real terms as against 10.7% a year earlier);

„X sluggish consumption, which can be attributed to the cautious fiscal policy via spending control, but also to the slowdown in household demand for non-durables as a result of the joint action of the following factors: (i) the alteration of consumer behavior, with the focus shifting to durables (because the decrease of interest rates and increase of consumer loans); (ii) the hike in utility expenses induced by swift rise in the price of heating; (iii) stepped-up saving caused by deposit rates staying in real positive territory over most of the year under review;

„X smaller adjustment of administered prices (from 43% in 2001 to 23.5% in 2002), due widely to the capping of increase in prices of electricity and natural gas and to the delay in raising the price of railway transport;

„X imported disinflation, as inflation touched rock bottom in many European countries, the USA and Japan.

In 2003 the inflation rate, as measured by the consumer price index (December/December), reached 14.1 %, very close to the 14% target.

The reduction of the inflation rate carried on in 2003 for the fourth straight year. This was the result of the interplay of several factors, some of them entailing positive effects and other negative effects. Among these factors, the following deserve mention:

„X slowdown in nominal depreciation of the domestic currency against the implicit EUR/USD