Mugur Isărescu: The 39th Meeting of the Central Banks Governors'
Club of the Central Asia, Black Sea region and Balkan countries
Speech by Mr Mugur Isărescu, Governor of the National Bank of Romania, at the Conference
"The 39th Meeting of the Central Banks Governors' Club of the Central Asia, Black Sea region
and Balkan countries", Bodrum, Turkey, 14 May 2018.
* * *
Dear colleagues,
Let me start by saying that I am honoured to have been invited to speak here, in beautiful
Bodrum, at the 39th Meeting of the Central Banks Governors' Club of the Central Asia, Black Sea
Region and Balkan Countries. Our club includes central banks from EU countries, some already
in the Eurozone, while others belong to countries outside the EU. Some of the members in our
group come from countries that have enormous economic potential and belong to G20, which
has become an essential part of the architecture that has fostered international debate on
financial and economic issues after the crisis. This is why our club reflects quite interestingly the
constellation of political and economic interests that defines our world.
This meeting comes at a time when the international landscape is dominated by an overall
positive mood, on the economic front at least, even though, recently, a number of downside risks
have become more apparent. In the European Union, economic growth reached in 2017 its
postcrisis peak, with most Member States witnessing higher GDP dynamics. At the same time,
unemployment continued on a downward path and economic sentiment improved across the
board. Some recent signals point to a slowdown, yet they seem to have more to do with
temporary influences, growth prospects continuing to look strong. The past year recorded, on
average, positive developments in EU candidate and potential candidate countries as well, in
spite of GDP dynamics delivering a more mixed picture (from over 7 percent in Turkey to around
2 percent in Serbia and even stagnation in the Former Yugoslav Republic of Macedonia).
Nevertheless, the outlook is positive, with recent forecasts pointing to relatively robust growth in
the coming years.
However, against this relatively rosy background, I should highlight that our economies, even
those that belong to the Eurozone, have still much to do in order to become robust and offer
good living standards to most of their citizens. Some members of this Club, Romania included,
had to go through very painful adjustments during the past decade, as the global crisis found
them trapped in a pro-cyclical policy stance and it remains to be seen to what extent they will
manage to break free from this pattern in the current good times; some need to fight high
inflation, pressures on their currencies or to correct their external imbalances. Nevertheless, the
common denominator of all our economies is having to deal with institutional weaknesses and
the need to undertake reforms that should make them stronger.
A common challenge our emerging economies are facing is the need to speed up convergence
towards the development level of mature economies. In order to achieve this, the responsible
policymaker should be concerned with steady progress and not with delivering bouts of
accelerated growth, which may turn out to be reversible. This brings us to the need to address
bottlenecks to potential growth - even though in Central and Eastern Europe, for instance,
growth is now much stronger than in the euro area, most countries have still work to do in order
to ensure that potential growth matches the catching-up needs. At least in the non-euro EU
members in Eastern Europe, bottlenecks to sustainable growth usually stem from structural
impediments to labour supply (high emigration, low participation rate, decline in working age
population, skill mismatch), inefficiencies in public administration, quality of institutions, in
general, and in some cases, inadequate infrastructure.
While inflation has reemerged in Central, Eastern and South-Eastern European countries, in
most cases it remains tepid (broadly, around 2 percent). Nevertheless, it has spiked in such
cases as Romania and Turkey, where it currently stands at 5 percent and 11 percent
respectively. Part of this reemergence is related to the global cycle, as it comes from
international commodity prices, with idiosyncratic supply-side factors and domestic demand
pressures accounting for the rest of the explanation. These latter two sources are particularly
relevant in Romania, where changes in indirect taxation and regulated utility prices have played a
significant role in the recent inflationary spell, adding to the underlying inflationary pressures
stemming from the opening of the positive output gap (to which contributed a persistently
expansionary fiscal policy), increases in wage costs, and, last but not least, an upward
adjustment in inflation expectations.
As a matter of fact, significant acceleration in wage growth is a common feature of the non-euro
EU member group. Nevertheless, in most cases this has not led to a deterioration in the current
account positions, which remained in surplus. Unfortunately, Romania appears as an outlier
within the group: while its current deficit is well below pre-crisis levels, it widened rapidly from a
minimum of 0.7 percent in 2014 to 3.4 percent in 2017, which puts Romania closer to the group
of EU candidate countries (around 5.5 percent in Serbia and Turkey). Against such a
background, it is no wonder that - while the monetary stance remains largely accommodative -,
the picture is quite heterogeneous regarding inflation expectations, inflation targets, and policy
tools used.
Romania has already started the tightening of monetary policy by hiking the rate three times this
year, after further narrowing the corridor around the policy rate last year, but going forward we
believe a gradual approach is warranted. And this brings us to the issue of monetary policy
normalisation. What I believe most people understand by this concept is a return to the standard
operating mode of monetary policy, i.e. the withdrawal of the unconventional policy tools deployed
during the crisis, which would entail a gradual increase in short-term interest rates and a gradual
unwinding of bloated central bank balance sheets. The latter is by far the most challenging
process, as the impact on global asset prices is a delicate issue, which not only requires good
planning and favorable macroeconomic conditions, but is also bound to be lengthy.
As regards the other element of policy normalisation - the increase in short-term interest rates -,
while less controversial, it is by no means problem-free, considering its implications for financial
stability. To quote the BIS Annual Report 2017, "policy normalisation presents unprecedented
challenges, given the current high debt levels and unusual uncertainty".
The increase in short-term interest rates is an element of normalisation that also applies to the
central banks that did not step out of the conventional framework - and this is the case in most
Central, Eastern and South-Eastern European countries. Personally, I see normalisation as
amounting ultimately to a return to real positive interest rates. I doubt, however, that this will be a
swift process. In the case of Romania, the steps taken so far along the road to policy
normalisation, were facilitated by two favourable developments in the banking sector.
First, the NPL ratio dropped from above 20 percent at end-2014 to almost 6 percent presently,
making it the largest adjustment in the EU over a relatively short time period. At the core of this
adjustment were conservative requirements for provisioning NPLs, our hands-on supervisory
approach, and a fiscal facility that was conducive to the development of the secondary market for
NPLs. Second, the share of leu-denominated loans in the total stock of loans has increased from
one third prior to the crisis to two thirds nowadays, with the benefit of reducing contagion risk and
improving the transmission mechanism of the monetary policy.
However, it would be risky to press ahead too fast. In the case of the ECB, while the tapering of
its QE has already started, an upward move in the interest rate is not likely to happen soon. As
for peer countries such as Poland and Hungary, their macroeconomic conditions do not seem to
warrant a start of the tightening cycle this year either, with still below-target inflation. As long as
real interest rates remain negative all over Europe, straying too far away from our regional peers
in terms of policy rate would invite disproportionate appreciation pressures, which - while helpful
in terms of inflation - would not be a welcome development, given Romania's increasingly
negative external imbalance.
Therefore, striking the right balance in terms of the interest rate differential is of the essence -
after the substantial tightening undertaken so far, translating into money market rates increases
by almost 200 bps (a normal development given the size of the inflation differential), it is probably
wise to proceed more cautiously from now on. As such, the future action of the NBR is likely to
depend on how the process of monetary policy normalisation will be unfolding in Europe.
Policy normalisation is a question of "when", not "if". It will eventually gain momentum and the
impact of major central banks' policy reversals on emerging economies should not be
underestimated. When the tide eventually hits, the extent of the damage depends on how
vulnerable emerging economies are to external financing. A contained current account deficit, a
long average maturity on public and private foreign currency debt and a proper policy mix will help
limit the negative externalities.
Summing up, keeping internal and external imbalances in check is the only way our economies
will be able to cope with the strong volatility headwinds ahead of us. Indeed, it would be a shame
if the necessary reforms were not undertaken now, while there is a window of opportunity.
14 May 2018, Bodrum, Turkey