Wikileaks - MCVII

162817 7/21/2008 8:48 08BUCHAREST574 Embassy Bucharest UNCLASSIFIED//FOR OFFICIAL USE ONLY 08BUCHAREST562 VZCZCXYZ0003 PP RUEHWEB DE RUEHBM #0574/01 2030848 ZNR UUUUU ZZH P 210848Z JUL 08 FM AMEMBASSY BUCHAREST TO RUEHC/SECSTATE WASHDC PRIORITY 8496 INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE PRIORITY RUCPDOC/DEPT OF COMMERCE WASHINGTON DC PRIORITY RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY UNCLAS BUCHAREST 000574

STATE FOR EUR/NCE KSOLERA, EB/IFD TREASURY FOR LKOHLER COMMERCE FOR KNAJDI

SIPDIS SENSITIVE

E.O. 12958: N/A TAGS: EFIN, ETRD, ECON, PGOV, RO SUBJECT: ROMANIA: POLICYMAKERS ATTUNED TO INFLATION AS ELECTION SEASON APPROACHES

REF: A) Bucharest 562

Sensitive but Unclassified; not for Internet distribution.

1. (SBU) Summary: Rising inflation is capturing the attention of Romanian policymakers and is likely to play a significant role in the upcoming election season. Annualized inflation (June 2007 to June 2008) is up to 8.61 percent, with price increases in consumer staples acutely affecting consumers across the board. As is the case elsewhere in the world, energy and food prices are outpacing increases in other sectors and helping to drive up the overall inflation rate. The openness of the Romanian economy to world market forces has limited the tools available to the Government of Romania (GOR) to respond effectively to these increases. At the same time, pre-election politics appear to be keeping the GOR from exercising the few fiscal policy levers it does have to control inflation. The National Bank of Romania's (BNR) efforts to rein in prices through tighter monetary policy have so far met with little success. End Summary.

2. (U) In the last 12 months (June 2007 to June 2008), foodstuffs in Romania have shown dramatic price increases, rising at an annualized rate of 11.77 percent. Last year's poor, drought-damaged harvest, combined with rising domestic consumption and global commodity price increases, are to blame. Further increases are expected later in the year, with some business leaders forecasting a 10 percent rise in the price of bread, 10 to 15 percent in sugar, and 3 to 4 percent in dairy products just by September. The hope is that a good agricultural season this year will mitigate some of the price increases, especially in the productive summer months, but high energy prices will likely act as a brake on any significant price reductions. (Comment: Market survey data on agricultural output and prices for June and July are not yet available, but local seasonal produce is currently plentiful and reasonably priced in Bucharest. This is likely a temporary effect, and prices should start to tick back up again in the fall as local produce goes out of season. End Comment.)

3. (U) Increasing energy prices are also of major concern, even though Romania produces a substantial portion of the natural gas and oil consumed domestically. The natural gas distribution companies have lobbied the government for significant price increases to cover higher production costs, and although the GOR regulator only just approved a 12.5 percent increase in gas prices as of July 1, pressure is building for another round of rate increases later this year. Electricity rates show a similar trend, with the regulated price rising 4.4 percent on July 1. The present national average price for gasoline of approximately 4.58 Lei per liter (the equivalent of USD 7.95 per gallon at current exchange rates), up 12 percent so far this year, is a further drain on the Romanian consumer. Diesel fuel is up 17 percent, which in turn makes all manner of goods and services much more expensive.

4. (SBU) The policy responses on the part of the Government and the BNR have been mixed. The BNR recently raised the Romanian Lei benchmark nominal interest rate to 10 percent in an effort to curb inflation. However, as reported reftel, other factors limit the BNR's flexibility to boost rates further. (It is also worth noting that, with inflation at over 8.6 percent, the real interest rate is only about 1.4 percent, making the actual dampening effect minimal.) This places additional burdens on the GOR to avoid aggravating inflation through expansionary fiscal policies, tough to do in an election year. So far the only significant efforts in this regard have been to postpone until October 1 the scheduled increase in the monthly minimum wage (from 500 to 540 Lei), and to hold the line on some public sector wage increases. On the other hand, the GOR just announced a budget "rectification" of over 600 million euros in additional spending, mostly for infrastructure projects.

5. (SBU) In addition to these limited fiscal restraints, the GOR has announced several initiatives aimed at mitigating the effects of higher prices. These include lobbying the European Commission for a reduction in the recently increased tax on diesel fuel for agriculture; increasing (modestly) the amount spent on bread and dairy subsidies for primary school students; providing a heating subsidy for low-income households; cutting employee payroll taxes; and putting together a "solidarity fund" to distribute 160 million Romanian Lei (approximately USD 71 million) to households earning less than 615 Lei (approximately USD 275) per month.

6. (SBU) Comment. The approaching national election season, not economic fundamentals, appears to be driving the political response to inflation this time around. Rather than focusing on tightening its belt, the GOR is instead trying to treat the symptoms by lessening the pain of higher prices. Despite the BNR's assertion

that its maneuvering room for further interest rate hikes is limited, the lack of tighter fiscal policies will put additional pressure on the Bank to continue raising rates before higher inflationary expectations become more firmly entrenched. If high inflation continues, not only will it dampen economic growth, in part by removing the Romanian competitive advantage of inexpensive skilled labor, but it will also make Romania's long-term goal of entering the Euro zone an increasingly distant one. End Comment.

TAUBMAN