Download How could Romania avoid the threat of payment default in 1999 and

Managing a financial crisis:
Romania story, 1998-1999
Ilie SIMON
Academy of Economic Studies
Bucharest
Agenda
1. Short economic background
2. Worsening economic situation in 1988
3. The threat of payment default in 1999
1. Short economic background

Real GDP was in 1992 down by 8.8 percent
as compared to 1991.

1993-1996, GDP grew at an average annual
rate of 4.1 percent.

1997-1999, real GDP declined at an average
annual rate of 4.1 percent.
1.1 First recovery
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During the first recovery, the current account deficit
worsened from USD 428 million (1.4 percent of GDP)
in 1994 to USD 1774 million (5 percent of GDP) in
1995 and USD 2571 million (7.3 percent of GDP) in
1996.
NBR borrowed USD 1.5 billion at relatively short
maturities from international capital markets in 1996
(7 credits: 2 were credits in euro and 5 were bond
issues in euro and in yen.)
The maturity for a good part of these credits was 36
months, that means payment concentration in 1999.
1.2 The economic program
I would only emphasis the two key
components of the Program:
 The liberalization of the foreign
exchange market;
 The increase of energy prices
towards their border parities.
1.2 The economic program( 2)
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The exchange rate depreciation stimulated exports
and discouraged imports.
The exports went up from USD 9648 million in 1996
to USD 9955 million in 1997 (an increase of 3.2
percent).
Import went down from USD 12503 million in 1996 to
USD 12349 million in 1997 (a decline of 1.2 percent),
net exports having a positive contribution to GDP.
However, real GDP dropped in 1997 by 6.1 percent.
The shock induced by the increase of energy prices
apparently was stronger than the positive demand
shock due to the depreciation of the exchange rate.
2. Worsening economic situation
in 1988
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contraction
inflation
external deficit of about 7 percent
of GDP
an overvalued currency (ROL)
foreign debt repayment: 2.2 billion
USD
2.1 Market sentiment towards
Romania
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Worsened after the Russian crisis in August 1998.
Plus the external deficit together with the peak of
external debt service scheduled for 1999.
The major rating agencies downgraded Romanian
sovereign ratings: in 1996 before launching a
Eurobond issue, Romania was rated similar with
other countries from the region (BB-).
Starting with 1998 the grade has diminished reaching
in 1999 the level B and even B-, which means high
level of risk.
At end-1998, the spreads between the Romanian
external debt in a very thin secondary market and
comparable US treasuries bonds were about 13
percentage points.
2.2 Major macroeconomic
indicators
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The Russian crisis in August caused a serious
turmoil on international financial markets and
changed the market sentiment towards
emerging economies, including Romania;
Official foreign exchange reserves of Romania
declined from USD 3 billion at the end of
1997 to USD 2.3 billion at the end of 1998.
Inflation was in 1998 much lower than in
1997, but persisted at a relatively high level,
consumer prices having been in December
1998 by about 41 percent higher than in
December 1997.
Inflation and the average
exchange rate
2.2 Major macroeconomic
indicators(2)
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The change in the exchange rate was well
below inflation: the ROL turned significantly
overvalued against the USD by mid-1998.
The accelerated depreciation towards the end
of 1998, and in early-1999, corrected ROL
overvaluation.
But exports dropped from USD 9955 million in
1997 to USD 9519 million in 1998, while
imports increased from USD 12349 million in
1997 to USD 12798 million in 1998.
2.2 Major macroeconomic
indicators(3)

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Following the contraction of 6.1 percent in
1997, real GDP further declined in 1998 (by
4.8 percent).
Imports increased despite the contraction of
the domestic economy, which points to the
severity of ROL overvaluation.
The prolonged economic contraction appears
to have played its role in worsening the
market sentiment towards Romania and
putting downward pressures on the ROL.
2.3 Central bank interventions
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As indicated by the decline of official
reserves, NBR was a net seller of
foreign exchange on the market, which
contributed to ROL overvaluation.
Market participants understood towards
the end of 1998 that the exchange rate
was unsustainable. Consequently
expectations of downward correction of
the ROL firmly consolidated, and it
made no sense to the central bank to
go on fighting against such strong
expectations.
3. The threat of payment default
in 1999
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On top, the external debt service was
scheduled to reach a historical high in 1999.
The service of the medium and long-term
external public debt amounted in 1997 to
USD 1581 million and in 1998 to USD 1520
million. It was programmed to surge to USD
2160 million in 1999.
The gross foreign exchange reserves
(including gold) of the central bank amounted
at the end of 1998 to only USD 2299 million.
The strong market sentiment at the end of
1998 and early in 1999 was that Romania
would default on its external obligations.
3.1 Fiscal and budget adjustment
in 1999
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In 1999 a new finance minister was
nominated, and a close cooperation with NBR
has developed:
-Tax increases – notably social security
contributions, excises and property taxes; the
main component of fiscal adjustment.
-Elimination or suspension of previously
granted tax facilities and exemptions;
-Expenditure cuts – notably wages in the
public sector and capital expenditures.
3.1.1 Budget revenues in
Romania
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Budget revenues
Current
Tax
Profit tax
Income tax
Social security
VAT
Custom duties
Excises
Other
Non-tax
Capital
Grants
1998
29.7
29.7
27.8
3.0
4.0
8.9
6.0
1.5
2.3
2.1
1.9
l0.0
0.0
1999
31.9
31.8
30.1
3.1
3.2
10.7
6.0
1.4
3.0
2.7
1.7
0.1
0.0
3.1.2 Budget expenditures in
Romania
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Budget expenditures
Current
Goods and services
Wages and salaries
Material expenditures
Interest
Subsidies and transfers
Subsidies
Transfers
Capital
Lending minus repayments
1998 1999
35.1
30.9
11.4
5.0
6.4
4.7
14.8
1.7
13.1
l3.6
0.6
34.7
31.7
11.5
4.9
6.6
5.2
15.0
1.6
13.4
2.8
0.1
3.2 Deficit financing in
Romania
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The budget deficit shrank from 5.4 percent of GDP in 1998 to 2.8
percent of GDP in 1999.
The adjustment in 1999: budget deficit financing
(Percentage of GDP)
1998
Financing
5.4
Domestic borrowing
3.9
External borrowing
0.0
Privatization revenues
1.8
Bank asset recoveries
0.0
Discrepancy
-0.3
1999
2.8
1.6
0.4
0.9
0.0
-0.2
3.3 Real GDP and inflation in
1999
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The fiscal and budget adjustment in
1999 played its part in entailing a
decline of 1.2 percentage point in real
GDP.
However, inflation – measured on the
basis of the GDP deflator – dropped
from 54.1 percent in 1998 to 47.8
percent in 1999.
3.4 Interest rates in 1999
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Interest rates on government borrowing
stayed high in 1999 because of the likelihood
of payment default. They surged at 104
percent in May on account of the scheduled
peak of external payments, but they declined
to about 70 percent towards the end of the
year.
Gross fixed capital formation was in 1999
down by 4.8 percent. However, lower interest
rates played their role with a lag, gross fixed
capital formation having picked up in 2000 by
5.5 percent.
Borrowing and interest rates
3.5 The exchange rate and the
external current account in 1999
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The ROL depreciated in 1999 by 72.8 percent
against the USD, which was well above the
inflation rate.
Exports were up by 3.5 percent (from USD
9519 million in 1998 to USD 9854 million in
1999).
Imports were down by 9.8 percent (from USD
12798 million in 1998 to USD 11538 million in
1999).
The deficit of the external current account
was down to USD 1469 million (4.1 percent of
GDP).
3.6 Foreign exchange reserves in
1999
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Market expectations that the central bank would
exhaust its foreign exchange reserves in 1999 did not
materialize.
Romania could meet its external obligations and,
increased its reserves to USD 2493 million towards
the end of 1999.
Eventually Romania avoided the threat of payment
default but the price paid for this success was the
GDP decline.
However, had the situation of payment default
occurred, the associated financial turmoil would have
presumably caused a much larger drop of real GDP.
3.7 Changing the rating
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A positive change in rating for Romania came
only on September 2002, to the grade B.
Romania came back to the capital market on
October 2000 with a bond issue of 150
millions USD for 36 months at 11 percent.
In 2001, an issue of 600 million bond at
10,625 percent was followed by one in 2002
for 700 million at 8, 5 percent.
One can notice the diminishing of the risk
premium for Romanian borrowings.