Central Bank leads up interests. Info-Prim Neo economic commentary

Nobody expects that raising the norm of compulsory reserves and the basic rate will leave indifferent the commercial banks, which in their turn will raise the saving rates and, respectively, the loan interests. On May 23, the Administration Board of the National Bank of Moldova (NBM) decided to raise by 1.5 percentage points the basic rate applied on the main operations of monetary policy of the NBM. This is the second hike operated by the Central Bank in 2008, after it had raised the rate by 1 percentage point. Concomitantly, it decided to gradually raise, by 6.0 percentage points, the norm of the compulsory reserves constituted from means attracted by banks in Moldovan lei and non-convertible currency, and in freely convertible currency. The decision, made public almost a week later, did not surprise bankers and economists, although many were shocked at the pace of the hike. The National Bank desperately tries, on the background of rampaging inflation and enormous excess of liquidity, to contain the inflation, by increasing – from 16 to 22% -- the norm of the compulsory reserves kept by banks and the basic rate from 17 to 18.5%. “The loan interests are going to skyrocket to 30-32% annually, thus the crediting activity will slowdown and, respectively, the economy's growth,” is the vision of some bankers and economists on the effects, while Johan Mathisen, the International Monetary Fund Resident to Chisinau, says any increase of reserves would add to fighting inflation. It is the BNM's only solution, but increasing the norm of compulsory reserves could trigger even higher inflation. [The situation is critical indeed] The annual inflation rate soared in April to 16.2%, the highest in the last 4 years. Also the interest of state securities dropped to the low of the end of 2003. By the end of March, the money supply rose by 42 per cent compared to last year. The loans see a record high, reaching the level of 52% in 2007, while in the first quarter - 53%. The enormous excess of liquidity is putting pressure on the market, and is assessed by some economists at 2 billion lei. The NBM has to curb this liquidity overspill by selling certificates and by paying more and more for those transactions. If in January 2007, the nominal average rate on sterilizing transactions was 14.07%, and it dropped to 13.23% the next months, in April 2008 it reached a record high of 16.82%. On the other hand, the NBM has to buy foreign currency on a market overwhelmed by more and more currency and thus it “pumps in” new liquidities, that it sterilizes later. The currency flow is bigger and bigger. In March, the transactions on the domestic currency market reached a record high of $622 million, while in April they run up to 837.7 million. More and more experts and officials are inclined to believe the matter is not only about the remittances of the Moldovans working abroad, but also about foreign citizens depositing in Moldovan Banks against high interests comparatively. And this happens in an conjuncture not favorable at all, when the food, the fuels and the electricity are getting more expensive. The speculators profit of any instability, the example of raising the sugar price on grounds of alleged higher consumption is an ordinary one. [NBM raises the rates] After running out of other “arguments”, the National Bank, though a purely administrative measure, attempts to master the inflation. The NBM Board decided to gradually raise, with 6.0 percentage points, the norm of compulsory reserves constituted from means attracted by banks in Moldovan lei and non-convertible currency, and in freely convertible currency. The NBM argues its decision by the high rise of consuming prices main caused by “the secondary effects of unfavorable weather conditions in 2007, what has led to diminishing the supply, and, consequently, to raising food prices. Another problem is more expensive power resources tariffs, which in April essentially influenced the increase of tariffs for transporting passengers, tourism services and trips. At the same time, the persistence of excessive liquidity on the domestic financial market, the high inflation in the region, as well as the high inflation-related expectations of the people and companies have influenced the price rise. The rigid management of the liquidity on the monetary market by the National Bank aims at counteracting inflation-related pressures and bringing back the inflation rate into the planned limits.” The solution chosen by the NBM to intervene on a market overheated by excess of liquidity is natural, including because the law points out that the Central bank's main goal is to contain the inflation. [The first hike has partially attained its goal] In October 2007, when the annual inflation rate ran up to 14.0% (compared with 10.4% in June), the norm of compulsory reserves was raised from 10 to 15 %. A little bit earlier, the NBM increased the basic rate from 13.5 to 16.0%. Since April 2008, the norm of compulsory reserves has been raised by one percentage point. The amount of the means held by banks in the compulsory reserves has doubled the last year and has reached 2.2337 billion lei, in the period 6-20 April 2008, compared to 1.193 billion lei, in the period 1-15 April 2007. This money is practically taken out of circulation, being kept by the NBM at an interest of 2%. By the end of the year, the inflation slowed down somewhat, dropping to an annual rate of 13.1% in December, only to skyrocket from 13.9 to 16.2% the coming months. [What could be the effects of the NBM's last decision?] The IMF resident is optimistic: the austere fiscal-budgetary and monetary policies will lead to decreasing inflation, as it was last year. And “if one wants to master the inflation pace, it is necessary to decrease the volume of loans in economy,” Johan Mathisen says. Bankers say they will have to offer higher interests on deposits and will make the loans more expensive. Some banks already announce deposit interests of 23%. It is clear that at a margin of 3-4 % between the deposit and loan interests, and in unstable circumstances they can go up, the loan interests cannot be lower than 26-27 %, or even more. It is true that after the first and the second hikes the last two months, the loans in Moldovan lei rose by 1 percentage point only, while the ones in foreign currency even less. Also the deposit interests almost has stood still. The last generous offers of up to 15% on deposits in USD, 14% - in euros and 23% in lei entail sooner a growing inflation-related expectation, than an influence of the measures orchestrated by the National Bank. The banks make their own assessments of inflation and if they offer an interest of 20% on deposits, it is not excluded that one expects an inflation at the same level. Bankers and experts say the situation in going to be another after the last hike, it's one thing to set in reserve 16% of the attracted means and wuite another thing to immobilize 22%, that you can use for crediting. The high interests attract the small speculators, as they gain profits by depositing several hundred thousand euros converted into Moldovan lei in the Moldovan banks. Although nobody knows them, one supposes this money would come from Italy or other South European countries. And the more the deposit interest runs up, the more attractive the Moldovan market will become for those speculators. As a consequence, Moldova can expect huge money inflows from abroad, that would put pressure upon the market and inflation. Most probably, if the interest rate goes up, the appetite for loans will go down. As a consequence, the consumption, the economic growth lies on, could fall. The growth rhythm of the volume of credits in economy, a thing wanted by the Central Bank and the IMF, will slow down, but this will affect the economic growth itself. Another consequence, admitted by the IMF, is the further appreciation of the leu in relation with the dollar, which gets closer and closer to the 9-year low – 10 lei/USD. Increasing the compulsory reserves will affect different banks differently. Some banks have more liquidity than others, consequently they could face problems. Other banks will have either to raise the deposit interests, or to seek for other ways of attracting means. What is certain is that the strong inflation-related pressure will not be eliminated as it is generated by the continuous rise of the prices of natural gas, electrical power and food.