Central bank, mandatory reserves and June deflation. Info-Prim Neo economic commentary

The June deflation of 1.1% seems to confirm that the inflation in an agrarian country like Moldova depends more on the food prices, which have a significant weight in the formula for calculating the consumer price index, rather than on the monetary factor. The average decrease of 3.5% in the prices of food products after the fresh vegetables cheapened by 26.4% and the potatoes by 30% tempered the inflation, which was close to this year’s target five months after the start of the year. This is the sixth time in the past 15 years that the rate of inflation is negative in the first summer month and that the inflation fell so much after the 3.4% deflation of June 2002. What’s next? Will the three-month deflation of the summer of 2001-2002 repeat? Or will there be a repeat of the 2005 situation, when the rate of inflation was negative in June and July and almost “zero” in August? Will the Government and the National Bank give up modifying the target as, after a rise of 7.4% in the first five months of this year, they began to say that a rate of 12% would be more real? Will the central bank yield up and reduce the norm of obligatory reserves if the June deflation is followed by a negative inflation in the next months? Evidently, the low inflation in the first summer month is not the result of the National Bank’s May decision to raise gradually by 6.0 percentage points (up to 22%) the norm of obligatory reserves formed of the resources attracted by the banks in Moldovan lei and nonconvertible currency and of the money attracted in freely convertible currency. The banks were to pass the first reserve stage of 20% between June 21 and July 5. An immediate effect is rather improbable even if several hundreds of millions in lei and foreign currency are withdrawn from circulation. In the speech delivered at the news conference held to mark 100 days of the appointment of the new Government, Prime Minister Zinaida Grecianyi said that the rise in the base rate and in the norm of mandatory reserves carried out by the central bank “tempered the lending rates to the national economy and allowed to withdraw from circulation the excessive liquidity, which were the main source of inflationist pressure. The first effects of the successful policies are already felt as June saw a deflation of 1.1%, the Prime Minister said. It is true that after the central bank made the decision, most of the banks stopped lending money or reduced considerably the amounts lent, except maybe some of the banks with foreign capital. The 15.4% decrease in the amount of bank loans released in May was only a first sign. The June data have not been made public yet, but many economists expect this amount to decrease further. It is not excluded that the perpetuation of the tendency to reduce the volume of money lent to the economy would have much more serious consequences on the development and economic growth than expected. The tempering of the lending rates favors the combating of inflation. Such a conclusion results from the speech of the Premier, who says that the foreign direct investment will grow at a higher rate in the second half of the year, growth that will exert pressure on inflation, in the same way as the rise in salaries above the level of economic growth. The central bank in June sterilized a larger amount of excessive liquidity than in May. The average daily balance was 1.327,5 million, as against 1.130,9 million in May. But the costs were also higher, the average nominal rate of the transactions rising to 18.25%. Preoccupied with the curbing of inflation, the National Bank seems not to bother about the continuous appreciation of the leu against the US dollar. “We intervene only when the exchange rate deviates suddenly,” said earlier the central bank’s governor Leoniud Talmaci, making it clear that such a moment has not yet come. The lower inflation can determine a further appreciation of the leu against the dollar, experts consider. The exporters and persons that receive foreign currency from abroad are concerned about the appreciation of the national currency, which has grown in value by about 13% since the start of the year. The official exchange rate rose to 9.8218 lei per dollar on July 14, from 11.3192 lei/USD at the start of the year. Economists and bank specialists are very skeptical about the immediate prospect, anticipating a quotation of up to 8.50 lei at yearend. Any forecast is relative given the powerful pressure caused by the depreciation of the dollar against other currencies, the continuous rise in the remittances sent home by the Moldovans working abroad, the rising direct investments and external debt. Regardless of the steps that the central bank will take, the pressure from outside will persist and will mount in line with the depreciation of the dollar and the rise in fuel and food prices. In addition, a strong leu and a weak dollar make the persons that receive dollars to change them into lei and deposit them at an interest rate that is almost two times higher than the interests on the deposits in foreign currency, influencing thus the leu/dollar exchange rate. The National Bank ascertained that one of the factors that lead to the appreciation of the national currency is the rising supply of currency following the increase in deposits in Moldovan lei, as a result of the partial conversion of the means from foreign currency into national currency. But the persons that sent money home and those that live in Moldova from this money lose twice more, first of all because the currency is converted in lei at rates that are continuously falling. Secondly, the lei are used to purchase imported products whose prices have not been recalculated after the exchange rate has decreased. Some experts estimate that the taxes paid by those that transfer dollars to Moldova have amounted to more than 20 million dollars from the start of this year. The exported products become less competitive because the appreciation hits directly the production costs. The importers profit from such a situation as they obtain large profits from the difference in the exchange rate following the appreciation of the leu, as some experts say. Imports over five months exceeded exports more than three times, while the degree of covering imports with exports is decreasing and is close to 30%. The major objective of the central bank, according to the law, is to curb inflation and the National Bank is making effort to reduce the price rises at a time when the pressure from outside is mounting. But is seems that the continuous appreciation of the leu could be as dangerous for the economy and have lamentable consequences in the future, intensified by the lower volume of money lent. Will the central bank intervene on the currency market to stabilize the leu/dollar exchange rate after the June deflation and an expected decrease in the inflation index in the next months? Or will the incredible forecast that if the central bank does not intervene, the exchange rate could fall to 7 lei per dollar come true? Much will depend on the steps that the central bank will take. Meanwhile, some of the currency exchange facilities buy dollars at night for 9.10-9.20 lei a dollar.