GDP growth in Q1 above expectations

Flash estimate made public recently by National Statistical Office shows real GDP expanded by 0.5% qoq in Q1 2013, which was above our expectations (+0.3% qoq) and market consensus (0.4% qoq). Better than expected dynamics are clearly evident in annual growth rate (2.1% yoy on gross data) which was well above our expectations (1.0-1.2% yoy) and market consensus (1.0% yoy).


The upward trend in real GDP in Q1 was previously predicted by dynamics of short-term indicators available at monthly frequency (industrial output, deflated turnover in industry, exports, retail sales, construction output, and unemployment rate). Their dynamics offer hints about potential drivers of GDP growth in Q1. So, advance in real GDP in Q1 2013 should have been supported to a larger extent by increasing exports and industry (despite the fragile external demand), while advance in domestic demand should have remained modest (hampering the growth of imports). Very low level of foreign trade deficit in goods and services in Q1 2013 (around 3% of GDP) compared with Q4 2012 (4.2% of GDP) and Q1 2012 (5.9% of GDP) suggests net exports had a positive contribution both to the quarterly and annual growth rates of real GDP in Q1 2013. 


New estimates and more details on dynamics of GDP components will be released on 5 June.


…but economic recovery pace is not improving


As we have shown in the previous section, real GDP excluding agriculture is a better proxy for underlying tendency of economic activity in case of Romania. We believe we are not far from reality by assuming this aggregate expanded at a similar pace with real GDP in Q1 2013 (2.1% yoy). As agriculture accounts only for 3% of GDP in Q1 of each year, only large swings in agricultural output will result in divergent moves in annual rates for real GDP and real GDP excluding agriculture in this season. In our view, this was not the case in Q1 2013.


With a 2.1% yoy advance in real GDP excluding agriculture assumed for Q1 2013, our in-house models for seasonal adjustments show a modest quarterly growth rate  for real GDP excluding agriculture in Q1 2013: +0.2% qoq in a first model and +0.4% qoq in a second smoother model. 


A key conclusion emerges from this analysis: speed of economic recovery did not improve in Q1 2013. On the contrary, it might have even decelerated given quarterly advance in real GDP excluding agriculture might have been at its lowest level in the last five quarters. Weaker performance is also visible in deceleration of annual growth rate for real GDP excluding agriculture (2.1% yoy in Q1 2013 in our view, vs. 2.8% yoy in Q4 2012 and 3.4% yoy in Q3 2012). Such deceleration should have been supported by domestic demand (private and public consumption, gross fixed capital formation) which should have expanded in Q1 13 at a slower pace compared with 2012 (+2.5% yoy in H2 2012 and +2.9% in 2012).


Weak economic activity in Q2 2013 as well


Recent indicators suggest economic activity would remain weak in Q2 2013. We expect quarterly growth rate for real GDP and real GDP excluding agriculture to be close to 0.3% qoq (at most 0.5% qoq). In this context, annual growth rates for real GDP excluding agriculture and real GDP should decelerate further in Q2 13 to around 1.0% yoy from 2.1% yoy in Q1 13. 



Q1 figure bodes well with our forecast for full year GDP growth


Before the release of GDP figure for Q1 2013 we had adjusted upward the GDP growth expectations for 2013 to 2.0% from 1.5% previously,. The upward revision has been a technical one, aimed to take into account revision of historical GDP data. It has not reflected any improvement in our expectations on GDP dynamics in 2013.


The better than expected figure for Q1 2013 (+0.5% qoq compared with our expectations of +0.3% qoq, and 2.1% yoy compared with our expectations of 1.0-1.2% yoy) suggests a faster advance in real GDP in 2013 than our 2% should not be completely ruled out provided no major shock occur in the following quarters on external and domestic markets and there is a normal agricultural year. The better than expected figure for Q1 2013 implies also increasing chances for a faster than expected growth in real GDP excluding agriculture than our current call (1.3%).


However, given uncertainties related to developments on external markets and weather conditions this year, we believe it is reasonable to wait for more data before deciding a new adjustment of our current forecast (2.0%) which was at the upper limit of market expectations before release of GDP figures in Q1. For instance, severe weather conditions in the summer (drought) cannot be fully excluded. While production of summer cereals (i.e. wheat) can be good, production of autumn cereals (i.e. maize) or vegetables might be again negatively impacted. Recent weather forecast point to a hot summer, which implies chances for drought. So, the better than expected GDP figure in Q1 might be offset by weaker than expected GDP figures in Q3 and Q4.


Growth rates below 2% should be seen as week from a medium and long term perspective


We believe the growth potential of the Romanian economy is close to 2-3%, while the output gap is negative (at around 2%). In this context, persistent GDP growth rates below  2% of GDP should be seen as fragile from a medium-term perspective even though they are good news as they come at a moment when many EU economies face recession.


An increase in real GDP by around 2% this year in the context of a normal agricultural year implies an advance of 1.3% in real GDP excluding agriculture, which is below the potential growth rate. Basically, this means that negative output gap is deepening (when excluding agriculture). This is consistent with the foreseen deterioration in activity in the Euro area.



Another low inflation rate in April 


Another low monthly inflation rate was recorded in April as consumer prices inched up only by 0.1% from March. Annual inflation rate stood at 5.3% yoy, unchanged from March. Underlying inflationary pressures remained low. As a result, annual growth rate for CORE3 inflation measure decelerated from 3.0%  yoy in March to 2.9% yoy in April (the lowest level since it peaked at 3.4% yoy in October), while annual growth rates for our in-house statistical core inflation measures (weighted median and 40% trim mean) also were flat or decreased marginally in April. Except for the increase in excises which boosted prices for tobacco by 2.8% mom, no other shocks were recorded. Annual growth rate for CPI excluding volatile food prices (fruits, vegetables, eggs) remained unchanged at 4.5% yoy in April. As we have shown in the first section of the report this is a very useful aggregate to track tendency in headline inflation rate in short-term (up to one year) as is less impacted by swings in prices resulting from volatile weather conditions. Faster increase in this inflation measure (4.5% yoy in April) than our estimates for medium and long-term trend in inflation rate (4.0%) results from very rapid increase in administered prices (10.6% yoy in April) which are included in its structure.


Benign inflation dynamics support monetary policy easing


High level for annual inflation rate (5.3% yoy in April) is mainly the result of jump in volatile food prices in the second half of 2012 and hike in  administered prices in Dec 2012-Jan 2013. However, dynamics of core inflation was very favorable starting November (limited impact from adverse weather conditions on processed food prices, leu appreciation), while headline monthly inflation rates were very low in March-April. Moreover, a very low level of inflation rate (0-0.1% mom) might be recorded in May. All these developments point to a favorable inflation outlook and pave the way for a sharp decrease in annual inflation rate in Q3 (to 3.5% yoy by end of September) as adverse statistical base effect induced by jump in volatile food prices in 2012 will vanish. Provided no major shocks arise on domestic and external markets (i.e. one resulting in visible pressures for leu depreciation) and there is a close to normal agricultural year, then annual inflation rate can end the year at 3.5%. Moreover, in this context, there are chances for annual inflation rate to decrease towards 3.0% yoy by end-Q1 2014 (helped by a positive statistical base effect resulting from hike in administered prices in Dec 2012-Jan 2013).


Summing up, inflation dynamics support central bank in supplementing already loose control over liquidity conditions in money market by cuts in monetary policy rate as soon as possible (first cut is on the cards at the next monetary policy meeting on July 1st). 



Low rates, but only a small surplus of liquidity


Management of liquidity conditions as a tool of monetary policy


A feature of liquidity management is the large corridor (around key rate) which characterises the monetary policy in Romania (as we have underlined in our previous report). The current corridor enables interbank rates to fluctuate between 2.25% and 8.25%. Historical evidence hints that the large corridor translated into volatile money market rates. In some cases, the volatility moved from FX space to money market. This is due to the fact that the central bank pays attention to exchange rate dynamics in order to achieve its objectives (price stability and financial stability). So, smoothing ample exchange rate fluctuations might have impact on interest rates dynamics (i.e. upward pressures when leu faces hefty depreciation pressures). The central bank manages liquidity conditions through open market operations – see NBR site, credit facility, bilateral operations and purchasing/selling euro. An important player is also Ministry of Finance as its actions (spending, scheduled auctions, and deposits taken from banks) influence liquidity.


Liquidity conditions are important as impact interest rates and represent also a tool to shape RON dynamics. Liquidity conditions become important also for yields as some non-residents might have funded their bond buying through short-term FX swap rates. Thus, a potential prolonged tension on money market could dent the appetite for Romanian T-bonds or determine some players to reduce their portfolio.



Improving liquidity conditions


The amount injected at repo operation declined significantly in April and May, suggesting decreasing liquidity needs. Accordingly, the central bank injected RON 0.7bn in April compared to RON 9.9bn in February (in daily average terms). On the other hand, last week was characterized by volatile rates as short-term rates drifted higher (although from a very low level) both on money market and FX swap market. The partial correction of upward moves suggests they might have been the result of a transitory tightening in the liquidity conditions in the market. However, we think the episode could also show the fragile facet of liquidity conditions in the market. Our assessment is that there is not yet a surplus of liquidity in the market as the low level of rates might suggest. There are also limits for such a large surplus to arise in the next couple of months.


Excess of liquidity is not so ample


Ministry of Finance represented the main source of liquidity (given large spending and negative net issuance of debt) in 2013, excluding January. However, from a stock perspective, the central bank is a net creditor in the banking system since August 2011. 


While liquidity picture from April hinted that NBR is close to return to a net debtor position, two factors do not support this in the short-run. First, some banks still rely on liquidity injected by NBR even in the context of low interest rates, suggesting that the money market remains partially fragmented. Some market players have liquidity, but they do not have risk limits so as liquidity could pass through to other market players who need cash. However, a positive development is that the structural need for liquidity decreased recently. Second, the liquidity surplus is rather small. The money deposited by banks at deposit facility was almost constant in Feb-Apr (RON 335mn in daily average terms). Comparatively, in the same period of 2012, banks put RON 900mn in daily average terms at deposit facility. 


Looking forward, the sources of liquidity seem limited. After injecting liquidity from its buffer in Feb-Apr, Ministry of Finance might not support liquidity in the near term. Behind the recent upside pressure (visible especially on the front end of the FX swap curve) could be low spending of Ministry of Finance (after it has paid public sector wages in advance by end of April) and plans to tap more than redemptions in May (by RON 400mn) after two months of negative net issuance.  In June, the auction plan might exceed the low redemptions of only RON 1.3bn. Moreover, the budget deficit for Jan-Mar was RON 4.1bn out of the full year target of RON 13.4bn, not leaving too much room for spending. Historically, November and December see large budget shortfall (RON 7.5bn in 2012). While the government might not achieve the ambitious goal of 2.2% of GDP under cash methodology, keeping the budget deficit under 3% of GDP (ESA95) means additional spending of RON 4bn.   


Should banks go to repo operations organised by NBR to get liquidity at 5.25%, the money market rates would increase. So, higher levels for rates compared with record low levels in April-May should not be fully excluded. 



Time for consolidation


1Y yields have corrected the recent sharp decreases over last week and drifted higher by 30bp to 4.4%, while 3-5Y yields moved up to 4.65% from 4.50% previously. Behind this correction could be some players who wanted to mark their profits given extremely low levels of yields and also the upside pressure on short-term rates as some players funded their exposure through short-term rates. As this correction comes from low levels of yields, we do not believe this poses a threat to our outlook. Still, the magnitude of downward move (the bond curve shifted downward by some 190bp since mid December) hints at limited downside potential.  


The dynamics of Romanian currency and yields were closely related since the beginning of the year. RON appreciation by almost 3% from early April towards 4.30/EUR in the beginning of May was supported by positive appetite for risk globally and portfolio inflows. As the appetite for RON instruments softened, the Romanian currency lost 500pips to 4.35/EUR in the last two weeks. 


We believe that foreign capital inflows into the real economy (FDIs, loans) remain poor and we stick to our scenario that the EUR/RON exchange rate is likely to trade mainly between 4.35-4.40 in the next quarters. We reiterate our call that the large share non-residents held in debt securities could induce more volatility on the FX rate and yields.