Leu should drop to 1 euro / 4.5 leu

I am tested, these are my answers… (part 1)

to read part 2, click here

Leu should drop to 1 euro / 4.5 leu

My friends, I think you have overestimated me a little bit (or a lot). I am a high school graduate, without any university degree at all and I have received an email by a technical analyst, who really challenged me. I will do my best to reply to him (and together with him to all of you), but I will ask you to be gentle with me, because I will try to tell you truths that Romanians don’t like listening to (exactly as Greeks never like to hear their truths too).

So, the comment I received was:
“Well, it looks like I understimated the financial crisis. These have been some weeks! Good thing I’m a technical analyst and I can change directions everytime something new appears in the markets. Considering the given circumstantes, it looks like you were very right with what you were saying about the R-E market Mr. Ilias (mostly overvalued properties) going back to lower prices. The problem is all prices are still in EUR and I’m quite reserved about the future value of the Romanian currency as it looks like 1 EUR = 4 RON would be a fundamentally correct value. I don’t want to monopolize space, but I feel that an analysis released 1 year ago by Danske Bank is relevant for the current situation:

• The Romanian economy is among the most imbalanced in the Emerging Markets universe, with overheating asset markets, excessive credit growth and a large current account deficit. We place Romania in the same group of countries in CEE as the Baltic states and Bulgaria in terms of heightened risk of a hard landing in the economy and financial distress. However, while there are currency pegs in the Baltic states and Bulgaria, there is a floating exchange rate in Romania, which makes the leu the easiest FX to trade if one wants to trade the case of overheating in CEE.
• Fiscal policy is strongly pro-cyclical and hence contributes to increasing imbalances in the economy. The political situation remains uncertain.
• After the recent rise in FX volatilities the key policy rate in Romania of 7.5% does not give any real protection in terms of carry-to-risk.
• The large Romanian funding needs due to the high external imbalances make the Romanian markets and economy sensitive to a global credit crunch.
• Romanian households to a large extent have funded real estate investments in foreign currency (mostly EUR and CHF) and that makes them very exposed to currency risk.
• The leu is the most overvalued currency in our entire Emerging Markets universe. Some of our models indicate that RON could be overvalued by more than 20% on a fundamental basis even when taking the latest weakness into consideration.
• Technically, we have broken the nearly three-year downtrend in EUR/RON and a new uptrend has been established.

I don’t think that any of these fundamental considerations have changed since then: the trade deficit is the same (even bigger), real estate investments in EUR and CHF are still there for the next 20 years and have to be paid, the key policy rate went to 10.25% making the RON one of the high yield carry-trade currencies (currently being liquidated against EUR and USD -> see EUR/JPY, GBP/JPY, AUD/JPY etc…), the fiscal policy is the same as last year while the political situation remains to be determined in a month. So it looks like the picture is not very good for the RON untill something fundamental appears. So the question arrives: we have fair prices for R-E properties (or we will in near term) but is there any chance of growth or at least stability in the next 2 years? Or are we going to the undervalued zone because of projects remaining unsold, R-E businesses going broke, houses taken by the banks etc…? The R-E sector has been a driver for the Romanian economy for at least 5 years now and a fall in this sector would take the entire growth with it. What do you think about these facts Mr. Ilias?”

My answer is:

Leu should go down to 1 euro / 4,5 leu (and why)
I will start with my strong belief regarding the leu, the Romanian currency. If someone wants to help the country in a longer term basis, he should arrange so as leu will have a fixed rate of 1 euro / 4,5 leu. This is the rate that in my opinion leu should lock forever, being connected to euro. This decline would cause some problems today (mainly stopping the aggressive expansion of consumption in the country, also the bigger cost of funding the economy’s deficit, plus temporarily higher inflation), but it would also help Romania to become the European paradise for productive investments for the next ten years.

This will happen mainly because:

• The production cost will become much lower than today, helping especially the Small and Medium companies to export in better terms.
• In general, the exports will be boosted, based on the more competitive economy, thousands of new jobs will be created and the Trade Deficit will be partially covered in a healthy way (in combination with the decrease of imports, as imported products will be more expensive).
• The flow of billions coming from Foreign Direct Investments will continue, in even higher numbers (and this flow is vital for Romania today).
• The lack of productivity (that all experts point out as a major problem) will be covered for few years, allowing to Romanians to accelerate and then receive higher salaries.
• Leu will be able to adjust to today’s  very difficult world, without fears for an aggressive fall, which would trigger very high interests by the Central Bank (BNR) and would lead to the financial struggling of the majority of the population.

BNR Governor has secured the system, even if his actions do not always please the investors
I have seen mr Isarescu, the Governor of BNR, in several conferences but I never had the chance to discuss with him. If I will ever have, I will congratulate him for the approach he has regarding the market. Although as a Real Estate broker I have problems with several decisions of his, as a businessman who wants Romania to rise, protected from all major problems, I am very happy that this gentleman exists and imposes restrictions every time the banks want to exaggerate. He is one of the reasons why Romania does not have any serious threat from the Credit Crunch. We all heard once more this period that when the banks exaggerate, in the beginning everyone is happy but in the end 90% of the people will cry “with black tears” (as we say in Greek).
In the same time, no one can be sure for the political situation after the next elections, but what is amazing for me is that the last years Romania managed to improve although it was changing ministers more often than its national football team was winning (and it was winning a lot). I don’t expect any dramatic change in the real economy after the elections, most of the important decisions are already made in Brussels.

(to be continued tomorrow)