5 Min Read
* Energy deregulation, new taxes to push inflation higher
* Growth seen at 1.5 percent, inflation at above 3.5
* Gives central bank no scope to cut rates
By Luiza Ilie
BUCHAREST, Jan 31 (Reuters) - Central banks across emerging Europe have responded to slowing economies by cutting interest rates, but Romania's policymakers will have few options when they meet next week.
Under pressure from the European Union and the International Monetary Fund, the EU's second-poorest state is deregulating power and gas prices which had been capped below market cost for years to protect consumers.
That will drive up power and gas prices for households and industry. The leftist government has also introduced taxes on energy firms and other measures which will feed into higher prices for goods.
The price rises will weigh heavily on Romania's economy, still struggling to recover from two years of recession after a housing bubble burst in 2009, forcing it to seek help from the IMF.
This is cutting off the usual avenue for boosting the economy - providing cheaper money.
"I don't see how the central bank could cut rates and don't expect them to," said Credit Europe economist Georgiana Constantinescu.
"Rises in (controlled) energy prices are the first and foremost hurdle for inflation this year, followed by the new energy and ... other taxes."
Inflation and political instability prompted the central bank to halt a rate cutting cycle at 5.25 percent in May 2012, a record low for Romania but still among the highest in the EU.
Since then, Hungary and Poland have cut borrowing costs and the Czech central bank is threatening to weaken its currency - with rates already near zero - to help a recession-hit economy.
With growth of only about 0.2 percent last year, Romania's economy is still significantly smaller than its 2008 peak and showing few signs of recovery. The IMF expects only a modest advance of about 1.5 percent in 2013.
Inflation was already at 5 percent last year after a harsh winter and scorching summer hit food prices and is set to remain well above the central bank's 1.5-3.5 percent target through 2013. Core inflation was also high, at 3.3 percent, and most analysts see flat rates this year.
Erik de Vrijer, Romania's International Monetary Fund mission chief, said a case for rate cuts could be made only if and when inflation approaches the bank's target and provided the exchange rate is stable.
"As long as inflation is between 4 to 5 percent it would be unwise to cut the policy interest rate," de Vrijer told Reuters.
Romania put off deregulation for years to protect voters whose average income is less than 350 euros ($470) a month. But controlled prices have deterred private investment in facilities that are outdated, inefficient and in dire need of upgrades.
The changes will account for at least 1 percentage point of inflation in 2013, excluding indirect pressure on other prices, according to analysts and IMF estimates.
Knock-on effects from the three new energy taxes could add up to 0.3 percentage points and other small taxes on farmers and small enterprises could also add pressure.
The cabinet expects the new taxes to generate about 3 billion lei ($924 million) in additional revenue for the budget, giving it room for small public sector wage and pension hikes.
The central bank's next rate-cutting meeting is on Feb. 5. Next week it will also release its quarterly inflation report, and investors will watch for its revised forecasts.
A good harvest, persistently weak domestic demand and the leu currency - central Europe's best performer this month, firming 1.5 percent to about 4.39 per euro and recovering from an all-time low in August 2012 - could offset some price growth.
The comparatively high interest rates will lend the currency support through the rest of the year but will also stop debt yields - which have plunged by about 1 percentage point since a December parliamentary election - from falling much further.
"The leu will trade around 4.35 per euro, we think that's where it belongs," said Daniel Hewitt, emerging Europe economist at Barclays Capital. "A stronger leu will help stabilise the economy."