Europe's Longest-Serving Central Bank Chief in Policy Bind

  • Romanian bank governor grappling with deflation and loan boom
  • Policy response to shape economy's growth trajectory

A quarter-century at the helm of Romania’s central bank has readied Mugur Isarescu for most policy challenges. His latest test may be the most puzzling yet.

After 25 years of battling inflation, at times the hyper variety, Isarescu now faces prices dropping for the first time since communism during the biggest-ever surge in local-currency lending -- two forces that call for opposite policy responses. As President Klaus Iohannis weighs whether to sign a controversial bill that would allow citizens to walk away from their mortgages, how Europe’s longest-serving current central bank chief tackles that conundrum will help steer one of the continent’s fastest-growing economies as it pursues euro membership.

Deflating prices concurrent with soaring mortgage debt aren’t unique to Romania. Sweden and Switzerland are grappling with that same combination. Unlike them, Isarescu still has room to trim borrowing costs, even with the benchmark interest rate at a record-low 1.75 percent. That gives him a choice: cut and risk a credit bubble like the one that burst in 2008 and forced the nation into an international bailout, or raise and chance denting demand and crimping economic growth.

“Isarescu is backed into a corner because he wants to avoid imbalances as Romania looks toward joining the euro area,” Roxana Hulea, a London-based economist at Societe Generale SA, said by e-mail. Pay increases for state workers and more monetary easing by the European Central Bank complicate the situation further, she said.

Isarescu, 66, who was first named central bank governor in 1991 and has served in that post ever since except for a stint leading a technocratic government in 1999-2000, also has to account for the effects of Romania’s volatile politics. Since Victor Ponta resigned as premier last month, giving way to another non-partisan cabinet, the leu has weakened 1.6 percent against the euro, the BET stock index has dropped 6.9 percent and the yield on the nation’s local-currency debt due in 2025 has risen 35 basis points to 3.889 percent.

The declines in consumer prices that began in June were triggered by pre-election reductions in the value-added tax by Ponta’s government. While more tax cuts are due next year, with the effect on inflation heightened by the latest oil crash, their influence should wane by mid-2016, turning price growth positive, the central bank predicts. Isarescu didn’t respond to questions sent by e-mail and through his staff.

The rush to leu loans has helped propel economic expansion, which quickened to 3.6 percent from a year earlier last quarter as retail-sales growth surged beyond 11 percent. In particular, Isarescu has singled out real estate, with prices that still haven’t recovered to pre-2008 levels and a stronger preference for home ownership than in other parts of Europe are proving an alluring combination to buyers accessing cheap mortgages.

Leonidas Anastasopoulos, who builds luxury residences on the fringes of Bucharest, says his company is struggling to keep up with demand. “Sales have outpaced our construction capacity,” he said.

This may change through a walkaway law, which would allow citizens to hand over the property to the bank and become debt free if they can no longer pay, enters into force. Iohannis is weighing whether to sign the bill into law or send it back to lawmakers after the central bank warned that it may cause lenders up to 4 billion lei ($974 million) in losses and would boost mortgage costs.

What will Isarescu do?

He could relax banks’ reserve requirements as he waits for deflation to reverse. Rather than tackling credit expansion by raising the benchmark from the current 1.75 percent, Isarescu has mooted macroprudential tools that could resemble the stricter limits on mortgage borrowing deployed by central banks such as the Bank of England to cool property prices.

With all the conflicting factors facing the governor, whose term doesn’t end until 2019, the best approach may be to stand pat, according to Nicolae Covrig, an economist at Raiffeisen Bank Romania SA in Bucharest.

“These factors should prompt the central bank to keep the monetary-policy rate unchanged until the beginning of 2017,” he said.

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