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Betting on exchange rate
Iurie Gotisan, March 1, 2006

1. Exchange rate like in a crystal globe

Beyond different figures unveiled by bankers, two words are often met in their commentaries on exchange rate that indicate a convergence of opinions.

The first word is "appreciation" and it is related to the leu, which could moderately strengthen in 2006, mainly due to a record share of credits in lei and foreign investments - either direct or speculative, according to bank functionaries. Of course, the millions of euros or dollars that come from Moldovans working abroad (remittances were estimated at about one billion dollars in 2005) are also important.

"Volatility" is the second word that bankers often use while speaking about currency market. Less predictable moves of exchange rate will continue in 2006, too, though no big fluctuations will be registered. Indeed, the direct intervention of the National Bank in the monetary and currency market could amplify the volatility of the market. On the other hand, the commercial inflows (collections from export-import operations) will be more important in evolution of exchange rate.

The volatility, which everyone speaks about - as concerns the evolution of the currency market - is like "reading on water," especially because the domestic currency market was predictable nor in 2005. Considerations related to the currency market are interesting for everybody, but how much the dollar will cost is the question of anybody who reads or listens to currency forecasts and thinks about exchange rates, variations of salary negotiated in foreign currency or deals that one must put across. Will it cost 13 lei? Or 14 lei? But how worthy the euro will be?

A medium exchange rate for the entire year 2006 could be 13.5 lei per dollar. Several factors will shape the currency market the next months, including direct foreign investments, evolution of trade deficit, rise of natural gas prices, capital inflows, and not the last, decisions of the central bank, besides the evolution of economy in general.

The Moldovan leu has depreciated verso main reference currencies this year and we think that the jump of the pair euro-dollar on international markets is a primary cause, since the domestic market depends on the foreign market in a very big measure. On the other hand, we consider that both season factors and some long-term factors have superposed as motives of depreciation.

Indeed, if you try to monitor the evolutions on currency market from interest, you will observe a correction of the exchange rate at the beginning of every year (taking into account that many importers make massive reserves at the beginning of year, buying currency and the National Bank is probably trying to intervene through commercial banks, influencing the rise of inflation this way), that means a season depreciation. Moldova registered in 2005 the largest trade deficit in all these years of transition and this deficit pressures the Moldovan leu in a bigger or smaller measure.

What is happening over the borders is also important, from performances of savings in the region and decisions of the American and European central banks to oil price on world market. Year 2006 will likely mark a re-balance of factors of influence on exchange rate on domestic market. In our opinion, the trade deficit is on one scale of the balance and we think that it will be high in 2006, too, and will act against leu. We mean the record imports last year and unbalance between them and exports, which have generated a trade deficit of over 40 percent of GDP.

Financial factors will be on the other scale of the balance and we think that they will act in favour of the leu. Capital inflows, private foreign credits and foreign direct investments (which are expected to grow up to 300 million dollars in 2006) would increase this year. What would be the result? The cumulated effect will be a real appreciation of the leu or a nominal appreciation.

Shall we expect a sudden depreciation of the leu? Such a possibility seems to be excluded, if we take into account the currency reserves of the central bank - approximately 600 million dollars in early January 2006. Thus, BNM has enough reserves to combat a strong trend of depreciation of leu and to control the prices.

Perhaps it is premature to estimate the influence of some massive depreciations of the leu

(of course, if there will be some) on economy in general, but in particular the depreciation disadvantages those who receive their salaries in Moldovan lei and want to make reserves or savings by purchasing foreign currency and lose while exchanging. Workers who earn salaries in foreign currency or their wages are calculated in foreign currency harvest the benefits, since they gain after the exchange into lei. In addition, exporters profit from depreciation, while importers suffer losses. At the same time, the state is also affected by depreciation, as it buys fuels, as for example natural gas.

2. External currency fluctuations on domestic market

Perhaps BNM will practice a directed currency regime in 2006, too, especially to control the inflation. Those who monitor the international currency market forecast a downfall of the dollar in 2006, while the main cause of the "collapse" should be searched in the United States, which has an excessive trade deficit and current account deficit. Performances of American economy and European economy, the oil price, BCE policy and American Federal Reserves will influence the exchange rate at world level.

It is important to understand the macroeconomic impact of evolutions on international currency market on balance of payments of Moldova. As most of export contracts stipulate prices calculated in dollars, while import prices (except for energy resources) are calculated in euros (or in dependence of euro), the situation of trade balance is worsening. We could register a "super-performance" of trade balance in 2006, too.

In addition, the exchange rate will have an impact on all families who have debts in currency. The bank world uses the term effect of wealth and balance. It is simple - when the leu-euro or leu-dollar exchange rate declines (the leu is appreciating), you pay less lei to reimburse the loan, thus you save more money, and vice versa. It should be noted that BNM likes a strong leu because it helps the decline of inflation, but exporters and finally Government do not like it because it affects the external competitiveness of economy.

The financial market is in charge with establishing the exchange rate in the entire world. The story of the Moldovan leu is becoming more fragile, if we look in perspective. In our opinion, the trade deficit is one of reasons that raise concern. It does not matter that it is financed without problems for the time being, similar developments in East European countries (Hungary, the Czech Republic or Poland) show that a monetary crisis occurs sooner or later.






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