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Leu - "holy column" of economy
Iurie Gotisan, December 1, 2006
The Moldovan leu turned 13 on November 29. It is not a very long period, but also not too short and the central bank has managed to prevent a system crisis by playing the role of a guardian that ensures the stability of the "holy column" of economy - the "strong leu" - in spite of all difficulties. I do not want to judge the evolution of monetary market and Moldovan banking system the way I have done in many commentaries and analyses, this does not interest our reader or common citizen. I will analyse some trends of the Moldovan leu and currency market, notably the exchange rate, interesting aspects for all people.
There is an exact question that everybody who reads or listens to currency forecasts asks himself when thinking about exchange rates, variances of a salary negotiated in foreign currency or future deals: how long will the leu survive or how much the dollar will cost? Will it cost 13 lei? Or 14 lei? But how much the euro will cost? The Moldovan leu has easily grown versus dollar in the past two months, but it has constantly depreciated versus euro. The appreciation of the dollar was probably linked to the growth of currency remittances produced mostly by rise of transfers by Moldovans working abroad. In addition, the appreciation advantages the Government, which buys energy agents such as natural gas, for example.
At the same time, the latest developments on domestic currency market in the latest period manifested through higher prices (implicitly of inflation rate, which rose up to 10.9 percent in ten months of this year), signals the perpetuation of some currency risks. In all likelihood, the appreciation of the leu versus dollar may be also a result of monetary policy of the National Bank of Moldova focused on strict control on monetary base (M0), it means of cash in circulation and amounts held by banks in the central bank. Another factor that depreciated the dollar was due to a strong fall of the dollar versus euro on international markets. In addition the appreciation of the national currency could be artificial because it lacks the support of an economic growth.
Finally, there is an explanation why commercial banks have increased interests under conditions of nominal appreciation of the leu versus dollar. Perhaps banks do not want to direct their investments in foreign currency and they will be forced to reduce the volume of credits released to real sector of economy, and so interest rates also grow. But if the relatively high interest rates are kept, the currency market could be prisoner of some short-term capital inflows, which may increase more the leu in real terms, reducing the collections from export and increasing the trade deficit in continuation.
As regards the euro, our forecasts of up to 17.5 lei per euro for the end of the year have finally become true. The depreciation of leu versus euro was conditioned by interventions of central bank on currency market; it means the bank has influenced the fall of the leu in order to help exports. It is well-known that exporters profit from depreciation. The growth by more than 9 percent of exports to the European Union in the 3rd quarter of 2006 is an additional proof. But the high rise of purchase of currency (euro) of importers could also contribute to depreciation of the leu. A depreciation of the leu versus euro was expectable. I have mentioned above that the central bank has forced the depreciation especially because most foreign investors (particularly from the West) distribute their profits at the end of the year and, therefore, they will allocate more lei to buy euros and this is a positive fact indeed.
Of course, the currency market like other markets is ruled by standard economic rules and the exchange rate is formed depending on relation between demand and supply on this market. It is known that currency market is also influenced by another two important factors: trade deficits that need financing and capital inflows invested in an economy. In their turn, they create the demand and supply for a currency; that means its price versus other currencies. But how to explain the implications of exchange rate in economic realities in Moldova approached in the light of these two factors?
The permanence of a negative trade balance (of 1.1 billion dollars in the first nine months) may be another factor to press the leu/euro exchange rate. However, increasing remittances which local media describes as important and capable to cover the trade deficit are nothing but an aleatory source of financing. In their turn, foreign direct investments are easily reversible, not to speak about typical instability of "hot money", it means of speculative inflows on currency market. Given all these facts, the apparent financing of trade deficit through autonomous inflows seems to be less safer at the first glance.
We think that the National Bank of Moldova will practice further a directed currency regime, especially to control inflation because the stability of prices is the No.1 priority of the central bank.
Many international experts forecast a continued fall of the dollar versus euro, while the main cause should be searched in the United States.
Although the dollar is losing positions and values on all international and national markets, the leu/dollar relation remains relatively stable and the leu has even depreciated recently.
The exchange rate at world level will be forced by performances of the U.S. and European economies, petroleum price, BCE policy and American Federal Reserve.
Developments on international market will influence the balance of payments of Moldova for sure. We have a negative situation of trade balance since most of export contracts stipulate prices established in dollars, while import prices (except for energy resources) are established in euros (or depending on euro). We will have an "over performance" of trade deficit in 2006, too, for sure.
Appreciation of the leu versus dollar will advantage those who earn salaries in lei and want to make reserves or savings by purchasing foreign currency (and inversely, disadvantages them in case of euros); they gain when they exchange lei into dollars and lose when they exchange lei into euros. Employees who earn salaries in U.S. dollars or their salaries are calculated in dollars will lose when they will exchange dollars into lei.
We consider that the Moldovan leu will face some pressures in early 2007 and we may be witnesses of a depreciation due to the rise of internal prices, a modest promotion of exports, and negative influences of some financial markets from the region. It is difficult to forecast the evolution of national currency in early 2007. However, we estimate an exchange rate of approximately 13.1-13.4 lei per dollar and 17.2-17.6 lei per euro.