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-- JP Morgan announced Romania is eligible for inclusion in its popular domestic debt indices.--After selling Romanian domestic debt for the past year and a half, non-residents are once again embracing these assets.--The aggressive buying started close to the end of last year and looks to have been sparked by the dissipation of political stress: the ruling alliance has secured a Constitution-changing majority of just above 67% (well above the 60% hinted by polls) and the fierce conflict between the PM and president has suddenly ceased.--The entry point looked attractive as Romania had managed to attract only about €1bn from non-residents in domestic debt over the past three years (on a net basis) and these investors hold only some 5% of these papers (data as of October).--We believe the executive will stick to the current view that another IMF deal is needed and will eventually comply with the Funds requirements. The current deal ends in March and there are reasonable prospects to expect a new one by the end of 2Q13. When it will become clear that the negotiations are heading in this direction, RON assets can continue appreciating.
Domestic government debt yields, long-term: After selling Romanian domestic debt for the past year and a half, non-residents are once again embracing these assets. The announcement that Romania is eligible for inclusion in JP Morgans popular domestic debt indices on 16 January 2013 spurred further advances in local debt prices. However, the aggressive buying that started close to the end of last year looks to have been sparked by the dissipation of political stress. The ruling alliance has secured a Constitution-changing majority of just above 67% (well above the 60% hinted by polls) and the fierce conflict between the PM and president has suddenly ceased. Negotiations for a new SBA with the IMF may prove tough, as Romania has lagged on many reforms required under the previous deal. The current deal ends in March and there are reasonable prospects to expect a new one by the end of 2Q13. When it becomes clear that the negotiations are heading in this direction, RON assets can continue appreciating.
Exchange rates, long-term: The RON embarked on a clear firming trend over the past weeks, but this trend may not continue for long as these inflows hold. The poor growth backdrop (we estimate GDP stagnated in 2012 and project a 0.5% expansion this year) with flat exports and industrial output suggests there is no clear room for appreciation. The RON now trades some 2% stronger vs the previous years average and inflation looks to be tracking around 5-6%.We think the NBR will channel these inflows into boosting FX reserves by keeping short- term rates low (signalled in last weeks rate-setting meeting but not yet implemented) and even with FX interventions (now most likely taking place).
Last week JP Morgan announced Romania is eligible for inclusion in its popular domestic debt indices. While the inclusion is said to be subject to final determination, it should be a phased process lasting between 1 March and 1 May. Such indices usually serve as a benchmark for asset classes and this inclusion will put Romanias local currency debt on the map, as it joins 15 other EM markets.
The driving factor of this decision was most probably the development of the domestic debt market. The hard landing experienced by Romania in 2009 massively hurt public finances, widening the deficit to a bit more than 7% of GDP. Thus, the stock of local currency debt has increased from about RON20bn at the end of 2008 to almost RON90bn currently. A more consistent pattern of debt issuance, as exhibited by the MinFin over the past months, has probably also helped. But most likely this inclusion would have not taken place were it not for the current generous liquidity in many developed markets that prompted investors to seek returns in new markets. Also, the entry point looked attractive as Romania has attracted only about €1bn from non- residents into domestic debt over the past three years (on a net basis) and these investors hold only some 5% of these papers (data as of October).
Since Romanias potential weight in the diversified index is estimated at 0.54% and the index compilers surveys are said to show US$175bn is benchmarked to this index, this would suggest Romania might see inflows worth €0.7bn. If the EM bond space remains en vogue, these inflows should increase further.Apart from the flows induced by portfolio rebalancing, Romania might lure back the capital outflows from the debt market seen during 2011-2012 worth about €1.5bn. Additionally, this would attract some fast money and together these inflows might total around €3bn though. Looking at the scale of demand in the latest debt tenders, this estimation may be on the conservative side.These potential inflows could be larger than projected FDI (€2bn). Also they would limit the future crowding out effect as a good part of the new public debt would be financed by non-residents. Still, this may not visibly support lending in the short run as banks continue to deleverage and some of the institutions have recently stopped offering foreign currency retail lending.
The impact on the RON from these inflows has been significant but future gains look to be limited by the NBR. Fresh data shows the NBR has started curbing its gains in December as it bought about €0.3bn and current intraday data suggest the banks presence has intensified. While our new end-2013 forecasts point to a much stronger 4.30/€, the NBR resistance and a likely difficult negotiations for a new Stand-By Arrangement could provide the market with a near-term negative surprise. Bonds probably have more to gain. The 3Y-5Y yields have already dipped below our 2013 trough of 5.5% and look to be limited mainly by the issuance strategy. For the moment, the MinFin looks set to increase issuance rather than drive yields lower, but with about 20-25% of this years domestic needs covered, there are good risks for the 3Y-5Y segment to eye 5.25%.
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