Price Liberalization in Romania
Stage 5: On 1 August 1992, the manner of price and tariff negotiations were regulated under the conditions of completely liberalizing the exchange rate
2.4 Evolution of the Price Level
The movement of prices is illustrated by the data presented in Table 2.2A in the Appendix. The accelerated increase of the general level of prices between 1990 and 1992 was determined by:
(i) the critically high level of costs and low level of profitability in many enterprises and industrial sectors in the 1980s; and,
30 I. Buda (ii.) the subordination of the 'price system' to a general resource allocation system drafted and maintained for multilateral development with autarck economic tendencies until 1989;
(iii) the imbalance between demand and supply on the domestic market which existed previously, but was accentuated by excessive revendication on the part of the employees in 1990;
(iv) the rapid devaluation of the national currency after 1990.
The increase of wholesale prices was more rapid than that of the consumer prices.
The determination and the pressure of wholesale prices on consumer prices was obvious due to the coincidental increases. The tendency of the producer and consumer price indices to move together was clearly apparent in the period between 1990 and 1992. In certain periods, the postponement of actualizing the prices according to modifications of the exchange rate generated rigidity of prices. The price level continued to be altered as a result of understating the depreciation of capital equipment which occurred due to the delay in updating the values of fixed assets.
The development of consumer prices showed the specific flexibility commensurate with the situation of diminishing incomes over the three year period.
The prices of food products increased more than those for non-food and both exceeded the dynamics of the prices for services. Food products constituted more than 50% of the average family's consumer expenditures. Furthermore, the limitation of the mark-up restricted the movement of relative prices, granting protection to the producers against an unexpected movement (change) in demand.
The Romanian economy exhibited the characteristic features of an inflationary situation during the period studied in this paper. The presence of imported inflation can not be ignored, considering the decline of domestic production and the increase of imports. In these circumstances, three factors are acting jointly: the 'emptying' of the domestic market, the pressure on imports of consumer goods, and the increase of the exchange rate. In fact, Romania made an effort to fulfill its commitment to liberalize foreign trade and not create new restrictions in this area.
However, there are experts who support the maintenance of some commercial restrictions in the period of unification and liberalization of the exchange rate.
In the period from 1990 to 1992, domestic production shrank (to 50%
compared with industrial production of 1989) and imports of consumer goods could not cover the difference. The monetary overhang accumulated in the past tended to dissolve. The polarization of incomes determined important structural changes in aggregate demand. The development of real wages between October 1990 and February 1993 is shown in Table 2.1. The real wage (monthly average) in January 1993 represented only about 60% of its level in October 1990, when price
Price Liberalization in Romania 3 1
The sources for statistical data for this table apply also to all other tables.
Sources:
National Commission for Statistics, Monthly Price Statistics Bulletins (multiple issues 1990-1993).
National Commission for Statistics, Romanian Statistical Yearbook 1993. Ministry of Finance, Deparment for Prices and Protection of Competition.
liberalization began. This drop discloses the drastic impact of price liberalization on the purchasing power of the population.
During the period observed, the exchange rate surged ahead of prices (see Figure 2.1 and refer to Tables 2.2A and 2.3A in the Appendix). The contribution of the devaluation of the lei to the revival of exports was hampered by increased costs of the inputs. About 60% of Romanian imports were nonsubstitutable and the production costs depended on the level of the exchange rate to more than 50%
via direct imports and via the adjustment of domestic prices according to the evolution of the exchange rate. Further negative trends arose in response to the depressive effect of the restrictive monetary policy and the hesitation in maintaining other strict budget constraints as well as the lack of support by and co-ordination with the measures of trade policy. The estimated influence of various factors on the price increase in the liberalization process is shown in Table 2.2. The price increase is mostly due to the depreciation of the lei. In fact, the data already referred to in Table 2.2A in the Appendix clearly illustrates a 16 fold increase of the general price level compared to a 32 fold decrease of the exchange rate level of the lei during the three years of transition (from January 1990 to February 1993).
32 I. Buda
I
&change rate IOct.90 = 100, 21 lel/USD) C o n s u m e rprice m d e x iOct.90 = 1001I
Figure 2.1 Exchange Rate of Lei to USD and the Consumer Price Index
Thus, some of the fundamental economic indicators - as wages, for instance -
reach alarming heights when converted into USD.
As far as prices are concerned, the level attained could be explained by the general unfavorable condition of the economy: the reduced utilization of the output
Table 2.2 Estimated Influence of Selected Factors on Price Development, 1991 and 1992
I
1991 I I 1992
I
Wholesale Consumer
1
Wholesale Consumerprices prices prices prices
(industry) ) (industry)
I
The price index (end of year) 676.3 344.5
j
1836.0 1230.0compared with October 1990 I
(%) of which: I
i
modification of exchange rate 313.0 167.0
1
1092.0 662.0 modification of wage level 240.0 114.0/
529.0 385.0reduction of subsidies - - I - 57.2
other factors 123.3 63.5 f 215.0 125.8
Source: see Table 2.1.
Price Liberalization in Romania 3 3
capacities; the increase of the specific material consumption; increase of nominal wages; lack of financial discipline; and so forth. In the case of the exchange rate of the lei, which followed the trend to align with inflation, the level in mid April 1993 should have been 320 lev1 USD; however, the actual rate was about 600 lev1 USD - 37.5 times higher than the rate in January 1990.
In contrast to Romania, other countries in transition have exhibited a much closer relationship between price development and devaluation of their national currencies (see Table 2.3). The data shows that the countries which devalued their currencies less, registered smaller price increases. As a rule, except for Romania and the ~ S F R (until December 1991), the devaluation index is not in excess of the price index. In Romania, the price increase is smaller than the devaluation of the lei due to the measures taken by the government to combat the monopolistic tendencies of the economic agents. The process consisted of the notification of the intention to increase prices three months in advance (now 30 days) and selling goods from inventories at the old prices in order to erode the profits to compensate for the unfavorable influence (increase) of the exchange rate and, generally, the prices of inputs.
The objective of sharply devaluating the lei was to encourage exports, while some additionally relevant side-effects were largely ignored. These included, for example, inflationary impacts of the imports and vanishing of the export stimulus when the rate of growth of the domestic price level exceeds the rate of devaluation of the currency. In fact, the Romanian government resorted to the import tax and
34 I. Buda turnover tax exemptions and as well as to the reduction of profit taxes on exported goods in order to stimulate more export. As already mentioned, imports have been a necessity for Romania and, in most cases, the main supply of basic raw materials and energy resources. By increasing the exchange rate, the costs of those who use imported resources inevitably increased. For example, domestic crude oil was sold to the oil distilleries at 2,000 legton in October 1990 and 42,225 leilton in October 1992. In comparison, prices of imported crude oil were 52,000 to 54,000 leilton. The price of gasoline increased 15 times and that of diesel oil 16 times in the same period. According to our estimates, about 60% of the increase of the price level could be attributed to the increase of the 'cost' of foreign currency, i.e.
to the devaluation of the Romanian lei.
If all the influences of the exchange rate were transferred into prices, the inflation in Romania could reach alarming dimensions. Indeed, this could destabilize the social equilibrium, including the minimum agreements reached with the social partners (trade-unions) in 1991 and 1992. From this point of view, pushing the exchange rate upwards had a destabilizing impact and did not support in anyway the interests of the Romanian economy throughout the transition period.
Under such circumstances, the application of the rules acting in a standard market economy is completely unrealistic. The theoretical construction implemented until today in the Romanian economy, no matter how substantiated in other countries, was in no position to resolve the crisis the country was confronted with at the time this paper was prepared. The entire range of regulations in the field of pricing were to facilitate the alignment of domestic prices for energy, fuels, and other basic raw materials with world market prices. Since the electric power costs constitute a portion of almost all products' prices, the impact of the exchange rate is obvious.
The prices of imported consumer goods are based on the prices in hard currencies negotiated with foreign suppliers and converted into lei at the current exchange rate. The final prices are supplemented by import duties, turnover taxes, and the commercial margins of the wholesalers, intermediaries, and retailers. The higher the exchange rate, the higher will be the domestic market price. A substantial contribution to the increase of consumer goods prices was brought about by the importers, who often added an exorbitant margin of up to 3,000% (which was, in fact, meant to cover their costs and profits). This situation required better regulation of import pricing so that the determination of the prices would remain free as before, but the possibilities of charging speculative prices would be limited.
The exchange rate of 600 leg1 USD in the spring of 1993 pushed up the general price level. The price increase due only to the devaluation of the lei was expected to be as follows when compared with the price levels registered in August 1992 (when the exchange rate was 375 lei11 USD):
Price Liberalization in Romania 35
. basic raw materials, fuels, and energy (which have already internationally aligned prices) by 65%;
other industrial products by 30-52%; and, consumer prices by 30%.