Romania and the euro

Overview of the relationship between Romania and the Euro

Romania's national currency is the leu. After Romania joined the European Union (EU) in 2007, the country became required to replace the leu with the euro once it meets all four euro convergence criteria, as stated in article 140 of the Treaty on the Functioning of the European Union. As of 2023, the only currency on the market is the leu and the euro is not yet used in shops. The Romanian leu is not part of the European Exchange Rate Mechanism (ERM II), although Romanian authorities are working to prepare the changeover to the euro. To achieve the currency changeover, Romania must undergo at least two years of stability within the limits of the convergence criteria. The current Romanian government established a self imposed criterion to reach a certain level of real convergence as a steering anchor to decide the appropriate target year for ERM II membership and Euro adoption. In March 2023, the government set the target to enter the antechamber of the eurozone (ERM II) to 2026 and the target for euro adoption to 2029.

Romania has been an open economy with free capital flow since September 2006, and with total foreign trade exceeding 75% of Gross Domestic Product (GDP) (Isărescu 2007). Romania's financial market is developing, and experts have noted a trend toward greater efficiency of stock exchange transactions. Consequently, inflows of portfolio investments appear likely to increase. This could become a resource to address the current account deficit. Remittances from Romanian people who work abroad are expected to maintain high levels in the short term. Nevertheless, the country's accession to the EU also gives rise to a new resource capable of covering the deficit, namely transfers from structural and cohesive funds to Romania, as a cohesion country that would be achieved starting in 2008. The first step required to prepare for the changeover of the leu to the euro took place at the same time as depreciation of the national currency. In 2005 the new Romanian leu was printed with the same physical dimensions as the euro in order to fit the Union's automatic teller machine (ATM) system. In 2006, the Romanian government announced that the new plan to join the ERM II (a prerequisite for euro adoption) would take place only after 2012 because of significant impediments such as price instability and high interest rates. The president of the European Central Bank said in June 2007 that "Romania has a lot of homework to do over a number of years" before joining ERM II. The Romanian government announced in December 2009 their official plan to join the Eurozone by 1 January 2015. In 2011, the Romanian government announced it would work to comply with the first four convergence criteria by 2013, but the economy would need further reforms to successfully change to the euro.

In Romania, the main objective of the BNR is to ensure and maintain price stability while concurrently promoting the Government's general economic policy. As stated in Article 2 of Law 312/2004, the National Bank is responsible for defining and implementing the monetary policy strategy (Direct inflation targeting) and the exchange rate policy. Over the years, the BNR has supported the monetary policy by progressively decreasing the policy rate. The first step achieved was between February 2009 and March 2012, when the BNR cut the policy rate by a cumulative 500 basis points, to 5.25%, followed by rapid decreases in the annual inflation rate, which made it possible for the BNR to resume downward adjustment of the policy rate. Between July 2013 and February 2014, the BNR cut the policy rate by a cumulative 175 basis points, to 3.5%. Romania has managed floating exchange rates and is in line with using inflation targets as a nominal anchor for monetary policy and to enable flexible policy responses to unpredictable shocks that would potentially affect the economy. Reasons for not entering the euro area are complex, covering national problems, including insufficient economic convergence over a lacking perceived attractiveness of euro membership, as well as an unresolved institutional reform agenda (Backé and Dvorsky 2018).

Disclaimer of the monetary policy instrument. Responsibility for monetary policy and exchange rate would pass to the European Central Bank, leaving Romania without the ability to control an important monetary policy instrument (the monetary policy interest rate) and giving up to the exchange rate, another instrument that contributes to adjusting the economy, especially during recessions. Convergence. In order to suffer a smaller cost from the currency changeover, the structural, real and institutional convergence must be as high as possible. Business cycles must be synchronized (periods of economic downturn and economic growth to be simultaneous in Romania and in the Eurozone). In general, Romania is a quarter lagged room against the Eurozone economy. Hence, the effects of the ECB's monetary policy will have an asymmetrical effect. The decision to change to the euro currency is not appropriate to the phase of Romania's economic cycle. Control of macroeconomics balances. Romania must maintain the balance of macroeconomics: in the private sector (low debt rate), in the budgetary sector (a low budget deficit) and in the external sector (a stable balance). An alternative instrument for interest rate and exchange rate. By renouncing the two instruments, Romania needs to find a substitute tool: economists usually recommend the flexibility of the labour market, the flexibility of wages and mobility of production factors. It is an exercise of will and power. The ambitious objective can bring Romania a solid, robust economy. Also, if Romania enters unprepared into the EU, the benefits will be smaller than the costs.