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Saturday, June 7, 2008

Polish Monetary Policy - A Hypothesis

Poland's Monetary Policy Council left interest rates unchanged in May for a second consecutive month as it awaits more data on inflation and economic growth before making any further increases. Rate setters kept the seven-day reference rate at 5.75percent at their meeting this morning.

The central bank has raised rates seven times in the past year to curb inflation as rising salaries and record-high employment spur consumer demand.

The question is, what impact will this have on the appetite among Poles to contract debt in euros rather than zloty. There is a considerable market for non-zloty loans in Poland, although this does not seem to have grown disproportionately vis a vis zloty loans (both have been growing very fast) in recent years.

More specifically there has long been a healthy demand for non zloty mortgage finance.

But interestingly, if we come to look at the comparative year on year changes between the two possibilities in terms of mortgage finance, what we will see is that while the zloty loans were gaining ground while monetary policy in Poland was relatively loose, since the National Bank of Poland started tightening in a serious way last autumn, the situation has inverted, and the year on year rate of increase in forex loans has been accelerating, while the rate of increase in zloty mortgage lending has been slowing. If the Polish central bank needs to continue to tighten and the ECB (despite Trichet's most recent sabre rattling) starts to loosen, then it will be interesting to follow the comparative path here, since it gives a pretty good birds eye view of the effectiveness of single country monetary policy (or its limits) in the present globalised world.


Mary Stokes said...

Not surprisingly, as you have shown Edward, the greater the interest rate differential and the 'cheaper' the fx-denominated loan, the greater incentive there is to borrow in foreign currency, even if you're an unhedged household.

So far, it seems like attempts to regulate fx-denominated lending haven't been effective...can you think of any way for Poland to staunch this?

If euro adoption was not on the table - that is, if it wasn't seen as inevitable...would we see such strong fx-denominated borrowing?

The fact that the ECB and NBP appear headed for moves in opposite directions raises the question for me about whether EU newcomers should be clamoring to join the Eurozone, making them subject to the ECB's one-size-fits-all monetary policy, when their catch-up dynamics would seem to make that problematic.

Edward Hugh said...

Hi Mary,

"So far, it seems like attempts to regulate fx-denominated lending haven't been effective...can you think of any way for Poland to staunch this?"

Well I think conventional monetary policy just can't handle this situation without unwinding big chunks of financial globalisation.

Of course I think it would be prudent to be pushing regulatory advice measures from the central bank about the loan to value ratios on new mortgages and earnings to capital sums lent ones etc, but I guess here they run into difficulties from the construction lobby. My feeling is keeping a grip on construction activity administratively is important here - why for example doesn't France currently have the problems Spain does, look at the internal bank regulation environment would be part of my guess - but you try convincing people of this while there is a property boom going on.

So we are left with running fiscal surpluses to drain liquidity and demand. I think the IMF are on the right lines here, but this needs to be pushed more, and the levels of targeted surplus may need to be increased.

Of course it would be a good idea to address the labour shortage issue BEFORE it really arrives and be doing something to really systematically stimulate and support labour migration into Poland, otherwise you are just going to hit the Baltic problem eventually, one day or another.

"If euro adoption was not on the table - that is, if it wasn't seen as inevitable...would we see such strong fx-denominated borrowing?"

Well I think the existence of the eurozone is definitely one part of the problem here (and all of this will need carefully looking at (with hindsight) one day, but it is not the be all and end all.

If we look at India or Brazil, the more people become convinced that the direction of currency movement is likely to be more or less onward and upward the more we are likely to see non local currency borrowing in these countries.

So the eurozone is only one part (albeit an important one) of the situation. The big picture scenario is undoubtedly financial globalisation, and the existence of very low interest rates in countries like Japan and Switzerland etc (and of course now in the US).

Indeed I do think I am right in saying that there is extensive dollar denominated lending in the Ukraine (since at one point the Ukraine was very highly "dollarised").