Erratic zloty not expected to cause currency crisis
Despite the zloty's dramatic plunge two weeks ago, economists said last week that a currency crisis is not in the cards. Nonetheless, should the current account (C/A) continue to deteriorate in the long term, the risk of such a crisis will be much greater.
The Monetary Policy Council (RPP) reacted to the situation by not hiking interest rates at its extraordinary meeting last Monday, convened to discuss the zloty's near 4% fall against the dollar on the back of the euro's losses and March's C/A data.
"The RPP is saying that there are global forces shaping the zloty's movement and it won't intervene without good cause," said Sonja Gibbs, a currency strategist at Nomura International.
She said that since the currency's free float in mid-April, the zloty's peaks and valleys against the dollar have been based on the euro's performance in recent months. In addition, the showings of the Hungarian forint and the Czech koruna have been markedly similar to that of the zloty in the same period. Gibbs said that although the C/A deficit is a cause for worry, "we're beyond the point when the zloty has been trading on domestic fundamentals, so much of what's been going on in the region is the euro's weakness."
Two weeks ago the zloty dropped almost 4% against the dollar and 1.6% against the euro as traders sold off the currency following the release of March's C/A figures. The statistics showed a deficit of $1.43 billion against an expected $1.1 billion-$1.2 billion, or 8.25-8.5% of gross domestic product (GDP) from 7.8% in February. While the zloty had dropped to as low as zl. 4.73 against the dollar two Fridays ago, after the RPP's announcement it closed Monday at zl. 4.47 and held steady the following day. The remainder of the week saw the zloty strengthen, and on Wednesday it finished at zl. 4.42, driven by bullish news about Telekomunikacja Polska's (TPSA) privatization. Last week the zloty did X,Y and Z. While the zloty had dropped to as low as zl. 4.73 against the dollar two Fridays ago, following the RPP's announcement it strengthened to less than zl. 4.5.
But while the currency's recent behavior shows it to be increasingly tied to the euro, the RPP's decision not to hike the rates was also partly based on the fact that manipulations in monetary policy would have had a limited effect anyway. "A rate rise (of around 100 basis points) would have little effect, the zloty could stay volatile and still slip," said James Owen, chief economist at SG Bank, due to concerns over the current account deficit. He said that the C/A, in turn, would be better managed by a tighter budgetary and fiscal policy to make exports more attractive.
However, for the time being analysts said they were not worried in their short-term outlook for the zloty. "We're not faced with a currency crisis situation right now, which is why we don't have to do anything desperate," said Mateusz Szczurek, an economist at ING Barings. He said that so far there have been no problems in financing the C/A deficit, especially at a time when interest rates run 20-21.5%, and although the National Bank of Poland (NBP) prefers not to intervene, foreign reserves still stand at $27.7 billion.
Szczurek said that even "a 10% depreciation of the zloty against the dollar and 4% against the euro (as occurred in April) would hardly have any significant effect on the real side of the economy." He added that the plunge could in fact have a positive effect on the trade balance, making imports less attractive and causing reductions in domestic demand.
Moreover, the zloty's free float makes it harder for speculators to devalue the currency, he said. While speculators compensate for the high interest rates they pay with large capital gains when a fixed currency devalues, "in a floating currency, you not only pay a high interest rate premium, but you also run a strong risk it could appreciate, and therefore you can lose a lot of money," Szczurek said.
In addition, the negative C/A deficit figures are likely to improve in the next few months. Owen said that he expects the figures for April and May to come in at around $1.1 billion and $900 million respectively. Furthermore, Central Customs Office (GUC) figures show Polish exports to have risen 5.7% in dollar terms in the first two months of 2000 against the same period last year. Szczurek said that at present Polish exports are similarly competitive to other countries in the region.
"Many are quite optimistic and expect the C/A to stabilize and then come down," Owen said. "The question is at what level it stabilizes, and the risk is you get four months of bad numbers and then another wave of selling off the zloty." He said that consequently the zloty will be volatile for the next few months, but is optimistic that the situation will improve by the end of the year.
"But you can't predict currency crises or they'd never happen," he added.
However, in the longer term, should the C/A deficit be at the same level in two to three years' time, the scenario carries a far greater risk element, he said. By that time, privatization revenue is scheduled to start drying up, and if Poland is not yet a member of the European Union, the country can't bank on inflows from the bloc either.
In that case, "if the C/A deficit is still large, the likelihood is that there will be greater debts in foreign currency," he said, which could cause a deterioration of external accounts, prompting a much sharper and deeper fall in the zloty's value. In the worst case scenario, currency crises can lead to businesses folding nationwide and the derailing of banking systems.
"The deficit is still large and it's not going to shrink rapidly to 4-5% of GDP," Owen said. "The longer you have it very high, the more vulnerable the country will be to currency crises and losses of confidence."
The RPP next meets this Wednesday to discuss April's inflation data, due today. Szczurek said that ING Barings forecasts inflation at 10.1%, down from 10.3% in March. Economists said that there is little chance interest rates will increase. According to Citibank (Poland), the RPP "will keep the interest rates unchanged in the near term. The next step in the monetary policy would be a rate cut, but not earlier than in the third or fourth quarter."
