Macro worries keep ministry, NBP from cutting zloty loose
Anxieties over the current account deficit and a potential currency destabilization last week caused the Finance Ministry and Monetary Policy Council (RPP) to pull back from plans to allow the zloty to float freely.
Analysts said that if the RPP had decided to cut the zloty loose, the council probably would have done so as early as March or April. Analysts said that now it is unlikely the council or the Finance Ministry will float the currency until June or July, depending on how the nation's economy fares in the next six months.
If the National Bank of Poland's (NBP) 2000 inflation target of 5.4-6.8% seems achievable and the spiraling current account deficit which hit 7.2% of gross domestic product (GDP) in November is kept under control, then the zloty's trading band will be eliminated sometime in the summer, said Mariusz Pypec, an analyst at CA IB Securities. He added that a cut in interest rates would also be likely.
"If the government is sure that the macroeconomic (picture) is normal, then the full liquidation of the zloty may be introduced in June or July," Pypec said.
Presently, the zloty fluctuates in a band of 15% on either side of a parity rate set daily by the NBP against the euro and the dollar. Through the crawling peg, the NBP devalues that parity rate 0.3% per month, which accounts for about a 3-4% depreciation annually. The crawling peg is designed to stabilize the zloty by automatically weakening it in line with inflation. But with inflation now in single digits inflation for 1999 is expected to come in at about 9.7% economists said that little natural threat remains to the currency's stability. Even without the restrictions, economists said that the zloty would typically hover around the currency band of +/- 15% of parity.
The potential double whammy of a possible rate cut combined with a zloty allowed to depreciate beyond the currency band could be the impetus the economy needs to stimulate exports, economists said. A rate cut would cut the real return the difference between inflation and interest rates that investors holding zloty-based instruments would see. That in effect would stymie demand for the currency and potentially cause it to weaken, which would in turn make Polish goods cheaper on international markets.
Overall economists were positive about the NBP and the Finance Ministry's desire to float the zloty, saying that it was a sign of the economy's maturation.
"Freeing up the currency makes sense because Poland has graduated to a stage where it should be easily capable of allowing the currency to settle without the authorities intervening," said Krzysztof Bledowski, chief strategist at Wood & Co. "It's very welcome to investors."
The market had expected the announcement of a time frame for the flotation last Monday, expecting the currency band to be abandoned at the end of the first quarter. The zloty opened Monday at 3.37/3.18% above parity due to expectations of an announcement. Despite a weaker opening on Tuesday, at 2.97/2.88% above parity, the currency strengthened to 3.6% on the back of capital inflows, according to daily reports by Citibank (Poland). Further inflows and enthusiasm for the free float kept the zloty strong, opening at 2.88/2.78% last Wednesday.
The move toward a liberalized zloty is part of NBP policy to make Poland more attractive to foreign investors, by bringing the country in line with European Union (EU) and OECD standards, Pypec said. Investors would see the move as another signal to investors that the nation's economy is less prone to drastic movements either in the currency's trading or in capital flows.
Liberalizing the zloty is also a key part of the NBP's desire to join the European Monetary Union (EMU) in 2007, which requires the elimination of the crawling peg and inflation of 2.5%, Pypec said. For strategic investors, "this will be perceived by foreigners as the first step to full liberalization of the market and they will be more attracted by it," he said.
Foreign direct investment (FDI) hit $6 billion-$7 billion in 1999, and is expected to rise to $7 billion-$8 billion this year, Bledowski said. These figures take into account only strategic stakes and greenfield investments, he said.
As part of an agreement with the OECD, Poland had agreed in 1997 to fully liberalize its markets at the beginning of this year, but shelved its plans as a result of the world financial crisis in 1998 and at the beginning of last year. Currently, however, zloty flows out of the country are limited, but those restrictions are expected to be softened as well.
One advantage that a free zloty would bring is that it would remove limitations on how much investors could gain or lose on their zloty-based instruments. "Investors love risk, it's a great opportunity to make more money," Bledowski said.
At the moment, however, the government's worries about the widening current account gap are shadowing any possible benefits of currency liberalization. Poland has hiked interest rates specifically the intervention rate twice last year to curb rising consumer demand, which was fueling imports.
Analysts are expecting another rate hike in the coming months, but said that that should be the last of the rises. Those hikes have widened the spread investors have seen on zloty-based instruments and prompted significant capital flows into fixed-income markets, Bledowski said.
In light of this, the Finance Ministry is worried that at present the demand for zloty-based instruments could strengthen the currency, which in turn would have a negative impact on exports and thus the current account deficit. For that reason, the Finance Ministry is not crazy about the idea of limiting the NBP's ability to intervene in the currency market just yet.
Economists said that the zloty's mid-term strengthening should not last long. "In the medium run, there should be no marked difference between the current exchange-rate regime and the float," said Krzysztof Rybinski, chief economist at ING Barings.
Although the zloty weakened last year, it remained fairly stable. The currency's greatest deviation from parity last year came in January when it hit 8.97% above parity.
