Rate hike tries to contain credit growth, gov't spending
Curbing public spending and overhauling a shoddy tax-collection system are key to maintaining steady economic growth, analysts warned last week in the wake of a drastic hike in interest rates.
The Monetary Policy Council (RPP) slammed on the brakes last Wednesday with a 2.5-3.5% interest rate hike in a bid to stifle inflation, which had hit 8.7% year-on-year in October and is now on a trajectory to exceed 9% by year's end, according to some economists. That's well beyond the target of 6.6-7.8% set by RPP members and government officials earlier this year.
The problem, the council said, is rising food and fuel prices and the lack of government resolve to rein in spending and control the budget deficit. Economists also pointed to concerns over the state's tax policy and a rising current account deficit.
"The first thing that has to be done is to collect all due taxes," said Krzysztof Rybinski, chief economist at ING Barings. And in terms of public finance, the government "has to control spending outside the central budget."
The spike in three key interest rates is the third and largest increase in the history of the National Bank of Poland (NBP). The council increased the Lombard and discount rates 3.5 percentage points to 20.5% and 19%, respectively, and the benchmark intervention 28-day deposit rate 2.5 percentage points to 16.5%. The Lombard rate is the amount the central bank charges for loans to banks, and the discount rate refers to the amount the NBP pays on bank deposits.
The rate hikes are designed to tighten the money supply, thereby curbing spending that has fueled rising prices. The first to feel the effects are banks, which will likely increase rates for loans in the near future, analysts said.
"The main Polish banks ... will be the first to increase their loan margins and then the other banks will do the same," said Mariusz Pypec, an analyst at CA IB Securities. He said that the Polish Bank Association (ZBP) had announced the increase would come within the next fortnight and that he expected it to be around the three percentage-point mark.
The rate hike surprised the market, which had anticipated the council would increase key interest rates in the range of one to three percentage points, according to Citibank (Poland). In trading Wednesday, the zloty drifted sideways until the afternoon announcement. The currency promptly strengthened in response to the rate hike.
"There were inflows from offshore and Polish names, everybody was trying to buy the zloty," said Mariusz Dudek, a currency trader at SG Bank. The zloty strengthened to close at 0.8% below parity before leveling off on Thursday after general profit taking, he said. In terms of zloty-dollar trading, the zloty strengthened from Wednesday's fixing of 4.2424 to the dollar to open Thursday morning at 4.1934. By the end of the day, the zloty was trading in the 4.2-4.3 range to the dollar.
The rate hike increases the real return investors can gain from buying zloty-denominated instruments such as government bills. That spread is the difference between inflation and the actual rates, which had narrowed in the last half year and caused less demand for zloty-based instruments.
The rate increase likely will not curb inflation in the short term, according to analysts and the RPP. Inflation could climb into double digits, they said, before a reversal in the second or third quarter of next year. Analysts, however, were confident of reaching next year's 5.4-6.8% target.
"This is a huge opportunity to cut inflation to 6.6-6.8% by the end of next year," Pypec said, predicting that by the end of the year it could well hit the 9.1% mark.
This year is a particularly bad year in terms of price rises; fuel prices alone having risen about 50%, he said. There are strong indications such increases will vanish next year and that the RPP is in part counting on this, he said. The government's raising of tariffs on imports to protect the nation's farmers has also put an upward pressure on prices.
Key to stemming inflation is curbing credit growth, which is running more than 46% on a year-to-year basis, according to Citibank. Since the beginning of the year, consumer loans have grown 5% monthly, Pypec said. Moreover, increased consumer credit and spending levels have directly eaten into Poland's trade balance, which could send the current account deficit to $11 billion, or 7.1% of gross domestic product (GDP), by the end of the year, he said.
"The RPP decided to hike this rate spectacularly to push the commercial banks to increase their loan rates and margins immediately to stop this negative tendency," Pypec said. With the increased rates, consumers will now put more of their cash into bank deposits. At lower spending levels, there will be no pressure on producers to hike prices, he said.
"If there were no rate hike, the economy might grow by 6%, the current account broaden to 8-9% of GDP, and inflation would be in double digits for most of next year," according to ING's Rybinski. Instead, the rate increase will reduce inflation and the current-account deficit, while slowing growth to a more reasonable 5-6%, he said.
But that won't be enough to steady the market, Rybinski said. "To put the country back on a stable growth path, it is absolutely necessary to reduce the public-sector deficit," he said. The budget deficit could exceed 4% of GDP this year, and a major driving force is the Social Security Office (ZUS) where spending alone could exceed 1% of GDP, Rybinski said.
The government underestimated pension spending and has fallen short of its collection targets, said Bohdan Wyznikiewicz, economist at the Institute for Market Economics. The government initially budgeted zl. 5.8 billion ($1.38 billion) in subsidies for the state pension system. But due to a shortfall in collections and a greater-than-expected demand from the new second-pillar pension system, ZUS ran short of funds. That led the government to issue the pension a zl. 4 billion ($1.03 billion) loan. In addition, ZUS has taken a commercial loan of zl. 2.8 billion ($717.95 million).
In addition to plugging unanticipated leaks in ZUS, a clear resolve may be hard to achieve regarding government spending on sectors undergoing economic reform, such as mining, agriculture and health industries. So far, the government coalition has gone back and forth over how to treat demands from workers. With many elements of the governing coalition sympathetic to these groups, belt tightening in the wake of the rate hike likely will cause further friction in the already ailing administration, Pypec said.
Not necessarily, since it's a matter of choosing your battles, Rybinski said. By cracking down on tax collection and public financing, the government has a smoother road before it, he said. "It would be enough to clean up the mess in ZUS and health reform to reduce the deficit by 1% of GDP," he said. "It would be much easier for (the government) than resisting the demands of these groups," he said.
