Too little too late?
By : Jeffrey Sparshott
Hands off the RPP: NBP President Leszek Balcerowicz
Stanislaw Stec knows how to get people's attention.
In a move to pressure for lower interest rates, the Sejm (http://www.sejm.gov.pl) deputy from Poznan last month introduced legislation that would have cut the Monetary Policy Council's (RPP) members' salaries and limited its independence under the National Bank of Poland (NBP) (http://www.nbp.pl) law. In return, one member of the council threatened to resign.
While the proposed measures did not succeed in a final vote, they did succeed in gaining attention for Stec's cause.
"I don't want to limit the bank's independence I just want to draw the RPP's attention to the economy," Stec said of his legislative effort, supported by his colleagues in the Democratic Left Alliance (SLD) and allies in the Polish Peasants Party (PSL).
Would he try again?
"Yes, unless the RPP will decide to cooperate they will have to answer to the financial committee," he told the Business Journal.
Will the measure succeed next time?
"Definitely yes."
And so last week the RPP's members cut interest rates by 150 basis points, surprising markets with the timing and size of the cut and bringing rates to their lowest level since November 1999; but absolutely not due to political pressure, members said.
"The government had absolutely no influence on the decision," said NBP President Leszek Balcerowicz at a press conference announcing the rate cut. The decision was based only on the country's economic prognosis, which no one can and no one did influence, he said.
The rate reduction was the RPP's third this year totaling 3.5 percentage points and brought the 28-day intervention rate to 15.5% from 17%, the re-discount rate fell to 18% and the emergency Lombard rate to 19.5%. It followed two months during which the RPP chastised the government for lax fiscal policy and warned against inflationary threats. Meanwhile, the budget deficit climbed to almost 100% of the 2001 plan after only five months and the government announced it is likely to loosen fiscal policy to cover the gap. Also last month, the government announced the highest inflation figures for the year.
"The council didn't expect inflation to go back up and it did; the budget is in worse shape than previously feared," said Robert Beange, an economist at Lehman Brothers in London. "So it is clear that they must now be influenced by what's happening in the real economy."
Beange said the rate cut itself was not surprising, though the timing was. If anything, the political pressure could have influenced the RPP to leave rates alone.
"The cut is a realization that the real economy is weakening more," he said. "While there are no factors supporting growth, they had to relent and ease an extremely restrictive monetary policy."
Gross domestic product (GDP) grew at only 2.3% year on year during the first quarter of 2001, the Central Statistical Office (GUS) announced last week, down slightly from 2.4% in the fourth quarter of 2000 and down significantly from 6% growth at the beginning of 2000. Meanwhile, domestic demand fell 1.4% and investments slowed 1.5% in the first quarter, according to GUS. GDP projections for the entire year are mixed with some economists seeing growth falling below 2.5%, though one economist projected 3.7%. Balcerowicz said the economic outlook for the year is uncertain while another RPP member said that growth should be about 3%; government officials last week said they would revise down growth figures, with Finance Minister Jaroslaw Bauc Thursday telling a Sejm committee that he estimated 2% GDP growth for the year.
The RPP's sole mandate is to maintain price stability by controlling inflation, not to spur growth. It is aiming for 4% inflation by the end of 2003 and its official statement last week focused on an improving inflationary outlook.
Rallying cry: Prime Minister Jerzy Buzek has pushed for NBP independence.
Changing the NBP mandate
The SLD looked to change that mandate last month with an amendment that would have altered the wording in the NBP act, giving equal weight to price stability and supporting government economic policies. As it stands, bank officials are to support government economic policies "insofar as this does not constrain pursuit of the basic objective of the NBP." That crucial bit of language would have been struck from the act.
Stec said that it would not be out of line for the government to set inflation targets. Marek Borowski, deputy speaker of the Sejm and one of the SLD's leading voices for economic matters, has been quoted in the press with similar suggestions. And the SLD last month voted almost unanimously there were two abstentions on the rules that would have changed the RPP's mandate.
Prime Minister Jerzy Buzek (http://www.kprm.gov.pl)'s Solidarity Election Action (AWS) coalition rallied around NBP independence last month and, with unanimous backing from the Freedom Union (UW), prevented its left-of-center opponents from rejigging the country's monetary regime. But according to most recent polls, the SLD is heavily tipped to win the Sept. 23 parlaimentary elections and UW's future as a viable party is in question.
"It's an eternal fight between governments and national banks," said Ivan Fabijancic, a macroeconomist for Erste Bank in Vienna who focuses on Central and Eastern Europe. "But central banks, especially of transition countries, should have a very high level of independence. This could be reached with having one target, and this should be inflation."
The NBP overshot its inflation targets in 1999 and 2000 by 1.2 and 1.7 percentage points, respectively but is expected to fall at the lower end of this year's 6-8% inflation target.
The RPP explained the recent rate cut almost exclusively in terms of inflation. "Taking into account all the factors that will influence the future inflation rate, and particularly the fact that most of them have improved, the Council decided to lower main market rates by 150 basis points and maintain neutral bias for future policy moves," the RPP's statement read.
"Looking at macro data, it was perfectly justifiable to cut rates," said Mateusz Szczurek, an economist with ING Barings. Though inflation jumped in April and May, it is expected to ease, making the RPP's year-end goal of 6-8% feasible, he said.
"You have some arguments why some people were not expecting a cut," he said. "These are problems with the budget. Fiscal news will get worse and worse."
Bad housekeeping
The RPP has been keen on the government's handling of the budget, citing it as the rationale for maintaining tight monetary policy at its previous meetings. "The Council will treat threats relating to fiscal policy as limits for future monetary policy," the RPP noted last week. "It has to be emphasized that decisions made by the lower house of Parliament, which significantly increase future state spending, threaten to deepen the imbalance of public finances in the coming years."
The government last week put off a decision on how to deal with revenues that have fallen dangerously below expenditures. After five months, the government collected only 33% of the year's revenues but it spent 40% of the budget. Weak tax collection due to slow economic growth is one culprit. Indirect taxes, such as VAT, are expected to raise more than half of total budget revenues, but low consumer demand and inflation stymied collection on pace with expectations.
Financing the gap has cost the government more than the entire amount it had expected to borrow. The Finance Ministry said the combination of revenues below expectations and spending in line with expectations means that the budget deficit will overshoot by at least zl. 7 billion ($1.75 billion) this year. The SLD officials have estimated a greater shortfall.
The deficit is now targeted at zl. 20.5 billion ($5.1 billion), or 2.6% of GDP. By law, the budget deficit is not allowed to overshoot targets. Economy Minister Janusz Steinhoff has indicated that the government will seek some sort of compromise making some spending cuts but also legally raising the deficit target.
"The way the economy is going, showing year-on-year domestic demand falling in the first quarter, proves the monetary policy is too restrictive and I hope the RPP will take this into account," Finance Minister Jaroslaw Bauc said in a radio interview as the Council met.
Many economists agree that the RPP has slowed growth, though they have a more nuanced view of the situation.
"The growth was falling in the last couple of quarters based primarily on high interest rates," said Erste Bank's Fabijancic. The RPP believed raising rates (last year) was the only way to stop rallying domestic demand, which would have placed pressure on prices. With such high interest rates, they were successful. But on the other hand the economy suffered. Nobody in the region was successful in fighting inflation without hurting growth."
Interest rates regulate how expensive it is to invest and to consume for companies and individuals. By contrast, interest rates in neighboring Hungary and the Czech Republic are markedly lower. Hungary's main interest rate is set at 11.25% and a Reuters poll indicated that a small cut is expected in August. The Czech Republic's two-week deposit rate is 5%. The real interest rate the percent above inflation is now more than 8% in Poland, less than 1% in Hungary and in the Czech Republic it is roughly zero, according to central bank and government figures.
"If you have lower inflation rates, you push growth and prices rise based on increased domestic demand. With every cut, you increase the risk of inflation in the future. I would say the RPP has a pretty sophisticated job, especially in this environment," Fabijancic said.
The RPP's job would change significantly if, instead of setting the inflation targets itself, the government took over that task. The model differs throughout the region. The European Central Bank (ECB), which Poland would join if it adopts the euro, sets its own inflation targets and, like Poland's central bank, makes price stability its main concern.
The Bank of England, which is outside the eurozone, follows the government's lead in setting inflation targets. The U.S. Federal Reserve makes supporting the economy a goal along with inflation control. The national banks in Hungary and the Czech Republic set their own inflation targets.
"You should judge interest rates not against neighbors but against the macroeconomic situation," ING Baring's Szczurek said. "Even with real rates so high, and with the zloty so strong, we still have GDP growth at 2.3%. That is considered low, but it's not really low compared to our neighbors. Even though there is tight monetary policy, the growth is still positive and we are still quite far from actual recession."
