Benefits of Czech central bank’s move to weaken crown questioned
The Czech National Bank’s decision to depreciate the crown through interventions on international currency markets has surprised many, from analysts to the country’s industrial sector. The bank argues that it had run of out ways to combat looming deflation that could undermine the Czech economy’s nascent recovery. But critics question the effectiveness, the timing and the costs of the move.
“We have until now employed our standard tools; we have lowered the key interest rates to ‘technical zero’. In order to avoid being unable to maintain the inflation target, and to speed up our return to a situation that will enable us to use our standard instrument, interest rates, we have started using the currency exchange rate as another tool of our currency policy.”
The central bank had been hinting at the possibility of selling Czech crowns on international currency markets for months. However, when it actually happened many seemed to have been caught off guard. Zbyněk Frolík is deputy chair of the Confederation of Industry.
“A weaker crown naturally means higher profits for exporters. It’s also good for the country when money from other countries’ taxpayers is channelled here. On the other hand, we would prefer to be able to better understand the central bank’s policy.
“We would appreciate if they attempted to meet the target of, say, 27 crowns per euro, gradually rather than through such radical measures which weakened the crown by 5 percent from one day to another.”
The decision has also come under fire from politicians. President Miloš Zeman questioned the timing of the move, and said it was unnecessary in a situation when the economy had already started picking up. His predecessor, Václav Klaus, even suggested the idea of inflation targeting was wrong, saying currency interventions had very questionable effects but very real costs.
Prime Minister Jiří Rusnok, on the other hand, said he trusted the central bank; the interventions would benefit the economy and increase the country’s competitiveness, according to Mr Rusnok.
The bank also believes a weaker crown will boost growth by increasing revenues for Czech exporters, and also, paradoxically, revive depressed household spending. That is despite the fact the move will inevitably raise prices of imports such as fuel, food, and other goods. But Mr Singer says that because consumers can no longer wait for prices to go down, they will start spending.
“The weak crown will certainly have negative effects in the initial phase. An increase in prices can of course lower real levels of demand. The problem is that we are an open, pro-export economy and we believe that these effects will be outweighed by profits for companies; people will keep their jobs and will know their salaries will not decrease.
“Consumers will also realize that growth recovery will come and that it makes no sense to postpone purchases of imported goods. We have been aware of issues related to postponed speculative consumption and this is one of the problems we are targeting.”
Mr Singer also said the Czech central bank would continue selling crowns on international markets for as long as needed; some believe the interventions could last throughout next year.
I discussed the central bank’s monetary intervention with Petr Zahradník the chief economist of Conseq Investment Management and advisor to the ANO party.
“The first reason for the intervention is the risk of deflation; I think Japan’s experience from the last 20 years has shown that an economy affected by deflation loses its dynamics and growth potential.
“I understand the central bank’s decision as prevention of irrational appreciation trends or tendencies, as well as support for our exports and indirect support of domestic producers which would result from more expensive imports. That could be the third motive behind the interventions.”
Well, all these reasons have been criticized by some of your colleagues. Also, President Zeman said the timing was wrong because the economy had already begun recovering, and inflation has started to rise. What do you think of this argument?
“I would agree that recovery or growth is usually accompanied by pressure on inflation and pushed-up prices. On the other hand, the recovery is still very weak; in a year-on-year comparison, we are still below zero and the recovery itself could perhaps be statistically confirmed only in the next quarter. Also, the inflation rate some 18 months ago was almost 4 percent and now is below 1 percent – that I think is a solid indicator of at least a short-term deflationary risk.
“But I would admit that foreign exchange intervention is always a risk with very uncertain results and their costs sometimes could produce to little if any effect.”
Critics have also questioned the idea that the interventions will help Czech exports. They say that most Czech manufacturers actually have to buy products abroad to process and resell them. That means a weaker crown would in fact increase their costs…
“That’s true but it’s a structural problem. If exporters depend so much on buying inputs abroad, I think this could provide a stimulus for the domestic production base to create sufficient quantity and capacity for the inputs being produced domestically.
The bank’s governor, Miroslav Singer also said the intervention should ease domestic spending; people should expect more price hikes and therefore should start spending. This seems to have happened in the electronics retail sector but how realistic do you think this expectation is?
“That’s really only temporary in my opinion, and will only last until the prices reach some higher level. From all the arguments in favour of the intervention, this one seems to me the most speculative.
“It could of course be connected with some upswing in domestic demand. But if this is the case, I don’t think it would be the result of the interventions. It could come as a secondary or supplementary effect but it really seems to me too speculative.”
