Recovering economy needs stable interest rates

www.dev.obserwatofinansowy.pl: Members of the Monetary Policy Council with unusual unanimity agree  that interest rates can be kept unchanged for as long as over six months. Doesn’t the Council take too much risk?

Marek Belka: Had we not done it, we would have to explain the reasons why, given that all market data indicate low levels of inflation in Poland. There is no reason to believe that within the next six months, and probably over a longer period, something could significantly change the course of economic developments specified in the November forecast of inflation and GDP. If the sky starts falling down, we’ll obviously react. Today, however, there is no reason to worry about it, and it was important to send a strong signal to the market and assure that interest rates will not be changed, so that nobody tries to persuade us to change the rates, also downwards.

Is anyone trying to convince you to do it?

A day later, the ECB cut interest rates. Hence you can always ask why there are no interest rate cuts in Poland. There aren’t any, because the economic situation in Poland differs from that in the euro zone. We do not face the danger of deflation, which, on the contrary, is looming in the euro zone. Deflation is the most likely of all unlikely events that may occur as a result of a crisis. But this applies to Europe, and not Poland.

Even if not directly, we may be affected indirectly. Deflation means less purchases, recession and danger for our exports…

It is true, but deflation is definitely not a threat facing Poland at the moment. Our inflation target is 2.5 per cent, not 1.5 or 1 per cent. Just as we were patient and persevering when inflation was growing to over 3.5 per cent on the back of external developments, we will be patient and will not act rashly when it is or will become extremely low. Were there no prospects of returning to the inflation target in the inflation forecast horizon, one might well ask whether monetary policy is not too restrictive. Today, there is no reason for us to make it even more accomodative.

By the end of the first half of 2014, and maybe even longer, interest rates will not be changed. Is this the Polish forward guidance?

It is.

Are there any forward guidance policy standards?

Actually, there are none. Generally speaking, a strong signal must be given – and the MPC did exactly that – that monetary policy will not be changed for a period of time. The same is currently being done by the Federal Reserve or the Bank of England and, indeed, also the ECB, which is talking about ultra-low interest rates over a long period of time. Some say that forward guidance is when you promise to maintain a loose monetary policy for longer than it is justified by the economic situation.

So we are facing a situation of no reaction when reaction would be called for?

The problem is that according to theoretical models, interest rates in some countries should be negative even now – and they cannot be negative, at least not the basic interest rates. The way theorists see the present situation is that currently interest rates are higher than indicated by the model. The rates will be lower in the future, even if the model  indicates the necessity to raise them.

But when one thinks of it, why is it impossible to have negative interest rates? I remember that in the old days in Romania it was not banks who paid interest on deposits but, on the contrary, they charged customers  for being able to keep their money on an account.

In Switzerland as well interest rates have been negative at some point. We hear increasingly often, that central banks will introduce negative interest rates on deposits of commercial banks. Which means that the deposit rate would in fact fall below zero. The goal is not to have commercial banks bring their money to the central bank, so that they start  looking for clients to whom they can lend it.

Isn’t it a little risky? Banks around the world have already been lending money to whoever would take it, and little good has come out of it.

It would be a bit like taking a leap into the unknown, as we do not know whether such action could cause any imbalances or distortions in the allocation of capital. The price of risk has plummeted and banks – the first beneficiaries of the ultra-liberal monetary policy – are desperately seeking higher profits. This leads them to invest in securities that normally would not be worthy of their attention, such as junk bonds.

On the other hand, it is sometimes necessary to take a step into the unknown. In Poland, we do not always realize it, but had central banks not taken this step at the start of the crisis, AIG would not have been rescued and the system of financing the U.S. housing market would have collapsed. Had Fannie Mae not been bailed out, that would have been a financial Armageddon.

Let’s go back to dangers faced by Poland. The point of reference – as I understand it – is the scale of a possible departure from the path determined by the average inflation or GDP forecast.

It is. Both GDP and inflation projections have been revised upwards as compared to the previous forecast, from July, but we should point out that the inflation forecast throughout the entire projection horizon remains markedly below the target, even though it is heading towards it.

Inflation forecast for 2014 had increased from 1.2 to 1.7 per cent. This is quite a significant change. Any conclusions as to the adopted econometric model?

The model cannot capture all the elements that come into play, for example the fact that beginning from January the excise duty on alcohol is to increase, or that weather conditions may push food prices up. Naturally, a somewhat stronger economic recovery than forecasted in July translates into higher inflation, but inflation increase on this account is actually relatively small.

When I recall your statements made in spring, I have the impression that they were more optimistic than what the model indicated at that time.

I believe that instinct sometimes provides better guidance than a model.

According to the forecast, economic growth in the coming years should reach the levels of 2.9 and 3.3 per cent. Looking at our past experience, do you think such growth is possible without inflation acceleration?

It is, indeed, possible over a period of a few years. Looking at the perspective of the end of the forecast, such economic growth will not yet close the output gap, even in 2015. This means economic growth with high unemployment, low wage pressure and, in the initial period, also a relatively rapid productivity growth. It means that no risk is looming from this source. If growth accelerates and begins to gallop – something we all probably wish for – then yes, we could expect inflationary tensions and an appropriate response from the monetary policy.

Exports have already accelerated. Could economic growth acceleration be possible then?

Exports have increased, which is good, but so far only by 8 per cent. And yet, I remember exports increasing at the pace of 18 per cent. One month is not enough to start drawing conclusions. It is indeed a fact that exports are a growing source of pride to Poland’s economy. It also shows that in terms of production costs we have a competitive edge unattainable to anyone else in Europe.

There is, however, the exchange rate risk. Poland may very soon stop being a competitive exporter.

Cost competitiveness undoubtedly depends on exchange rate. It is a sort of weak competitive advantage. We are all longing for true competitiveness, independent of the exchange rate of the zloty, German or Swiss style competitiveness. We are going up the ladder of the creators of added value. Alas, we are still on one of the lower ranks.

I am still picking holes in the projection in search of potential risks to it and, consequently, to the interest rates levels. What if the Fed abandoned the policy of quantitative easing (QE)?

It definitely will. This, of course, will be a source of some temporary turbulence, but I am fully convinced that Poland can handle this much better than the majority of emerging markets for a simple reason: we have not been a major beneficiary of this policy. Poland has received some funds, but their amount is equivalent to only a few per cent of GDP, not dozens, as has been the case of certain emerging countries. The outflow of capital will not be substantial.

However, the costs of debt servicing would rise.

Today, interest rates on Polish ten-year treasury bonds are only about 40 points higher than, for instance, on French ten-year T-bonds. Is this a poor result? And after all, investors must take into account the exchange rate fluctuations of the zloty.

Do you see the public budget for 2014 as posing any threats to current monetary policy?

No. Poland’s macroeconomics looks solid and stable. I’m absolutely convinced this is the case. Everybody complains that the introduction of restrictions in relation to open pension funds (OFE) can cause negative long-term consequences for the economy. Failure to adopt such restrictions will, however, require substantial fiscal adjustment already in 2014 – after all, we have a straitjacket of our own choosing, as we adopted a public debt limit. This, of course, poses some risks for the economy.

What would happen if the Parliament did not accept the government’s proposals regarding pension funds, or if these proposals were challenged in some other way?

Then we would have a recession and tax increases in the following year…

On the other hand, if open pension funds are subject to restrictions, the government will have a greater freedom when it comes to public spending. Given that elections are approaching, it is an important point.

Has any government ever remarkably increased spending because of the upcoming elections? I do not recall such a situation.

They may not have particularly increased spending, but neither have  they decreased it, even if it was desirable.

It is difficult to construct a highly disciplined budget when elections are nearing and the election campaign has already begun. But I agree, it is hard to imagine that in 2015, which is an election year, the government will tighten the fiscal policy.

As the president of NBP you increasingly often stress the necessity of establishing a Systemic Risk Council. But it is still not in place, alas!

Unfortunately, it is taking more time than initially expected.

Given that inflation is under control and GDP begins to rise, the Council may no longer be needed.

Just the opposite: the Council is needed when the economic situation improves, not in the face of a crisis. When the situation is improving too quickly, the role of the Council is to indicate where imbalances arise which may lead to a crisis at some later stage. The Council is not there to solve crises, but to alert about the future threats. What is more, the European Union has adopted an action plan in this respect and we are already lagging behind it, which is a worry.

Are such imbalances starting to arise somewhere?

Not yet. At some point, the area of imbalances was the housing market. Today, this sector is only just recovering.

What powers should the Council have to act effectively?

It should be able to issue public recommendations for each entity of the financial sector, including its regulator – the Polish Financial Supervision Authority. First of all, it should be able to voice its opinions publicly. As the actions of the PFSA indicate, this is quite enough.

However, the PFSA has Wojciech Kwaśniak on board and CEOs of banks are afraid of him.

Exactly. They should regard the Council and its recommendations with the same respect.

Banks are afraid of the PFSA because it can influence the amount of bonuses paid to CEOs. What about the Council?

I can hardly imagine a government that would ignore warnings issued by the Council. Especially since they will not apply to the government, but to measures regarding the financial system: banks, insurance companies and various other institutions of the financial infrastructure. The Council’s recommendations are to be an instrument that has an impact on the financial system, not the government.

The President of Poland  will soon appoint a new member of the Monetary Policy Council to replace Professor Zyta Gilowska. Taking into account the current economic climate, who should it be?

The new member will be appointed for six years, so not only the current, but also the future economic conditions are important and should be taken into account. As a chairman of the MPC, I would like it to be a person who is familiar with monetary policy and the central bank.

Would you rather he or she was a “hawk” or a “dove”?

I am not going to tell you that. But I am convinced that President Komorowski will make a good decision.

Interview by Krzysztof Bień