• Jacek Kotłowski, Paweł Michalik

What impacts the exchange rate of the zloty – global turmoil or domestic factors?

05.12.2011
The role of market analysts is to comment on developments in the economy and financial markets. The role of a central bank is to ensure that market participants and all parties concerned receive objective information about the reasons for developments in the economy and financial markets.

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Makroekonomia
What impacts the exchange rate of the zloty
Global turmoil or domestic factors?
The role of market analysts is to comment on developments in the economy and financial markets. The role of a central bank is to ensure that market participants and all parties concerned receive objective information about the reasons for developments in the economy and financial markets.
The message carried by the statistics on the economy and financial markets tends to be blurred by everyday noise of analysts’ opinions and reports. In other words, it is vital to act upon the overall picture implied by the data rather than follow the instigations of isolated statistics whose sense may be distorted by insufficient context.
Recently, the reasons for the volatility of the exchange rate of the zloty have been put in the centre of attention. In the opinion of some, fortunately not many, the depreciation of the zloty reflects some serious problems affecting our economy. However, if we take a closer look at the overall picture emerging from the data, and, at the same time, take into account the present situation in the euro area which is struggling with the sovereign debt crisis, we conclude that our currency is simply floating on the wave of turmoil in the global financial markets. If its behaviour really depended on the domestic economic conditions, the trend in the exchange rate changes would not necessarily have been the same as the present one.
The recent depreciation of the zloty reflects a growth in risk aversion in international financial markets. Consequently, investors naturally exit the markets for assets traditionally recognised as more risky (although current developments are likely to change, to a great extent, the existing division into more and less risky investments). As a consequence, not only the zloty but also other currencies of the region depreciate. Although in recent months CDS premia on the Polish debt have increased slightly, a much bigger rise has occurred in CDS on the bonds issued by Spain, Portugal, Hungary and Italy. We think it would be difficult to defend the thesis that changes in CDS premia for these countries result from disturbances in the Polish economy. The more so as despite temporary disturbances in the Polish government bond market their yield remains fairly low (below 6% for 10-year bonds). If investors fled rapidly from our market, the yields on these bonds would probably soar, certainly to levels much higher than those observed at the moment. There are, in fact, no (macroeconomic) reasons for withdrawal from the Polish market.
In many cases the analysis of Poland’s external imbalance focuses only on the size of the current account deficit, which is incorrect. The current account and capital account balance are much more relevant indicators (in the case of Poland which is a recipient of considerable transfers from the EU). In Poland, a major part of transfers from the EU is earmarked for investment, i.e. it shows in the capital account. In the second quarter of 2011, the ratio of current account and capital account deficit to GDP amounted to 2.2% in Poland. The size of this indicator, while being less favourable than in Hungary (+ 4.1%) and Slovakia (+0.4%) continues to stand at a safe level.
While discussing macroeconomic stability, it is worth noting that over 90% of the current account deficit (adjusted for capital transfers from the EU) is financed this year by the inflow of foreign direct investments (FDI) to Poland. By the end of September the inflow of FDI had exceeded EUR 7.5 billion and the outlook for subsequent periods seems favourable. Most recently, the Polish Information and Foreign Investment Agency has announced that the value of new investment projects accepted by the Agency in the first ten months of this year is almost twice as large as that accepted in the corresponding period of last year and that 2011 has been the best year since 2007. Other balance of payments forecasts also point to a projected rise in the inflow of FDI to Poland.
While considering another, extensively cited, indicator of macroeconomic equilibrium, i.e. the total external debt to exports ratio, which shows the part of the debt which can be repaid by the proceeds from exports, it should be noted that for Poland the ratio (amounting to 7.2%) is similar to levels observed in other countries of the region, such as Hungary (7.3%), Bulgaria (7.5%)  and Romania (7.3%), and is slightly higher than the corresponding ratio in Slovakia (5.3%). If this analysis, as it should be, also accounts for the inflow of proceeds from the export of goods and services and the transfer of wages − high and stable in Poland − the ratio turns out to be even more favourable and can definitely be said to be on a safe level.
In comparison with other countries of the region, Poland’s indicators describing external equilibrium note results markedly better than just satisfactory. In the case of indicators set by the European Union as part of the scoreboard, i.e. a set of macroeconomic indicators common for all the European Union used to identify imbalances in Member State economies, the average value of these indicators (among which is, e.g. an important indicator − the net external debt to GDP ratio) for Poland remains at a safe level (34%) and is better (sometimes significantly better) than for such countries as Portugal (83%), Hungary (60%), Latvia (53%), Spain (92%) or Bulgaria (44%) and only slightly worse than for Slovakia (24%) or, to a greater extent, for the Czech Republic (0%).
Analysts who seek reasons for increased volatility of the zloty among domestic factors also tend to quote the argument of a relatively high value of Poland’s short-term debt and do so in most cases in absolute values. It is easy to see that the scale of the debt reflects, first of all, the size of the Polish economy and that the debt-to-GDP ratio would constitute a more reliable indicator.
What is even more important is the favourable debt composition. Loans and deposits of capital groups account for nearly a half of this category. Such debt is normally rolled over and poses no problems, even in the case of unfavourable market developments. It may also be assumed with a high degree of probability that international organisations will not reduce their exposure to funding the Polish economy − after all, in other countries they have increased their involvement. Trade credit received (deferred payment for imports) in the amount of EUR 12.4 billion constitutes the largest position of the remaining part of short-term external debt. It should also be added that Polish enterprises (often the same ones which receive goods under trade credit arrangements) post receivables from non-residents in similar amounts. When we account for the rollover of loans from direct investors and for trade credit, the amount of short-term external debt that potentially is not subject to rollover stands at EUR 30.6 billion, which represents only 40.6% of foreign exchange reserves of the National Bank of Poland and 8.3% of GDP.
While analysing potential funding sources used to service external debt, we should also take into account the financing held by Polish entities that does not form part of the NBP official foreign reserves. Foreign assets representing financial debt instruments (excluding commercial loans) held by Polish banks and the sector of enterprises amounted to EUR 31.5 billion as at the end of June 2011. Trade credit liabilities (EUR 24.1 billion) are thus balanced − in 82.5% − by receivables from trade credit granted by Polish entities to non-residents (EUR 19.9 billion). The dominant position in the assets of both the banking and the enterprise sector is that of deposits in banks abroad, amounting to EUR 4.8 billion and EUR 2.1 billion, respectively. Deposits of banks and of enterprises alike can, if needed, constitute a direct financing source to service external debt. Taking the above mentioned financing sources into account in the analysis may considerably reduce the potential contribution of the NBP foreign exchange reserves to servicing external debt.
Summing up, we would think that if we wish to determine the real reasons for the currently increased volatility of the zloty, we should, to a greater extent, focus on what is going on abroad. If the euro area finds a solution to the ongoing crisis, the zloty will return to its equilibrium rate that is determined by the fundamentals of the Polish economy and we do not think any of the nowadays readily quoted imbalance indicators will be an obstacle in doing so.
Jacek Kotłowski, Paweł Michalik
Jacek Kotlowski is an economic advisor in the Bureau of Applied Research at the National Bank of Poland. Mr. Kotlowski holds a PhD in economics from Warsaw School of Ecnomics. Pawel Michalik is a deputy director in Statistics Department of the National Bank of Poland.

The message carried by the statistics on the economy and financial markets tends to be blurred by everyday noise of analysts’ opinions and reports. In other words, it is vital to act upon the overall picture implied by the data rather than follow the instigations of isolated statistics whose sense may be distorted by insufficient context.

Recently, the reasons for the volatility of the exchange rate of the zloty have been put in the centre of attention. In the opinion of some, fortunately not many, the depreciation of the zloty reflects some serious problems affecting our economy. However, if we take a closer look at the overall picture emerging from the data, and, at the same time, take into account the present situation in the euro area which is struggling with the sovereign debt crisis, we conclude that our currency is simply floating on the wave of turmoil in the global financial markets. If its behaviour really depended on the domestic economic conditions, the trend in the exchange rate changes would not necessarily have been the same as the present one.

The recent depreciation of the zloty reflects a growth in risk aversion in international financial markets. Consequently, investors naturally exit the markets for assets traditionally recognised as more risky (although current developments are likely to change, to a great extent, the existing division into more and less risky investments). As a consequence, not only the zloty but also other currencies of the region depreciate. Although in recent months CDS premia on the Polish debt have increased slightly, a much bigger rise has occurred in CDS on the bonds issued by Spain, Portugal, Hungary and Italy. We think it would be difficult to defend the thesis that changes in CDS premia for these countries result from disturbances in the Polish economy. The more so as despite temporary disturbances in the Polish government bond market their yield remains fairly low (below 6% for 10-year bonds). If investors fled rapidly from our market, the yields on these bonds would probably soar, certainly to levels much higher than those observed at the moment. There are, in fact, no (macroeconomic) reasons for withdrawal from the Polish market.

In many cases the analysis of Poland’s external imbalance focuses only on the size of the current account deficit, which is incorrect. The current account and capital account balance are much more relevant indicators (in the case of Poland which is a recipient of considerable transfers from the EU). In Poland, a major part of transfers from the EU is earmarked for investment, i.e. it shows in the capital account. In the second quarter of 2011, the ratio of current account and capital account deficit to GDP amounted to 2.2% in Poland. The size of this indicator, while being less favourable than in Hungary (+ 4.1%) and Slovakia (+0.4%) continues to stand at a safe level.

While discussing macroeconomic stability, it is worth noting that over 90% of the current account deficit (adjusted for capital transfers from the EU) is financed this year by the inflow of foreign direct investments (FDI) to Poland. By the end of September the inflow of FDI had exceeded EUR 7.5 billion and the outlook for subsequent periods seems favourable. Most recently, the Polish Information and Foreign Investment Agency has announced that the value of new investment projects accepted by the Agency in the first ten months of this year is almost twice as large as that accepted in the corresponding period of last year and that 2011 has been the best year since 2007. Other balance of payments forecasts also point to a projected rise in the inflow of FDI to Poland.

While considering another, extensively cited, indicator of macroeconomic equilibrium, i.e. the total external debt to exports ratio, which shows the part of the debt which can be repaid by the proceeds from exports, it should be noted that for Poland the ratio (amounting to 7.2%) is similar to levels observed in other countries of the region, such as Hungary (7.3%), Bulgaria (7.5%)  and Romania (7.3%), and is slightly higher than the corresponding ratio in Slovakia (5.3%). If this analysis, as it should be, also accounts for the inflow of proceeds from the export of goods and services and the transfer of wages − high and stable in Poland − the ratio turns out to be even more favourable and can definitely be said to be on a safe level.

In comparison with other countries of the region, Poland’s indicators describing external equilibrium note results markedly better than just satisfactory. In the case of indicators set by the European Union as part of the scoreboard, i.e. a set of macroeconomic indicators common for all the European Union used to identify imbalances in Member State economies, the average value of these indicators (among which is, e.g. an important indicator − the net external debt to GDP ratio) for Poland remains at a safe level (34%) and is better (sometimes significantly better) than for such countries as Portugal (83%), Hungary (60%), Latvia (53%), Spain (92%) or Bulgaria (44%) and only slightly worse than for Slovakia (24%) or, to a greater extent, for the Czech Republic (0%).

Analysts who seek reasons for increased volatility of the zloty among domestic factors also tend to quote the argument of a relatively high value of Poland’s short-term debt and do so in most cases in absolute values. It is easy to see that the scale of the debt reflects, first of all, the size of the Polish economy and that the debt-to-GDP ratio would constitute a more reliable indicator.

What is even more important is the favourable debt composition. Loans and deposits of capital groups account for nearly a half of this category. Such debt is normally rolled over and poses no problems, even in the case of unfavourable market developments. It may also be assumed with a high degree of probability that international organisations will not reduce their exposure to funding the Polish economy − after all, in other countries they have increased their involvement. Trade credit received (deferred payment for imports) in the amount of EUR 12.4 billion constitutes the largest position of the remaining part of short-term external debt. It should also be added that Polish enterprises (often the same ones which receive goods under trade credit arrangements) post receivables from non-residents in similar amounts. When we account for the rollover of loans from direct investors and for trade credit, the amount of short-term external debt that potentially is not subject to rollover stands at EUR 30.6 billion, which represents only 40.6% of foreign exchange reserves of the National Bank of Poland and 8.3% of GDP.

While analysing potential funding sources used to service external debt, we should also take into account the financing held by Polish entities that does not form part of the NBP official foreign reserves. Foreign assets representing financial debt instruments (excluding commercial loans) held by Polish banks and the sector of enterprises amounted to EUR 31.5 billion as at the end of June 2011. Trade credit liabilities (EUR 24.1 billion) are thus balanced − in 82.5% − by receivables from trade credit granted by Polish entities to non-residents (EUR 19.9 billion). The dominant position in the assets of both the banking and the enterprise sector is that of deposits in banks abroad, amounting to EUR 4.8 billion and EUR 2.1 billion, respectively. Deposits of banks and of enterprises alike can, if needed, constitute a direct financing source to service external debt. Taking the above mentioned financing sources into account in the analysis may considerably reduce the potential contribution of the NBP foreign exchange reserves to servicing external debt.

Summing up, we would think that if we wish to determine the real reasons for the currently increased volatility of the zloty, we should, to a greater extent, focus on what is going on abroad. If the euro area finds a solution to the ongoing crisis, the zloty will return to its equilibrium rate that is determined by the fundamentals of the Polish economy and we do not think any of the nowadays readily quoted imbalance indicators will be an obstacle in doing so.

Jacek Kotlowski is an economic advisor in the Bureau of Applied Research at the National Bank of Poland. Mr. Kotlowski holds a PhD in economics from Warsaw School of Ecnomics. Pawel Michalik is a deputy director in Statistics Department of the National Bank of Poland.

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