IMF concerned over East European currency gains

Agnes Lovasz

March 30 2010 11:09 AM

East European governments and central banks should move to curb currency gains that threaten to derail the economic recovery and damage competitiveness, an International Monetary Fund official said.

The zloty has surged 22pc in the past year against the euro, the second-best performer after South Africa’s rand among currencies in Europe, the Middle East and Africa.

Hungary’s forint is up 17pc, the Czech koruna has gained 8.6pc and the Romanian leu has risen 3.9pc as investors regained appetite for emerging market assets.

Strengthening currencies will “negatively” affect growth, said Marek Belka, director of the IMF’s European department, in an interview in Warsaw yesterday.

“This is something that we should fear. An excessive appreciation of domestic currencies can undermine growth.”

The zloty, forint, koruna and leu are benefiting as investors switch funds from some euro-region economies including Ireland, Greece, Portugal and Spain to buy assets in the eastern members of the EU, which have the potential to grow faster and where deficit and debt levels are lower.

Investors are rewarding austere fiscal policies, including IMF-led programs in Hungary and Romania.

Poland, the only EU member to avoid a recession during the credit crisis, and the Czech Republic are also returning to fiscal tightening after spending to stimulate economies and bail out banks.

‘Potential danger’

“All this liquidity that is in the world is looking for yields,” said Belka, who served as Polish prime minister in 2004. “The assessment of risk has improved so the money is flowing in. This is certainly a potential danger.”

Authorities must look at ways to limit the inflow of funds from abroad, including curbing the availability of foreign currency-denominated loans, Belka said.

Difficulty in rolling over those loans contributed to Hungary’s near-default in late 2008 after the credit crunch froze its bond market.

“The countries should look at prudential regulation that should discourage some of the foreign currency investments and loan-taking denominated in foreign currencies,” said Belka.

Central bankers are speaking out against the currency gains and have threatened to intervene to halt the moves.

Polish central bank Governor Slawomir Skrzypek said on March 11 the bank will intervene in the currency market if necessary.

Monetary policy maker Andrzej Rzonca said the zloty’s strength is the “main threat” to the economy.

‘First line’

Interest-rate cuts work better than currency sales or purchases to influence the exchange rate, as long as they are coupled with fiscal stringency, according to Belka.

“I would not exclude intervention as a last resort, not as a regular policy tool,” said Belka.

“The right fiscal and monetary policy mix is the first line of defense.” The right policy mix is “pretty lenient monetary policy and pretty disciplined fiscal policy.”

Hungary and Romania are set to reduce their benchmark rates further, from 5.5pc and 7pc respectively, as a continued recession keeps inflation at bay.

The Czech central bank held the benchmark interest rate at a record low 1pc on March 25, with two policy makers seeking a quarter-point reduction.

Investors last week pared expectations for an increase in Polish interest rates by the most in five months after a slower- than-expected recovery in consumer demand, forward contracts show.

Forward-rate agreements used to speculate on Polish borrowing costs last week had their biggest three-week decline since October.

In Poland “we see even some room for the relaxation of monetary policy,” said Belka.

“Inflation is well within bounds. What we should be concerned about is the inflow of foreign capital and the appreciation of the zloty. In Hungary the same forces are at work.”