Milda Seputyte, Marketa Fiserova (Bloomberg, 20.9.2006)
The Czech central bank may raise interest rates faster and in larger steps because of "expansionary"' government spending, Deputy Governor Miroslav
Singer said.
The budget deficit may be as much as 4.6 percent of gross domestic product next year, more than the 3.3 percent of GDP pledged to the European Union and the 3 percent threshold needed to adopt the euro, the Finance Ministry has said. The shortfall was below the euro threshold for the past two years.
This is definitely one of the factors why we might be raising rates higher and sooner than we would otherwise do with a reasonable budget policy, Singer said in an interview today
in Singapore.
The budget is expansionary at the top of the cycle and this obviously makes us do more on interest rates. A hung parliament that emerged from elections in June has
thwarted chances for cuts in spending to bring the budget deficit under control and remain on course for euro adoption in 2010. Policy makers in July lifted rates for the first time in
nine months, citing the inflationary effects of record oil costs and rising consumer demand.
Singer, 38, said a more restrictive budget would allow interest rates, the European Union's lowest, to damp koruna gains. Higher rates will instead push up the koruna, weighing on exporters and stifling economic growth, he said.
The economy, which expanded a record 7.1 percent in the first quarter, is expected to grow between 6 percent and 7.2 percent this year and 3.8 percent to 6.4 percent in 2007,
according to central bank forecasts.
Not the Time
This is definitely not the time anybody would like to raise rates, which would create frankly not an optimal policy mix, he said. Foreign trade, the foreign account, those are in a very good shape, but now the improvement has stabilized and maybe is starting to reverse.
A stronger than expected koruna rate earlier this year curbed expectations for more increases in the central bank's two-week repurchase rate, now at 2.25 percent. The July economic forecast released by the central bank assumed a gradual increase in the rate.
The koruna was trading at 28.44 against the euro at 3:15 p.m. in Prague, compared with 28.45 late yesterday.
The currency has been the fourth best-performing currency in the world so far this year and the sixth-worst performing currency in the past month. It lost 2.4 percent against the dollar and 1.2 percent against the euro in that period, now matching the central bank's assumptions, Singer said.
Koruna Forecast
Essentially, the koruna is where we expected it to be this and past quarter, he said. The July inflation forecast seems to be pretty much up to the point in terms of the exchange
rate now.
The Czech two-week repurchase rate, which was lifted once this year in July after an increase in October, is three-quarters of a percentage point below the European Central Bank's benchmark rate.
Singer said the trend of higher borrowing costs by the ECB has to be taken into account as well as the fact that the period of very low rates is essentially over.
Singer said that faster-than-expected inflation in August justified the July 27 decision to lift rates in a 4-3 vote. The next monetary-policy meeting, scheduled for Sept. 27, won't be as easy as the session last month with a unanimous vote to leave rates unchanged.
We will have some bigger discussion over rates, it's for sure, he said, reiterating that for the small and open Czech economy, it's necessary to have a more flexible monetary policy with frequent changes to interest rates.
Domestic Demand
The banker said that while food prices grew faster than projected, domestic demand fell behind expectations, even though there might be the first signs of demand picking up, and
there may be potentially some inflation pressures signaled by the data.
Singer welcomed yesterday's statement by new Prime Minister Mirek Topolanek and central bank Governor Zdenek Tuma that cast doubt on the planned 2010 euro adoption because of a lack of changes to the fiscal and economic policy.
It's a very realistic approach to the euro to delay adoption but I'm not happy about the reasons that are behind this, he said. This is not only slowing down the euro, which after all should be relatively less of concern, but it's slowing down the economy.
The post-election political deadlock hasn't had any negative impact on the economy, Singer said, although this doesn't mean it could go on forever.
The stalemate represents no threat if we can solve the political problems in a couple of quarters and go for a more ambitious pace in the budgetary and fiscal reforms, the policy
maker said. But if we don't, in two or three years, we may find ourselves in a very uncomfortable position.