Minutes of the Bank Board Meeting on 30 March 2000

Present at the meeting: Josef Tošovský (Governor), Oldřich Dědek (Vice-Governor), Zdeněk Tůma (Vice-Governor), Miroslav Hrnčíř (Chief Executive Director), Luděk Niedermayer (Chief Executive Director), Pavel Štěpánek (Chief Executive Director), Pavel Mertlík (Czech Minister of Finance)

The Board opened the meeting with an evaluation of the newly available information on GDP and the implications it could have for assessing future inflation pressures. It was expressed that while the overall results for 1999 corresponded to CNB expectations, quarterly seasonally adjusted data had fallen short of the Bank's expectations, particularly in 1999 Q4. There was significant quarterly recovery in investment demand, though net export dynamics were lower than anticipated. A continuing decline in the balance of services had contributed to this development.

In the area of fixed capital formation, the volume of investment had substantially declined in recent years. To a large extent, this development was conditioned by structural factors, especially the unique and unrepeatable infrastructure investment witnessed in past years. In the presence of moderate economic expansion, the CNB expected the gradual upswing in the year-on-year dynamics of fixed capital formation to continue. Investment, including foreign direct investment, was expected to be a factor significantly contributing to the acceleration of economic recovery. A substantial part of foreign direct investment was connected to green-field projects. In the first phase of the investment cycle, import of foreign technology would in all probability rise, and as a result, negative pressures on the current account balance would surface as well. Considerably higher output followed by a rise in export potential could be expected during the second phase.

During the discussion, the current stage of Czech economic development had been characterised as being "two-speed". Part of the economy was accelerating, and from the viewpoint of financing and growth, this segment was considered to be healthy. However, there was another sector of the economy where the restructuring processes had only just begun. These processes would bring about substantial regional implications not only in the social sphere, but on the supply side as well.

Despite a certain month-on-month decline in industrial production dynamics, the continuation of strong labour productivity growth in industry was one positive feature. Year-on-year retail sales had risen for the third month in a row, which was also confirmed by VAT revenues.

Future inflation pressures were assessed in relation to demand, cost and structural factors. During 2000, demand factors would have very limited impact on inflation. An anticipated rise in inflation was connected to cost factors, especially import prices and regulated prices. An analysis of available information had suggested that the results of a recent OPEC meeting could cause oil prices to fall. Nevertheless, this price decline was expected to occur at a slow pace. Information from the wage area confirmed that substantial changes would occur this year in comparison to 1999. Wage developments in 2000 would therefore not be a source of excessive inflation pressure. Even the performance of public budgets had not given any indication of adverse demand pressures in the short run.

The Board discussed at length the issue of foreign capital inflow and its impact on expected exchange rate developments. It was mentioned that there should be a distinction made between the character, maturity and mobility of capital flow, especially during the current period. While capital inflows are often very mobile, domestic savings had exhibited less mobility in respect to the higher transaction costs of small investors, which, in fact, exceeded costs in the corporate and financial sector. The latest information on the balance of payments confirmed that a decrease in the interest rate differential was reflected in capital outflow, including domestic savings. Lowering short-term interest rates has a role in this process. Despite certain risks involved, existing appreciation pressures has been reduced through this channel. The Board agreed that koruna appreciation in recent months and the continuation of this trend could lead to unwanted tightening of monetary conditions, which would not correspond to current macroeconomic developments nor to the inflation target at the end of the year.

During the discussion on the CNB's response to the macroeconomic situation, use of available monetary instruments was considered in view of their impact and the time lags involved. Concerning appreciation pressures on the koruna, it was mentioned that the CNB and the National Property Fund had agreed on the manner in which the privatisation account would be opened and operated. The central bank would act as an agent of the state, and if needed, the bank would convert privatisation receipts denominated in foreign currency to koruna. On the basis of the assessment of the current or expected situation on the foreign exchange market, the CNB would either increase its foreign exchange reserves by the converted amount, or the foreign currency would be sold on the market. It was also mentioned that only a portion of the current capital inflow had been generated by the privatisation of state-owned assets. Therefore, only this part would fall under the privatisation account regime.

Uncertainty concerning the intensity of future economic recovery, slower food price growth in relation to the underlying assumption of the inflation forecast, future exchange rate developments and structural concerns were indicated as potential risk areas for reaching the inflation target at the end of this year. Current structural changes had affected the supply side of the economy and may, in particular, cause higher unemployment and social uncertainty in the short run.

The Board unanimously decided to leave the two-week repo rate at its current level and to weaken the koruna by intervening on the foreign exchange market.

Author of the Minutes: Tibor Hlédik, CNB, Council of Advisers

Comments are welcome on the following email address: Tibor.Hledik@cnb.cz