Radovan Jelašić: Macroeconomic policy and export sector
Speech by Mr Radovan Jelašić, Governor of the National Bank of Serbia, a the First Summit
of Serbian Exporters, Belgrade, 8 November 2007.
* * *
Ladies and Gentlemen,
Recent debates on macroeconomic policy mainly focused on assessment of its
exportrelated effects. Basically, macroeconomic policy incorporates monetary policy (MPC
decisions related to interest rates) and fiscal policy (government decisions related to taxes
and public spending). In my comments, I shall concentrate on monetary policy related issues
(and defend our own back yard) first, because the NBS is responsible for implementation of
monetary policy and second, because it is the monetary policy that has been the subject of
numerous debates and criticism, especially by exporters. On this occasion, I wish to give out
six main messages to exporters in order to differentiate what can from what cannot be
accomplished for their purposes by monetary policy.
However, before I proceed, let me remind you of the events during last forty years in
Yugoslavia, and subsequently in Serbia, when our currency was losing value almost on a
daily basis resulting in an automatic growth in inflation, while exports were gradually, but
inevitably, declining. Is there a lesson to be learned from those events, and who are those
who have not had enough of that experiment?
My first message is in fact the answer to that question. I really think that there is no
need for another déjà vu, another failed experiment. Unfortunately, not even forty years
of failed experimentation are sufficient evidence to some that weak dinar cannot help support
certain business activities and that the outcome is inevitable inflation and chaos, i.e.
unpredictable and dangerous environment! The main role of monetary policy is, first and
foremost, to maintain stability of prices as stated explicitly in the Law on the National
Bank of Serbia adopted in mid-2003. There are at least two possible explanations as to
why exactly is monetary policy expected to do just that. First, it has been widely accepted by
economic theory and practice that monetary policy can not be employed to achieve either
economic growth or sustainable growth in employment. It, however, can be employed to
control movements in inflation. Second, low inflation is conducive to an improvement in
exports sector. Why is it so? Because it helps improve competitiveness. However,
appreciation of the exchange rate neutralizes positive effects of low inflation. What is the
point then of low inflation? The point is that low inflation is beneficial to everybody, including
exports sector, and such beneficial effect has two aspects. First, it increases efficiency of
operations of economic entities. When inflation is low, changes in prices give an important
signal to producers when taking decisions on what to produce, what to buy, how much to put
aside for savings, etc. because changes in prices represent something concrete, a change in
either demand or supply. On the other hand, when inflation is high, it is difficult to interpret
changes in prices - we cannot know whether demand for such product is increasing or a
change in price is actually a result of the general increase in prices. Investment decisions
taken in the environment of low inflation are almost always better than those taken in the
environment of high and variable inflation. For that particular reason, most economists
believe that economies operating at a lower level of inflation have a higher average growth
rate than those in which the rate of inflation is higher. Second, low inflation is beneficial to the
exports sector as well as to the economy in general as it induces lowering of interest rates.
I can safely say today that, despite all the shocks to which our economy (and not only ours)
is exposed, inflation is under control. Many may ask: If inflation is under control, why are
interest rates still high in real terms? There is not much enthusiasm in Serbia today for
saving money even though interest rates are quite high, but people are very enthusiastic
when it comes to borrowing at such rates. Thus, regardless of the fact that we assess current
interest rates as high in real terms, we borrow more and save less.
Therefore, my second message reads as follows: the best option for the NBS is to
persist in its attempts to attain low and stable rate of inflation in order to ensure low
interest rates in real terms.
But what about the exchange rate? Is it true that appreciation of the exchange rate keeps
inflation under control by putting an enormous burden on the exports sector? I wish to
underline that the monetary policy implemented by the NBS aimed to accomplish only the
main objective which is defined by the law - „to achieve and maintain price stability". During
the period when we were raising the key policy rate because of increased inflationary
pressures at end-August, we managed to strengthen the dinar. Tight monetary policy was
indispensable in order to keep inflation within the announced target range, which in this year
is closer to the lower bound of the projected range, and at the same time, making sure that
we will stay on targets announced for the next year as well! However, we could not estimate
the effect of tighter monetary policy on: (1) increase in interest rates, without affecting the
exchange rate, or (2) appreciation of the exchange rate, without affecting interest rates, or (3)
appreciation, if at the same time interest rates are declining, or (4) depreciation, if at the
same time interest rates are increasing. The policy mix to be applied depends on the
perception and reaction of many people, large number of economic entities in the country
and abroad. Such fine tuning has proved to be too much even for the European Central
Bank!
However, it is beyond doubt that appreciation of the exchange rate has reduced gross
income of many exporters below the level that would otherwise have been achieved if there
were no appreciation, assuming of course, that they have not protected themselves from
currency risk by entering into forward trade agreements. At the same time, reduction in net
income was much lower. The question is why is it so. Because strengthening of the dinar
reduced not only gross income, but many costs as well - had there been no appreciation of
the exchange rate for the dinar, price of fuel would have been much higher as well as the
price of transport vehicles, transport services, computers and various chemicals, while wage
levels would have been lower. Of course, in the short run, life would have been much less
complicated to exporters if there were no appreciation of the exchange rate for the dinar.
However, the following should also be taken into account:
- Inflation has been under control in the course of several recent years despite strong
inflationary pressures, both external (drought, price of oil, etc.), and internal
(increase in public spending and wages, credit expansion, still high inflation
expectations, etc.);
- Combating strong inflationary pressures requires high interest rate in real terms,
which affects the exchange rate, namely discrepancy of the real exchange rate from
its equilibrium long-term level;
- Many countries were and still are faced with appreciation and what is happening to
us is only part of the usual process - both in terms of duration and intensity.
It is also true that in the course of the last two years countries with currency board
arrangements experienced almost 50% higher inflation and lower economic growth than
countries that were implementing active monetary policy and the floating exchange rate
(check what Jürgen Stark said on this issue). For that particular reason my third message
would be that the NBS has a limited impact on the real exchange rate in the longer run,
and can have a significant influence only in the short run. Adoption of alternative
exchange rate regimes cannot resolve the problem of the real exchange rate.
It is, of course, my intention to also tackle on this occasion the other aspect of
macroeconomic policy - fiscal policy. It deals with tax revenue which the state can extract
from the economy and the amount of money it must spend. I do not wish to debate here the
optimum size of the public sector, though it is only natural that I should have an opinion on
that matter. I wish to underline, however, that changes in fiscal policy have very important
implications on monetary policy, real interest rate and the real exchange rate as specified by
the government in both the budget and the Memorandum on economic policy for 2008-2010.
Hence comes my fourth message that monetary policy can be applied to keep inflation
under control at low and stable level, but how tight should such policy be to achieve
its aim, depends to a large extent on fiscal policy, too. The increase in public spending
that is not covered by an increase in regular public receipts, or a significant reduction in tax
receipts without comparable reduction in public spending, shall have its implications on the
level of interest rates and the exchange rate for the dinar. I think that many exporters are
aware of the significance of this dependence.
My fifth message is that an exporter-friendly macroeconomic environment assumes
low rate of inflation, gradual decrease in real interest rates and implementation of
responsible fiscal policy. However, these can provide only indirect help in view of the
reality facing the ever increasing number of exporters. The fact is that, in the longer
run, world prices are falling in real terms. It is a long-term trend, of course, and has
nothing to do with macroeconomic policy. Improvement in productivity, product quality
adjustments to market requirements and better marketing are at least as important as
macroeconomic policy. These are the real challenges facing the exports sector
worldwide!
My sixth and final message is that the role of the NBS is not to hermetically isolate
Serbia from exchange rate changes coming from abroad but to secure conditions that
would protect the economy from such risks. The price of oil has been continually
increasing since the beginning of the year, prices of metals are several times higher now
than few years ago, electricity prices are three times higher now than on the onset of
transition. "Market is merciless place and carries a lot of stress" said Alan Greenspan in his
autobiography, as "each produces both winners and losers". Are we fully market-oriented or
are we still feeling nostalgic for various subsidies, incentives and agreements? Unfortunately,
the market and the economy at large have no sympathy for our past or future challenges,
Serbian market reacts like any other market in the world would!
Conclusions
I am aware that some of you and maybe even many of you - I sincerely hope not all of you -
are disappointed since I can not promise a simple and fast solution in the form of stimulative,
adequate and stable exchange rate that would suit all exporters. Few days ago I
discussed this topic with some economists and we remembered mistakes made when
"monetary policy of associated labour" was implemented. Should we now invent
"monetary policy of exporters"!?
As for exchange rate fluctuations, they are simply a part of the regular market mechanism
(oil, gold, dollar....). But, if these fluctuations are not to somebody's liking, there is a solution!
First, nowadays it is possible for exporters to fix several months in advance the exchange
rate at which they will convert their export proceeds! By doing so they are protecting
themselves from the strengthening of the dinar, but at the same time, they forsake the
chance of profiting from possible weakening of the dinar. Of course, exporters may opt not to
avail themselves of this chance and decide to gamble hoping for a much more favourable
exchange rate in the future. They are free to make their own choices. What is important is to
know that in such case they are assuming the whole of the foreign exchange risk as they
have decided to step out of the body of their professional knowledge. Assumption of the
foreign exchange risk by exporters is an example of irresponsible behaviour. It is a job of
banks, just like payment operations, granting of credits, etc.
What about the real exchange rate trends? Real appreciation is something that many
countries in the region and wider are currently faced with. It is quite possible that the
exchange rate of RSD 77 for EUR1 is as unacceptable as RSD 83 or RSD 100 for EUR 1.
None represents the equilibrium rate. But stronger dinar is an encouragement to exporters
and forces them to restructure and specialize in exports of specific products which would
reward them with a higher price (mark up). Stronger dinar also means easier restructuring,
as import of high technology is cheaper and thereby more accessible.
Most often asked questions
I am sure some of you think that MPC members do not care much about exporters - I must
prove you wrong. The real issue here, however, is something quite different. Can monetary
policy help and what it is that monetary policy cannot do? Let me reply to three most often
asked questions.
1. If the MPC were to relax its monetary policy and set higher target for inflation, would
that help exporters?
The problem that many exporters are faced with is that prices of
The answer is: No.
products and profit margins are too low relative to input costs which, to a certain
extent, reflects the strength of the dinar. Higher inflation can induce an increase in
prices of products but it would also induce higher costs as higher prices are the
outcome of higher wages and higher costs of intermediate goods. High inflation in
earlier years did not result in higher profitability of exports sector. Quite the contrary,
it led to a cycle of „boom and crashes" which made life much more difficult for
exporters.
2. Would it help exporters if MPC were to set the target in respect of something else
instead of inflation?
The answer is: No. I hope that everybody now understands that the MPC sets the
level of its key policy rate with respect to achieving core inflation within the 2-8%
range. That should help anchor inflationary expectations. If the level of the key
policy rate were specified with respect to achievement of some other objective, for
example a certain level of the exchange rate, the rate of inflation would overshoot
the target. Inflation expectations would increase, we would loose our anchor and we
would be back battling inflationary cycles of the past.
3. Should the MPC try to depreciate the exchange rate for the dinar?
The answer is again: No. The value of the dinar is determined in the market and
reflects expectations with regard to future steps by the NBS. The only way the MPC
could depreciate the exchange rate for the dinar is by giving up inflation targeting.
Who can trust a central bank which erodes the value of its own currency and
denounces its "main objective"? Let me remind you that currency depreciation
increases exporters' income only if all else - all inputs needed to manufacture a
product or render an export-oriented service, such as wages, energy prices, credits,
intermediate goods, etc. - were to remain unchanged. And we all know, and our
history confirms, that such a thing is impossible! In the light of our own and world
experience, we in the NBS appeal to all of you to renounce taking drugs called
inflation, to renounce short term effects, the so-called "better export performance"
for the sake of long term sustainability and stability. By the way, if the exchange rate
of the dinar were to be changed, would you, the exporters, be prepared to promise
that you will achieve a significant increase in exports? Is the government prepared
to promise to substantially cut public spending and not give in to the requests of
trade unions regardless of the effects of depreciation? The answer is NO! We have
already seen all of that and, in my view, transition is not going back to the past but a
way to the future!
There is a latent pressure on the MPC members to involve themselves with current problems
and to act fast. However, the task of the MPC is to look ahead into the future and to secure
stability in the long run. The support for low inflation will weaken if it is based only on
memories of consequences of high and unstable inflation of the past. There is a need for
understanding of the essence of positive features of low inflation and long-term stability
particularly by those who seem not to remember our inflationary past. Hence, the main task
of the MPC is to explain the significance of stability of prices and to gradually shape public
attitude towards low rate of inflation.