Krzysztof Rybiński: Monetary policy challenges resulting from the rapid
credit growth in the CEE
Panel discussion by Mr Krzysztof Rybiński, Deputy President of the National Bank of Poland,
at the National Bank of Poland International Conference of Central Bankers and Economic
Educators "Monetary Policy Challenges Resulting from the Rapid Credit Growth in
Converging Economies", Warsaw, 23 November 2007.
* * *
Ladies and Gentlemen,
In recent years we have witnessed a rapid growth of credit in CEE countries. Today, I would
like to focus on globalisation as one of the main causes of such development. First, I will
explain how globalisation contributed to recent credit growth in the CEE and then I will
discuss what could be the possible consequences for the monetary policy of vanishing
globalization "tail wind" in the nearest future.
To start with, let us define the term globalisation, as its meaning is so broad, that when it is
referred to in a discussion, various people understand various things. One of the definitions
of globalisation is provided by the International Monetary Fund1, where it is construed as "the
growing interdependence (integration) of national economies, in particular as a result of the
growing international trade and financial flows". Moreover, an element of globalisation that is
worth mentioning is the fast flow of information and knowledge, which is the driving force
behind globalisation processes. One should keep in mind that globalisation is not a
completely new phenomenon. In view of the existence of political barriers to international
trade, the flow of capital and goods was equally as possible one hundred years ago as it is
today. It goes without saying, however, that as a result of the rapid development of
technology, especially in the ICT area, which drastically lowered the cost of the said
exchange, the international integration of trade, investment, financial and other services is
now more advanced than it has ever been before.
In recent years globalization "tail wind", mainly through increasing competition, productivity
and growing imports from low-cost countries, helped to reduce inflation in CEE countries.
HICP inflation in the region2 fell from average 7.7 percent in the years 1997-2000 to 3.8 in
2001-2006. It led to a prolonged period of very low nominal and real interest rates. Nominal
interest rates (average for CEE countries with flexible exchange rate regimes) have fallen
from 8.8 percent during 2002-2005 to 5.4 during 2006-2007. Real rates decreased from 3.0
to 1.7 in the same period. This in turn helped to accelerate credit growth and fuelled asset
bubbles. The amount of loans granted to households increased 3.5 times since 2004 and
almost 10 times since 2000. Low deposit rates and economic upturn in CEE after EU
accession encouraged both financial institutions and individuals to move toward more risky
forms of investment. As a result, real estate prices soared after 2004 and equities listed on
stock exchanges reached historical highs. Since 2003 major stock exchange indexes in CEE
increased on average by almost 300 percent. While part of this asset price and credit growth
may be explained by structural factors often referred to as "convergence", the observed rates
of growth are clearly unsustainable and they contribute to economic imbalances.
With the benefit of the hindsight one could argue that monetary policy in the last few years
did not properly take into account the possibility that prolonged period of historically low
interest rates may contribute to asset bubbles and hence contribute to greater inflation
volatility in the future. As argued by Rogoff (2006) when faced with a tail wind monetary
authorities in both developed and developing world should have temporarily lowered the
inflation target rather that reduce interest rates too much for too long. But there is another
issue. It seems that globalisation tail wind is reversing these days and that in the coming few
years central banks can face "globalisation headwind" amid rising food and energy prices.
1.
Agflation is the rise of inflation due to increase of food prices. In recent months we
have witnessed a significant increase of food prices, grain and oilseeds being the
leaders. Prices of food products on international markets has risen by almost 40 per
cent within last two years and prices of grain and oil seeds has almost doubled
within this period. Many forecasters suggest that this trend will not end in the
nearest future. There are several explanations of such situation. Firstly, rising oil
prices increase demand for alternative sources of energy, biofuels being high on the
agenda in many regions. In effect industrial demand for food commodities will further
rise. By the way, it is worth to mention what may be the ecological consequences of
growing biofuels production. Spiegel online on 26th September 2007 described a
research led by the Nobel-price winning chemist Paul Crutzen which had found that
biofuels emit even 70 percent more greenhouse gases than fossil fuels. In effect,
global warming may accelerate and lead to further increase in frequency of disasters
such as floods, droughts, and unexpected weather changes that may have negative
effects on crops. Secondly, food prices will be lifted up by an increasing demand for
agriculture products in the emerging markets, especially in Asia, as the catching-up
process progresses. It is worth keeping in mind that the share of food in the CPI
basket is some 10 pp. higher in CEE countries than in the eurozone, so agflation, if
it materializes, will lead to inflation divergence.
2. Other commodities prices. Demand for commodities, just as for agricultural
products, has substantially risen in recent years. The "problem" lies again in the
emerging markets. Fast growing economies create still growing demand for all sorts
of commodities, especially metals and fuels (for example: oil consumption in China
has doubled within last 10 years). As the result, prices of metals and energy
commodities have doubled since the end of 2004. Although prices of these products
do not affect consumer inflation directly, in the medium term will contribute to further
increase of inflation volatility.
The tail wind of globalization will probably return in the medium run, but structural
adjustments, which may take several years, must be completed first. Rising white collar and
industrial wages in emerging markets will attract more and more people to the labour market
and will consequently lead to adjustments in education systems in those countries. Labour
force "great doubling"3, together with significant increase of the quality of human capital due
to better education system will contribute to further increase of offshoring directed to still
cheaper emerging markets. Offshoring, as a strategy of increasing competitiveness, is
becoming more and more common and includes not only the manufacturing of products but
also - increasingly - services. Numerous analyses show that the process of offshoring is
bound to grow and increasingly affect services4. For example, McKinsey Global Institute
estimated that in 2008 ca. 160 million jobs in services, i.e. 11% of the global employment in
services estimated at 1.46 billion, may theoretically be performed at a distance from the
customer.
It is hard to forecast, however, what the global consequences of such situation will be. On
the one hand, offshoring lowers operational costs of enterprises and thus optimal mark-up
pricing allows to reduce prices. On the other hand, rising labour demand will lead to higher
wages and depending on productivity growth may also lead to higher unit labour costs.
Higher wages also imply higher consumption and a further rise of demand for commodities in
emerging markets.
As the tail wind of globalization is reversing these days, the most difficult challenge which
CEE countries will have to face with is to keep fast real growth and, at the same time, to
manage nominal convergence - indispensable condition of EMU graduation. There are some
issues which will make this task even more complicated:
1. Migration. One of the major obstacles is the massive emigration of workforce
observed in the New Member States after joining the European Union. In Poland
and the Baltic states some 4 to even more than 7 percent of a labour force attracted
by higher wages, job availability and better living conditions migrated so far to the
EU-15. This has led to severe tensions in many industries pushing wages and unit
labour costs up. High corporate profits have provided a cushion yet, but, if this
situation continues, many companies will be forced to raise prices to remain
profitable.
2. Rising unit labour costs. Growing tension on the labour market is present in all
CEE countries, but Baltic and Balkan States seem to be the most threatened by
rising labour costs. Annual average dynamics of unit labour costs in the second
quarter of 2007 in CEE accounted to 8 per cent and in the group of Baltic and
Balkan states the figure was over two times higher. This shows that sooner or later
(rather sooner) enterprises will stop cutting their profit margins and will be forced to
pass growing operational costs on consumers.
3. Productivity growth. We live in a global knowledge economy, which is driven by
innovation - technological, business-process or customer related. The crucial factor
to succeed in the global knowledge economy is the country's ability to develop
intellectual capital. Only those who understand the importance of innovations for
growth will thrive and prosper in the coming decades. Unfortunately, CEE region
lags badly behind the leaders in terms of its current and future ability to generate
innovation. One of indicators measuring current ability to innovate is the number of
researchers. In the mid-1990s CEE-4 (the Czech Republic, Hungary, Poland and
Slovakia) and NIEs regions had similar number of researchers per million people,
while two years ago NIEs had almost twice as many persons employed in R&D per
million people in comparison with CEE-4. Future knowledge potential of particular
country or region can be measured by tertiary enrolment ratio. Tertiary enrolment
ratio in the CEE-4 countries improved to 50 percent in 2004, but still remains well
below 62 percent in the EU-15 and 82 percent in the United States. Because of a
relatively small population and a number of structural deficiencies it is very unlikely,
that increase in the number of students in CEE-4 that have occurred in recent
decade will translate into higher innovation potential in the coming years, unless a
dramatic change in policies in CEE-4 is made. This is also confirmed by a
dramatically low number of patents registered in the CEE countries and extremely
low number of scientific publications. As the ability to generate great ideas in the
CEE region is limited, it seems that in the transition period the most important
modernization channel in the region was through foreign direct investments. Indeed
CEE became a very large recipient of FDI, with FDI stock to GDP ratio topping 40
percent in CEE-4 region. Only NIEs economies managed to attract higher FDI stock
in relation to GDP and enjoy higher FDI annual inflows. However, in the global
knowledge economy it is important to attract foreign direct investments to sectors
that can become globally competitive, in particular to these sectors that export
hightechnology, i.e. high value added goods or services. While CEE-4 significantly
improved the structure of exports, the high-tech goods account for only 12 percent
of manufactured exports, which is the world worst result, lagging even behind Latin
American countries. NIEs are world leaders and China is about to take over the
second post from the United States. Above data suggests that in the long run low
ability to generate innovation combined with low value added FDI may harm the
CEE ability to improve productivity.
Summing up, with the inflation headwind expected in the coming few years CEE central
banks will face a possibly steep sacrifice ratio when controlling inflation. Keeping inflation at
the target consistent with EMU accession may require sizeable reduction of the output gap,
which in turn may make fiscal targets difficult to achieve.
Tail wind of globalization appears to be fading in the coming few years and if agflation or
surge in other commodity prices materializes, joining EMU may become "mission impossible"
for many CEE countries in the next few years. The window of opportunity created by global
inflation "tail wind" might have closed in 2007.
References
Freeman R. (2005) "The Great Doubling: America in the New Global Economy", Usery
Lecture, April 8, 2005. Georgia State University; What Really Ails Europe (and America): The
Doubling of the Global Workforce, The Globalist, June 3, 2005
IMF (2000) "Globalization: Threat or Opportunity?" IMF Staff, April 12, 2000 (Corrected
January 2002)
McKinsey Global Institute (2005) "The Emerging Global Labour Market", June 2005.
Rogoff K.S. (2006) "Impact of Globalization on Monetary Policy", Federal Reserve Bank of
Kansas City
Rybinski K. (2007) "Three faces of globalisation. Offshoring - global imbalances - monetary
policy", Difin, Warsaw 2007 (in Polish)
Spiegel online (2007), "Rethinking Renewables: Biofuels Emit More Greenhouse Gases than
Fossil Fuels", http://www.spiegel.de/international/europe/0,1518,508089,00.html