Between a US Dollar zone and a Euro zone

Hanna Gronkiewicz-Waltz*

INTRODUCTION

Poland is a country transforming in all areas of life. It is also an emerging market for foreign investors. For some this is a warning, for others - an incentive. This imposes on everybody a duty of thorough analysis of economic foundations and requires a skill of forecasting future trends in our economy. Those investors who are coming to Poland because they want stabilised development prospects remember that we are an OECD and NATO member. This is the difference between us and numerous turbulent emerging markets. The difference in country risk between Poland and the remaining emerging markets will increase when we successfully complete negotiations on European Union membership.

The purpose of this paper is to remind about another important and occurring under our eyes transformation, consisting in gradual and balanced transition from the US dollar zone to the euro zone. Its external expression is the difference in the structure of foreign debt and the structure of Polish exports and imports. Future obligations link us with the US dollar but future development opportunities are provided by the euro zone. However, before we move from the dollar zone to the euro zone numerous traps and disorders in monetary and exchange rate policies are waiting for us. I would like to draw attention especially to two of them. The first of them is balancing a trend to devalue Polish zloty that is beneficial to exporters and the countertrend to appreciate zloty that threatens the external balance of our economy. The second is the pace of transferring from zloty to euro and in particular the earliest and the latest deadline of our readiness to join the Economic and Monetary Union.


BETWEEN APPRECIATION AND DEVALUATION

Two clearly different periods may be separated within the exchange rate policy of recent years. The first is the period May 1995 - February 1998 with attempts to control the inflow of foreign capital. The second consists in releasing a market trend for zloty appreciation and increasing the risk band for speculation capital.

1995 - 1997 was a record period in the field of increase of official foreign exchange reserves. This originated a pressure on zloty appreciation. Parallel policy of high interest rates reduced the internal demand and hence impaired demand for imports. Such a mix of monetary policy allowed to maintain a high increase rate of domestic product and to further reduce the inflation level.

In February 1998 the fluctuation band of zloty was widened and the forecast zloty depreciation rate was slowed down. New exchange rate policy provided a wider area for monetary policy and brought threats for export expansion. The policy of cooling the economy made this manoeuvre easier, resulting in negative effects for the balance of trade in short term. Thanks to retarding the economic growth to 4.8% in 1998 it was easier to overcome negative effects for Polish economy of crises in East Asia, Russia and South America.

Establishment in the middle of 1998 of the system of irrevocable ECU cross rates, ancestors of fixed euro system currencies exchange rates to euro, substantially stabilised the situation on the basic market for domestic exporters - the internal European market. Formal birth of euro confirmed expectations for stabilising effect of euro introduction on financial markets of countries applying for EU membership.


BETWEEN FLOATING AND FIXED EXCHANGE RATE

Poland is on the eve of transforming its exchange rate policy from using benefits of floating rate to restore economic balance to de facto a fixed rate against euro within the ERM II. Selection of a proper period to perform a change of exchange rate policy regime and the pace of its realisation is an element of art of carrying out an effective economic policy.

A shift of inflation rate from a two-digit to one-digit rate after 18 years of inflation higher than 10% is an evident success of the monetary policy carried out so far. However, transferring to its full compliance with Maastricht convergence criteria must be a process extended in time. It will encounter a barrier in the form of inflation fluctuation directly after exceeding a psychosocial limit of 8.6% inflation measured with consumer price index from December 1997 to December 1998. As experience of other countries shows, waves of social claims appear immediately after breaking the barrier of self-denials in favour of curbing inflation. In Poland this universal process of revival of psychosocial trends that stimulate inflation is superimposed with a conceived on a wide scale systemic reforms of the second generation: a pension system reform, a self-government reform, a health care reform and an education system reform. Introduction of economic calculation to the domain of social services and enforcing financ ial discipline in the budget domain are their common denominator.

Fluctuation of inflation level generates an incentive to speculate on real interest rates and hence attracts an inflow of speculation capital to the country. New Foreign Exchange Law provides the national authorities with a possibility to intervene, including administration means in the case of occurring a threat for economic stability of the country. Nevertheless, a question remains open whether a faster joining the ERM II would not be a better solution than increasing the fluctuation band of zloty exchange rate against a currency basket composed of 55% of euro and 45% of USD. International authorities are split on the exchange rate policy recommended in such situations.

The Government of the Republic of Poland has assumed the date of 31 December 2002 as the date of technical readiness of Poland for membership in the European Union. Without taking into account the duration of ratification period of the currently negotiated treaty on membership of Poland in the European Union that means, that since 1 January 2003 Poland could join the ERM II at the earliest, while since 1 January 2005 it could become a member of Economic and Monetary Union. In the case that the ratification period of the treaty on membership of Poland in the European Union would last as long as the ratification of the European Treaty we would join the Economic and Monetary Union on 1 January 2008. This date shall be an irrevocable deadline of zloty changeover into euro. Postponing it further threatens with a Swedish syndrome, where the lack of social support leads to a peripheral position within the European Union of a country having sound economic foundations.

The success of financial innovations originated from introduction of euro in national banks proves a readiness of emphasising a private euro, as a currency in which households accumulate their surpluses. As a clearing currency euro is currently promoted in Poland by supranational corporations. Both raw materials and semi-finished goods to be processed in Poland and for exports as finished products are more and more often invoiced in euro.

The electronic form of euro is an obstacle in its wider dissemination in conditions where cash settlements still play an important role in Poland. We face a logistically complex and carrying forgery and falsification risks operation of withdrawing German marks. They are, like US dollars, a currency that is used with a special willingness by the untaxed zone of Polish economy.

The first experiences with introducing euro in Poland show that it was possible to gain confidence in euro as a future for zloty. During training it is emphasised that euro for its users shall mean the lowest transaction costs and liquidation of foreign exchange risk. Moving from the US dollar zone is a process in which accomplished facts shall be created step by step at a pace that will not disturb the economic balance of the country.

Assuming that the process of EU enlargement, conditioned inter alia by the success of the internal reform of EU institutions, the scope and schedule of which have been determined in the Agenda 2000, will proceed according to Polish expectations, it is also necessary to intensify, exceeding the formal course of screening and negotiations on Poland membership in the EU, the dialogue and co-operation between institutions responsible for co-ordination and carrying out the economic policy. If we want that decisions taken on the future of Poland in the euro zone are optimal, especially in respect to the moment of full "joining" the system on the generally binding conditions, a political acceptance of goals and principles of the Economic and Monetary Union will not be sufficient. It is indispensable to achieve operating capabilities to carry out proper policies on day x and maintain them in a permanent way. This objective may be pursued by developing capabilities created, e.g. within the "Institutional Building" pro gramme. This is in the interest of Poland as well as of all EU member countries. This will allow to avoid "an information asymmetry" in respect to intensification and extension of the European integration.


CONCLUSIONS

Controversies on the optimum path of moving by the countries transforming their economies from the US dollar zone to the euro zone make difficult determination of proper monetary policy and exchange rate policy mix. In a medium term strategy of reducing inflation Poland aims at establishing necessary but not sufficient conditions to access the European Union and in a foreseeable future to join the Economic and Monetary Union.

The hitherto achievements in systematic and permanent reduction of inflation will be tested in the turbulence period. It features significant fluctuations in financial markets of small open national economies of countries performing multi-directional system transformations. We expect that a consistent privatisation of the national economy and an extension of economic calculation application to the budget domain are allies in this process.

Mutual determination of the earliest technically possible for both parties date of Poland joining the Economic and Monetary Union and what is even more important of practical date of the deadline for changeover of zloty into euro would serve well stabilisation of our financial markets, would increase chances for success of attempts of Poland to access the European Union. We know what was the importance of setting such deadlines by the Maastricht Treaty. We consider that they will be as helpful for Poland.


* President National Bank of Poland