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The Warsaw Voice » Special Sections » June 30, 2011
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Inflation Under Control
June 30, 2011   
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Poland is not experiencing problems keeping a tight rein on inflation. This was not always the case though.
The harmfulness of high inflation, or excessive price growth, is unquestionable. Hyperinflation is particularly dangerous—when price growth spirals out of control and sometimes drastic measures are needed to counteract it. Economists differ as to what level of price growth constitutes inflation and when this becomes hyperinflation. But one common definition of hyperinflation is price growth of at least 50 percent in one month.

There were two cases of hyperinflation in Polish history. The first occurred in 1921-22 when, due to the faltering influx of revenue to the budget, the government started printing money without coverage, resulting in a crisis in 1923. Hyperinflation was halted by Prime Minister Władysław Grabski’s reforms. Within a short time, the Polish mark was replaced with a new currency called the Polish zloty, whose exchange rate was equal to that of the Swiss franc due to the same gold parity. These measures by Grabski’s government in 1924 effectively curbed hyperinflation and settled the economy.

The other example of hyperinflation was at the start of the economic transition when in January 1990 inflation reached 79.6 percent month on month. This was the effect of prices being subjected to market-economy rules as a result of almost complete liberalization of the retail and wholesale market for almost all consumer goods, materials and services, and also a substantial withdrawal of subsidies for enterprises. The inflation shock led to prices growing to market-economy levels and to a drop in the amount of money in circulation (in face-value terms). The zloty’s strong devaluation reduced people’s purchasing power and also substantially depleted their savings. The scale of this hyperinflation, however, was much smaller than in the 1920s (estimates say it reached 600 percent annually between 1989 and 1990). Hyperinflation was curbed thanks to the reforms of Deputy Prime Minister and Finance Minister Leszek Balcerowicz. These were generally similar to Grabski’s plan. The 1989 hyperinflation transitioned to galloping inflation of 60.4 percent in 1991 and to 18.5 percent in 1996.

Curbing rises
In the following years, curbing inflation became the main objective of the government and the National Bank of Poland (NBP)—the central bank, and the Monetary Policy Council (RPP) was appointed on Feb. 17, 1998 with this aim in mind. As of 1999 the implementation of monetary policy has involved the strategy of a direct inflation goal. The RPP defines the inflation goal and then adjusts the level of NBP basic interest rates so as to maximize the probability of reaching this goal. Since the start of 2004, the NBP has been maintaining a continuous inflation goal of 2.5 percent with a permissible fluctuation margin of +/- 1 percentage points. The NBP keeps interest rates cohesive with the inflation goal, influencing the level of nominal short-term interest rates on the money market. Money market rates have an impact on the interest rates applied to loans and deposits at commercial banks and consequently also on the loan volume, demand in the economy and the inflation rate.

Thanks to the mechanisms applied by the central bank and the RPP, and also the measures taken by consecutive governments, inflation decreased from year to year, to stand at 0.7 percent in 2005. In the following years, among other things due to the global crisis and growing raw materials prices internationally, inflation in Poland grew slightly. Even so, Poland still enjoys a much more stable situation than many other European countries. According to Eurostat, the EU’s statistics office, in December 2010 inflation in Poland was 2.7 percent (according to Poland’s Central Statistical Office it was 3.1 percent), while Romania had an annual inflation rate of 6.1 percent, Estonia 5.4 percent and Greece 5.2 percent. Annual inflation for the European Union was 2.6 percent in 2010.

Into the octillions
The current level of inflation in Poland, and even the several-hundred-percent price growth of 1990 fall far short of world records. As the portal www.nbpportal.pl reports, in Zimbabwe in November 2008 the monthly price growth was estimated at 79.6 billion percent. This means that prices in stores doubled almost every day. Even the poorest citizens of Zimbabwe could feel like billionaires when the country’s central bank issued a bank note representing 100,000,000,000 Zimbabwe dollars. If that sounds astronomical, it turns out that Zimbabwe’s inflation was not the highest in history.

Without a question, first place goes to Hungary. After World War II an irresponsible monetary policy caused inflation to reach 41.9 quadrillion percent in July 1946. Prices doubled every 13.5 hours. A bank note worth 100,000,000,000,000,000,000 (100 quintillion pengos was issued and an even higher one, worth 1 sextillion pengos, was in the pipeline. Before it was made legal tender, Hungary replaced pengos with forints at a rate of 1 to 400 octillion. Third place among countries most strongly affected by inflation goes to Yugoslavia. In January 1994 prices there rose by 313 million percent, doubling every 1.4 days.

Hyperinflation is a deadly disease for a currency. Currencies whose value drops by thousands, millions or trillions of percent per month simply cannot be saved. They can only be replaced with a new one that has fewer zeros. For denomination to be effective, the subsequent monetary policy has to be restrictive. What happens when it is not, can be seen in the example of Zimbabwe—the redenomination of 2006 was carried out at a ratio of 1,000:1; the next one had to be carried out in 2008, at a ratio of 10,000,000,000:1.

The Polish financial system remained stable during the global crisis, with the best proof of that being that no bank went down in Poland. What’s more, no Polish bank needed a bailout.

Many external and internal factors enabled Poland to emerge from the crisis painlessly. But—as foreign financial institutions and companies emphasize—this would not have been possible without the proper response from the Polish government and institutions responsible for the stability of the financial system.

Kai Koeppen, Managing Partner, The Riverside Company:
The Polish economy is not as geared towards exports as the economies of other CEE countries, or Western European countries. Exports comprise of only some 40% of Poland’s GDP, compared to 80% for Hungary or 75% for the Czech Republic. This is why Poland suffered less at the time of weak trade and from the economic environment that hit most EU markets. On top of that, domestic demand, and especially household consumption, has remained strong in Poland throughout the crisis; in fact, it has been consistently stronger than pretty much anywhere else in the EU. We must not forget how huge Poland’s domestic market is: 38 million people who continue spending on food, cars, TV sets and services is a very powerful force in times of economic weakness.

The financial crisis was not an issue because the Polish financial system is not reliant on U.S. or European financial institutions. The housing bubble and sub-prime lending in the U.S., the collapse of Lehman Brothers and the liquidity crisis have not had a major effect on the Polish banking system. Polish banks did not invest in Lehman brothers or sub-prime mortgages to any large extent. Polish pension funds invest more than 90% of their equity assets in Polish securities rather than foreign ones, so dramatic events in the U.S., UK or Germany left Poland largely unscathed. And given that Polish companies and consumers do not rely on debt financing to any large extent, the cut in bank lending that followed did not deteriorate the conditions of the banking and business sectors and did not trigger a recession, which is essentially what happened in Western Europe. There was some economic effect of course—after all Poland is not in vacuum and a drop in imports in Western Europe had a negative effect on the Polish economy, but this was a temporary dip rather than a systemic failure.

The economic recovery was mainly consumption-led. Not just household consumption, but also government consumption. The Polish government did the best thing that a government can do in a time of economic weakness: continue spending. A public investment program, and especially infrastructure projects (not only ahead of the Euro 2012 football championships but also for other purposes) kept the construction sector working at full speed and had a positive ripple effect across all sectors of the economy.

Kaspar Richter, World Bank Senior Economist for the Europe and Central Asia region:
Over the last decade, Poland and other Central and Eastern European countries outperformed many other emerging countries in the quest to converge with Western European living standards. In terms of integration, trade, finance and labor, the region has become one of the most integrated parts of the world. So it is not surprising that the impact of the global economic and financial crisis has been so significant in Central and Eastern Europe. Yet, during the crisis, sound macroeconomic and financial management allowed Poland to emerge relatively unscathed. Poland is the only country in the EU whose economy has continued to expand throughout the crisis and one of the few new member states that managed to continue its process of convergence with average EU income levels. Poland’s large domestic economy has limited its exposure to the decline in world trade. The flexible exchange rate regime has also facilitated the economy’s adjustment. Poland has therefore cushioned the shock, both in terms of the overall economy and job losses. But most importantly, Poland is reaping the benefits of sound economic policies that helped the country avoid the build-up of large macroeconomic imbalances prior to the crisis. Because there was sufficient fiscal space to adopt temporary stimulus measures, the impact of the crisis on growth was lessened.

The strong collaboration among the financial supervision agency—the KNF, the central bank and the ministry of finance has helped to ensure that Poland’s banking system has withstood the global financial crisis well. Poland’s credit expansion was more prudent than elsewhere in the region in the run-up to the crisis. This, along with policy actions aimed at maintaining liquidity and increasing surveillance during the crisis, has safeguarded financial stability. Measures include the recommendations that banks retain 2008 profits in order to bolster capital-adequacy ratios, and, more recently, that credit standards for household lending, in particular in foreign loans, be tightened.

Rainer Fuhrmann, CEO of DZ Bank Polska SA
Poland was successful in avoiding the crisis since Polish banks had practically no exposure to the American real estate market and toxic securities. That was mainly due to their conservative stance of investing in the ‘real economy’ but also an effect of the strong share of international banks on the market where Polish subsidiaries have clear investment rules imposed by their parent companies. Furthermore, although loans were easily accessible in the pre-crisis years, a credit bubble did not emerge. Strict banking supervision by the regulators helped to prevent exaggerations in that field.

The lower dependency of Poland’s economy on exports in comparison to its peers in Central and Eastern Europe was certainly favorable as the collapse of global trade had a lesser negative impact. In addition, the depreciation of the Polish currency helped Polish companies to regain their competitive edge in global markets quite soon. At the same time, the government accelerated public investment, strongly backed by EU funds, which proved to be supportive of the economy. Sector stabilization was also one of the priorities of the National Bank of Poland.
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