Role Role ofof thethe CentralCentral Bank in Economic Bank in Economic TransformationTransformation

Ludek Niedermayer, CNB Prague

Financial Policies for Pursuing High Growth and EmploymentBank of Indonesia

November 2007

ContentsContents

1. Role of the Central Bank in early days ofeconomic reform (from 1991)

2. Challenges of economic development during end

of 90s (from 1996)

3. Current role of Czech National Bank

www. .cz

Czech economy Czech economy –– heritage from heritage from communist timescommunist times

• In 80s, Czechoslovakia one of the most rigid and most heavily regulated economies in the East bloc;

• Level of macroeconomic stability, private savings and credibility of the currency relatively high;

• Nominal inflation low, hidden inflation high (demand overhang on market with state controlled prices);

• Field for the monetary policy;limited number of banks (monobank dissolved on Nov 89);no financial markets;koruna not convertible, existence of limited black market.

Design Design ofof economic economic reformreform„„1st 1st JanuaryJanuary 19911991““

• Liberalization of prices;• Liberalization of foreign trade;• Internal convertibility of Koruna (for CA transactions);• Start of privatization;• Unification of exchange rates and introduction of fixed rate

against trade weighted basket.

• Due to weak credibility, low capital inflows, financing through official resources at the beginning.

MonetaryMonetary policy policy frameworkframework

• Monetary policy:ultimate goal - monetary stability;intermediate targets - fixed exchange rate + M2;Instruments:

auctions refinancial credits (+ emergency credits and credits against the pledge of bills);interest rate ceiling 24%, lending limits;FX transactions for balancing of positions of the banks.

• First year performance (incl. dereg. of prices):inflation rate 56,6% (took place in Jan and Feb);GDP growth declined to -11,6% (internal and externalreasons).

OtherOther taskstasks ofof centralcentral bankbank

• Banker for the government;• Advisor of the government.

• Banking sector supervisior:Licencing of new banks;Regulation;Supervision.

• Financial market development:Infrastructure;Execution of the transaction.

EconomyEconomy isis changingchanging ......

• Reduced uncertainty regarding future economic course of the country;

• A large number of banks emerged;

• Financial markets gradually liberalised and developed;

• Convertibility of koruna deepened, regulations are gradually lifted.

On Jan 1, 1993, former federation CSFR was split, the CNB replaced SBCS - former central bank of CSFR, CZK was introduced

-5

0

5

10

15

20

1993 1994 1995 1996

GDPInflation

…… leavingleaving nominalnominal anchoranchor No. I No. I ……

• Since Sept 92 CNB has reduced its FX activities and introduced band (+/- 0,5 %);

• Both ultimate goal (monetary stability) and intermediate target (M2 + implicit assumption of FX stability) unchanged;

• Further liberalisation of the FX regime and reduction of the risk premium (OECD member since 95) made fixed FX rate policy difficult and costly - CPI was at high single digit and nominal IR were high), since February 28, 1996, band widened to ±7,5%.

CNB FX reserves (CZK)

0

50100

150200

250

300350

400

1993 1994 1995 1996

Czech Czech economyeconomy –– endend ofof 90s90s

Real economyHigh growth in mid 90s (6,9% in 95) followed soon by decline(-0,7% in 97);Growing inbalances, especially BoP (CA more than 6% in 96);Inflation „sticky“ (high single digits).

Banking sectorCummulation of bad loans in portfolios of the banks (20% +);Sometimes incorrect reporting;Missalocation of credits, related party loans, frauds.

Monetary policyAfter introduction of the 15% band, monetary policy in theory„independent“;In practice, still focused on exchange rate.

May 27May 27,, 1997 1997 –– CZK CZK isis floatingfloating

• Spill over from the Asian crises was the short term cause of crises;

• Low commitment of all other policies (or even discussion about it) to fixed FX rate and weak supply side compared to expanding demand were the real cause. Weak corporate governance in banking sector was important contributor to thecrises and obstacle for transmission of monetary policy;

• Too long existence of the regime in such an environment put CNB in front of the difficult decision under time pressure.

Do not stick to temporary policies for too long!

1515,5

1616,5

1717,5

18

18,519

19,520

1-I. 21-I. 10-II. 1-III. 21-III. 10-IV.

ChangesChanges in in thethe Czech Czech economyeconomy

Financial sectorPrivatisation of the large state owned banks;Focus on fast adoption of standard regulation (including independent SEC);Focus on law enforcement.

Monetary policyEffort to stabilize currency after the crises;Changing position of the central bank.

Real economyGradual effort to improve environment for enterprises / structural reforms;Support of FDI;Deteoration of fiscal policy;Only slow other important reforms (fiscal, pension, medical, labour).

AfterAfter crisescrises monetarymonetary policypolicy

„Real“ floating of the currencyafter may 97 reality;Monetary targeting neithercredible or transparent, targeting of inflation is thenatural choice;Setting proper „disinflationarytarget“ under big uncertainty isvery difficult;When real appreciation„natural“, nominal rates mustgo down.

26

28

30

32

34

36

38

40

2.1.

1995

2.5.

1995

2.9.

1995

2.1.

1996

2.5.

1996

2.9.

1996

2.1.

1997

2.5.

1997

2.9.

1997

2.1.

1998

2.5.

1998

2.9.

1998

2.1.

1999

2.5.

1999

2.9.

1999

2.1.

2000

2.5.

2000

2.9.

2000

2.1.

2001

2.5.

2001

2.9.

2001

2.1.

2002

2.5.

2002

2.9.

2002

2.1.

2003

2.5.

2003

2.9.

2003

2.1.

2004

2.5.

2004

2.9.

2004

2.1.

2005

2.5.

2005

2.9.

2005

2.1.

2006

2.5.

2006

2.9.

2006

speculative capital inflow

speculative attack

political crisis

exchange rate

bubble

after-crisis volatility

trend appreciation

burst of thebubble

trend appreciation

after-crisis volatility

0

1

2

3

4

5

6

7

8

9

10

1.1.

1999

1.4.

1999

1.7.

1999

1.10

.199

9

1.1.

2000

1.4.

2000

1.7.

2000

1.10

.200

0

1.1.

2001

1.4.

2001

1.7.

2001

1.10

.200

1

1.1.

2002

1.4.

2002

1.7.

2002

1.10

.200

2

1.1.

2003

1.4.

2003

1.7.

2003

1.10

.200

3

1.1.

2004

1.4.

2004

1.7.

2004

1.10

.200

4

1.1.

2005

1.4.

2005

1.7.

2005

1.10

.200

5

1.1.

2006

1.4.

2006

1.7.

2006

1.10

.200

6

Inte

rest

rate

(%)

ECB

ČR

InflationInflation vs. vs. targetstargets

Actual disinflation fasterthan intended;Two episodes of sharptarget undershootingrelated to exchange rateappreciation;FX interventions againstthe appreciation in 1998 and 2001-02, but no interventions since then.

-2%

0%

2%

4%

6%

8%

10%

12%

14%

I.96

VII.9

6I.9

7VI

I.97

I.98

VII.9

8I.9

9VI

I.99

I.00

VII.0

0I.0

1VI

I.01

I.02

VII.0

2I.0

3VI

I.03

I.04

VII.0

4I.0

5VI

I.05

I.06

VII.0

6I.0

7VI

I.07

Headline inflation Net inflation

headline inflation targets

net inflation targets

Inflation targeting

OutcomeOutcome -- Czech Czech economyeconomy in in newnew milleniummillenium

Speed up of economic growth;Improvement of CA situation, but at the sametime change of thestructure of the deficit;Improvement of bankingand financial sector (fastcredit growth, profitabilityhigh).

GDP growth rate

-4

-2

0

2

4

6

8

97/I III 98/I III 99/I III 00/I III 01/I III 02/I III 03/I III 04/I III 05/I III 06/I III 07/I

Y/y

gro

wth

rate

in %

-12%-10%

-8%-6%-4%

-2%0%2%4%6%

93:Q

4

94:Q

4

95:Q

4

96:Q

4

97:Q

4

98:Q

4

99:Q

4

00:Q

4

01:Q

4

02:Q

4

03:Q

4

04:Q

4

05:Q

4

06:Q

4

in %

of G

DP

(4Q m

ovin

g av

.)

Services Transfers TradeIncomes Current account

CentralCentral bank bank taskstasks

Monetary policy is the key taskTransparency;Know how improvement.

Other key areasEU cooperation, ESCB membership;Financial stability (it is …..);Since 2006, overall financial market supervision;Banking functions for government;Advisory role very limited;How to preserve independence?

Future – CR in Eurozone, CNB delegates monetary policy to ECB.

SomeSome challengeschallenges ofof thethe Czech Czech economyeconomy

In future, CA BoP will beinfluenced a lot by deficit of balance of income;Sometimes, currencyvolatility high, not dominated by „domesticfactors“. Forecasting verydifficult, credibility in risk;Decision of Eurozone entry is „tricky“.

Net position CR (ex. CNB)

-60000-50000-40000-30000-20000-10000

0100002000030000

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

CNB reserves

Other inv.

Portfolio inv.FDI

0,9

0,95

1

1,05

1,1

1.1.

2007

1.2.

2007

1.3.

2007

1.4.

2007

1.5.

2007

1.6.

2007

1.7.

2007

1.8.

2007

1.9.

2007

1.10

.200

7

EURCZKEURJPYEURPLN

www.cnb.czwww.cnb.czludek.niedermayer@ludek.niedermayer@cnbcnb..czcz