A SUPPLEMENT TO EUROMONEYDevaluation and the basketLike virtually all of the currencies of the so-called transition economies, Poland started its re-entry into the world’s free market community with a massive devaluation. In order to regain competitiveness, the Polish Zloty was then pegged to a currency basket reflecting the weight of the country’s most important trading partners and foreign investors. Due to the large inflation differentials between Poland and the countries whose currencies constitute the basket, since December 1991 the Central Bank has furthermore followed a crawling peg policy of gradual monthly devaluation. The regular devaluation factor is administered to shadow consumer price index development and has therefore been lowered in irregular intervals. From 1.8% per month in 1991, this rate has been 1% per month throughout 1996 and although the market has been expecting a further reduction to about 0.9% 0.8% per month in 1997, the Central Bank governor has recently ruled out such a step until domestic inflation has reached a level of 13% on a year-on-year basis.
Currency basket composition of the zloty
Monthly devaluation factor development Parity and the daily fixingPoland’s guardian of currency stability over the last years has been the Narodowy Bank Polski (National Bank of Poland NBP), the country’s central bank, whose independence and monetary policy have been modelled on the German Bundesbank. In order to effect the monthly devaluation policy while at the same time maintaining a semblance to a free-floating currency market, the NBP is administering a managed float. Every morning since early 1995, a preset algorithm combines the free market rates of the dollar, Deutschmark, pound, French franc and Swiss franc with the pro rata devaluation rate to produce a central parity rate. This central parity rate constitutes the centre of a 14% trading band, within which the zloty is the allowed to float in the domestic foreign exchange market. At around 3.00 pm the NBP administers the daily fixing, whereby a market rate is produced in an auction system similar to Frankfurt’s. The resulting rate then becomes the official exchange rate during the following business day. It is also the rate at which the NBP transacts foreign exchange orders received until 2.30 pm. For participation in this process, the ordering bank must be a member of the Polish central bank clearing system (Department Rachunków Banków DRB), and the minimum transaction size is $500,000 or Dm1 million.
Daily deviation of zloty fixing from central parity Convertibility and forexAlthough the NBP has relaxed a number of foreign exchange restrictions in the run-up to OECD membership during 1996, the zloty still falls short of full convertibility. So far, only the purchase of zlotys by foreign market participants is handled practically without restrictions. Foreigners generally are limited to the use of “free foreign accounts” when dealing with Polish banks, who have to be in possession of a full foreign exchange license. At the end of 1996, several dozens of Polish banks were in possession of such a licence. However, the number of active participants in the interbank market is still rather small, and it basically comprises the foreign-owned banks plus the three to five major Polish ones. Not all currencies are permitted for free trading against the zloty, as the NBP reserves the right to declare which currencies are and which are not convertible. At present, the list of convertible currencies includes virtually all OECD currencies. As a further limitation, foreign exchange trading virtually grinds to a halt during the start of the fixing so that there is hardly any liquidity after 2.30 pm. These obvious imperfections have encouraged the development of a sizeable offshore market which is dominated by the trading of non-deliverable forwards hedging instruments that are linked to the zloty exchange rate but only produce cash flows in convertible currencies. The hubs of this market are in New York and in London and the hedging is usually arranged via securities transactions with licensed Polish banks. With expected full convertibility sometime in 1997, this market segment will add strongly to the present $500 million a day zloty-related foreign exchange market. The exchange rateThe combination of a massive one-off devaluation in 1989 with subsequent constant gradual devaluation and strong productivity gains has allowed a substantial undervaluation of the zloty to persist. This point has not only been argued through the calculation of purchasing power parities but has also been strongly supported by the zloty’s continuous push towards the lower boundary of its floating band. At the height of this push the zloty gained up to 6% versus central parity before the NBP decided to readjust the rate and actually revalue the zloty by the same amount in December 1995. In the event, the currency still pushed about 3% firmer than the central parity rate, so the NBP initiated a policy of consecutive intervention against its own currency. Interventions had a strong comeback during the summer of 1996 and since then a level of roughly 3% under parity has been accepted as the tolerance limit of the NBP. Overall, the zloty has lost roughly 12.4% versus the dollar and 6.3% versus the Deutschmark in the 12 months since the end of October 1995. Considering that the managed devaluation alone should account for roughly 12.7% in the same period, the zloty has performed rather well and, in the light of the continuing surge of both direct and indirect foreign investment, is expected to continue doing so. The extraordinary growth of the NBP’s official currency reserves is a good illustration of this.
Gross official foreign exchange reserves Monetary policyIn terms of both exchange rate and monetary policy, the NBP has proved and continuously defended its independence, as laid down in the Central Bank Act of 1989. Notwithstanding increasingly vociferous demands for export-oriented devaluation in the face of nominal balance of trade problems, the Central Bank has stuck to its guns and thereby strongly assisted the growing community of foreign investors. In terms of interest rate and money supply management, the NBP relies mostly on the frequent issue of its own bills, the more or less regular offer of repo transactions and recently the outright sale of Treasury bonds from its portfolio. Given the quantity of underperforming assets on the books of most domestic banks, the market has been rather risk-averse over the last years. The result has been a strong preference to invest liquid funds in government and NBP securities and the interbank deposit market rather than to lend to corporate customers. As a consequence, the domestic money market has tended towards a state of constant excess liquidity, with the exception of the dates at which minimum reserves are calculated. On those days, the whole market is regularly caught scrambling for funds which frequently drives the short end of the curve up to the Lombard level. So far, the NBP has been honing its skills in mopping up excess liquidity in an environment of high nominal interest rates, but it remains to be seen how it would cope with a prolonged scarcity of funds.
Proportionate shares in the zloty money market Money market securitiesPolish money market securities presently comprise Treasury bills (issued by the Ministry of Finance), NBP ills (issued by the Central Bank), certificates of deposit (issued by the local banks) and commercial paper (issued by major corporates). The lion’s share of zloty-denominated market investment, Z24 billion ($8.5 billion) out of an overall market volume of roughly Z50 billion, is transacted in Treasury bills. This paper is auctioned regularly on Mondays and comes in volumes ranging from Z200 million to Z1 billion. However, this market is not restricted to banks and a lot of individual and institutional investors also participate via licensed securities brokers. As a complement to the Treasury bills, the NBP started to issue its own paper and has now reached an outstanding market volume of Z12 billion (as of June 30, 1996). The central bank sells this paper by way of irregular auctions of several hundred million zloty in five maturities (one, three, six, nine and 12 months). Interestingly enough, NBP bills have consistently offered a yield premium over T-bills during the past year. This can be seen as part of the reason for reduced demand in the latter, although NBP bills, unlike T-bills, are not available to foreign or retail investors. Treasury bills have been a steady feature of the market for quite some time, far outweighing the long end of the zloty-denominated capital market (as would be expected in a situation of a strongly inverted yield curve). In contrast, the commercial paper market is a relatively young segment with present market volume of roughly Z900 million, dispersed among a dozen domestic issuers which tend to be either large domestic trading conglomerates (for instance Elektrim and Universal) or subsidiaries of foreign multinationals (such as Unilever and FIAT). Zloty-CP tends to pay only a marginal premium over Treasury bills and is therefore a financing method of growing interest in a market that has been rather cautious with new lending activity. There are, however, certain legal snags involved. The market is divided as to whether to treat CP as promissory notes or as proper securities. Under the first definition, issue of CP would fall under the law governing bills of exchange (1936) with all the entailing legal definitions as to transfer of ownership and legal recourse in case of default. Under the second, issue of CP would be regulated by the civil law and the law governing securities. Most running programmes have come explicitly under the first approach but the most prominent issue has been explicitly defined as a security under the second approach. For the moment, both viewpoints have their local champions and the ongoing debate has yet to produce a final legal ruling. In general, all fungible segments of the zloty money markets (NBP bills, T-bills and commercial paper) suffer from a severe lack of secondary market liquidity, as investors tend to follow a buy-and-hold strategy. Recently, lending activity seems to be picking up dramatically, so that the emergence of a liquid Polish commercial paper market might be a foregone conclusion. Support for this view comes from the gradual decline of interest rates over the last year, preparing the way for more of a longer-term capital markets approach to corporate finance. The recent return to zero or even negative real rates of interest after a one year period of positive returns has already inspired considerable activity in this regard.
Overnight Wibor
Real returns in zloty money markets since 1993 Interbank depositsThe Polish banking system provides tradeable two-way prices in interbank deposits for up to 3 months, although liquidity rarely extends beyond 1 month. Similar to most developed money markets, a daily Interbank Offered Rate (Wibor) is determined by way of simple average quotes given by a number of designated market makers. In this process the most extreme quotes on both the high and the low side are omitted and daily bid and offer rates are determined as an indication for overnight, tomorrow/next, one week, two weeks, one month, two months and three months. For customers and on request, however, all banks usually quote deposit rates and forward rates for up to 12 months. The spreads, however, tend to widen drastically for prices on that maturity segment. Consequently, a swaps market also exists in more-or-less liquid form for the same maturity spectrum. Unlike in developed markets, however, the overall volume so far has been negligible when compared even with the relatively small spot market. The potentially most interested user group for these products foreign investors, hedgers and speculators is presently hindered by a considerable range of interpretations as to the legal possibilities within the current Polish foreign exchange regulations (Foreign Exchange Act of 1994, amended in 1996). Aspiring foreign market participants are therefore dependent on finding local counterparties that are equipped with a general foreign exchange license and willing to operate within a legal void of sorts. This experience is similar to the experience of currency and interest rate options, forward rate agreements and interest rate swaps. None of these transaction types are catered for in present legislation, so it is up to enterprising banks to provide the rules and standard practice instead. A market in terms of a liquid pool of supply and demand has not yet been provided.
Tomorrow/next and one week Wibor
One month and three month Wibor |
