Monday, November 19, 2007

The Koruna and the Euro

Two interesting pieces in Bloomberg this morning, both about central bank Governor Zdenek Tuma. First there is this:

The Czech koruna's climb to a record against the euro is ``unsustainable,'' though monetary policy makers must take the currency gains into consideration when setting interest rates, central bank Governor Zdenek Tuma said.

``In the open economy of the Czech Republic, the exchange rate is important and the pass-through on inflation is relatively strong,'' Tuma said in an interview in Cape Town yesterday. ``I always warn against panic regarding exchange-rate developments, but nevertheless this is very strong appreciation'' and ``we cannot ignore it.''

The koruna is the world's best-performing currency against the euro in the past month and has risen 2.6 percent in the period. The currency's surge has prompted policy makers to put off a fourth rate increase this year even after economic growth helped push inflation in October to the highest since 2001.

The koruna was at 26.65 against the euro as of 9:33 a.m. in Prague, unchanged from Nov. 16. It reached a record 26.50 per euro on Nov. 12 and climbed to an all-time high of 18.08 against the dollar on Nov. 15. The koruna has gained 14.4 percent against the dollar this year, helping to counter the effect of record oil prices.


``By definition this pace of appreciation is unsustainable,'' Tuma said on the sidelines of a meeting of central bankers from around the world. ``That is clear.''

The Czech 3.25 percent benchmark rate is the lowest in the European Union. Tuma said the currency's gain was one of the factors that prompted the central bank's seven-member board to keep the rate unchanged at its last meeting on Oct. 25.

The koruna's exchange rate will ``stabilize,'' Tuma said. ``The only question is whether we can expect moderate correction and some stability or just that stability at new levels.''

The central bank predicts a temporary surge in the inflation rate to as high as 5.1 percent in 2008 on one-time increases in indirect taxes and utility costs, surpassing its 3 percent target plus or minus a percentage point. It expects consumer-price growth to slow again in the next 12 months, Tuma said.

and then there is this:

Czech central bank Governor Zdenek Tuma said the country can ``afford'' to keep the koruna even if neighboring countries switch to the euro.

``The Czech economy has been growing between 5 percent and 6 percent in the past few years, this is not a failure,'' Tuma said in an interview in Cape Town yesterday. ``Because of that, I can imagine we can afford to stay outside the euro. I don't think in 1990 we expected people would trust the Czech koruna this much.''

The Czechs last year dropped a plan to adopt the euro in 2010. The country, which is committed under European Union rules to give up the koruna, has yet to set a new date. Slovenia so far is the only one of the eight former communist countries that joined the EU in 2004 to become a member of the euro region.

The Czech government of Mirek Topolanek has introduced tax changes and welfare spending cuts aimed at cutting the budget deficit below 3 percent of gross domestic product starting in 2008, and has pledged to overhaul pension and health-care programs by 2010.

`Economic Shocks'

``The decision in our case is not only to push through important reforms but also to have sufficient maneuvering room for economic shocks,'' the 47-year-old Tuma said.

To apply for the euro, countries must meet thresholds for the budget deficit, debt, inflation and long-term interest rates, and enter the exchange-rate mechanism, a minimum two-year test of currency stability.

``I wouldn't like to enter'' the exchange-rate mechanism, ``a system I don't like, then to fail to'' meet ``one of the criteria and then be trapped in the terms of'' the mechanism,'' Tuma said.

By delaying the euro, the Czechs are hoping to avoid the experience of Lithuania, whose euro bid was rejected last year because inflation was too fast. Slovakia wants to switch currencies in 2009.

Tuma said the country will eventually become a member of the 13-member euro region.

``Nobody is saying we're going to postpone it forever,'' he said. ``This is the dilemma: the more successful the country is, the less important the euro is. We are committed to the euro because it's a part of the treaty and we voted for the EU, including the euro. It's just a question of timing.''

Tuma declined to give a date by which the Czech Republic may be expected to adopt the common European currency, stressing the decision would be a ``political'' one.

Premier Topolanek said on state-run public television yesterday that adopting Europe's single currency in 2012 is ``not realistic'' because the country would have to fulfill all adoption criteria as of 2008, which is not possible without an overhaul of the pension and health-care systems.

Czech central banker Mojmir Hampl told Hospodarske Noviny newspaper today that the economy is not ready to switch currencies, and that fast adoption of the euro would increase inflation.

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