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Minutes of the Bank Board Meeting on 5 October 2000

18.10.2000 14:43

The Board opened the meeting with an assessment of current monetary and economic developments. Board members agreed that economic recovery thus far had been taking place in an environment of macroeconomic stability and low inflation. This year’s economic growth estimates had shifted slightly upward, and acceleration of domestic demand was mainly concentrated in the area of gross capital formation. Wage developments remained moderate and were in line with some productivity indicators. The inflation forecasts for this year and 2001 had been fluctuating within the desired bands and, therefore, no change in the setting of monetary policy conditions was needed. In view of present exchange rate and monetary developments, there were also no grounds for intervening on the foreign exchange market. The Board considered the central banks’ intervention in favour of the euro and the increase in the oil supply by the United States to be a positive development for the Czech economy.

The Board devoted a significant part of their discussion examining evidence for the shift in the level of the potential product. It was mentioned that the capacity-creation effect of foreign direct investment during a supply recovery had been confirmed by some signals – e.g. import structure, the improving product structure, and favourable developments in some indices or for the unemployment rate. However, indications of potential product growth had so far been mainly hypothetical in nature. Board members stressed that more detailed analyses and more concrete evidence for the supply side would be key for determining an economic growth rate acceptable from the standpoint of the external balance and inflation, as well as for evaluating the adequacy of monetary conditions. Members also discussed possible reasons for the improvement in the non-financial sector’s economic situation, which had developed alongside the decline in lending.

Revisions in the forecast for the current account and trade balance were approved on the basis of the current foreign trade results and assumptions for future import-export prices. This meant the trade deficit for 2000 rising to about CZK 120 billion. Several views were expressed on the risk level of the present external balance. Its controversial development was related to the fact that it was generated almost exclusively by import price growth in the SITC 3 group, while import-export relations in real terms (from the viewpoint of their contribution to economic growth) remained virtually stable. As a reminder, it was mentioned that the level of risk depended on the markets’ reaction to worsening data on the current account and the trade balance. In addition, members discussed the stability of financing internal and external deficits, which could be threatened by a large outflow of domestic capital abroad. On the other hand, it was emphasised that the most dominant form of capital inflow during the present period was foreign direct investment. The low-inflation environment and the minimal interest rate differential would guard against speculative capital, and in contrast to the situation in the mid-1990s, reduce the danger of exchange rate and monetary instability.

The Board appreciated the Ministry of Finance’s efforts to reduce the general government deficits. By the beginning of next year, the extent of these deficits could seriously threaten internal macroeconomic stability. The Board discussed the need to differentiate as much as possible between deficits relating to the one-time income and expenses for completing the transition process and the tendency towards a deepening imbalance relating to the structural components of the public finance deficit (according to CNB estimates, it had increased from 2.2% of GDP in 1999 to 3.6% this year, and is estimated to rise to 4.7% for 2001). This development was said to be inconsistent with the economic cycle, because it implied fiscal expansion during a period in which the economy was recovering, potentially causing macroeconomic disequilibrium and inflation pressures. Furthermore, this could create a risk of undesirable strengthening of the government’s role in the economy. A considerable increase in the burden of future budgets could, by way of debt service, hinder the Czech Republic’s ability to comply with the Maastricht convergence criteria in the future.

Price growth dynamics had shown that accommodation to energy raw material prices on world markets occurred within the range of the CNB’s inflation targets, even though consumer prices probably had not yet fully absorbed the secondary effects. Within the existing competitive environment, their effect should be minimal and should not interfere with the inflation target for 2001. It also should not negatively affect the markets’ inflation expectations or upcoming wage negotiations.

After reviewing the situational report, the Board decided unanimously not to change the setting of monetary policy instruments and to leave the CNB two-week repo rate at its current level.

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