2017: end of FX floor and gradual recovery of investment
01.11.2016 14:18:00Looking at the current and expected economic developments in the Czech Republic, we have decided to focus in more detail on two critical issues in this issue of the Czech Economic Outlook. There is no question that this year has been marked by a slump in investment activity, while the key issue for 2017 will certainly be an exit from the FX floor regime.
Where has all the investment gone?
The end of 2016 is slowly drawing near to its end and our expectations are obviously being borne out. Last year’s extraordinary economic growth of 4.6% is now a thing of the past. This year, the economy will grow by 2.5%, which is not too bad either. However, the main difficulty ahead lies in the structure of the economy’s dynamics: investment is not growing. We have taken a closer look at this in special boxes in this issue of Czech Economic Outlook.
This year has been a more sobering time in the wake of last year’s rich harvest when money was drawn at the last minute from EU funds allocated to the 2007-2013 programming period. The new, current programming period has been running for three years now, but the fact that projects have not been prepared is again causing the rise-up curve to rise only slowly. Jana Steckerová looks at this in more depth in her contribution. Nevertheless, we expect that 2017 will see many more new subsidy schemes, which should encourage investment activity. This year, the shortage of projects is clearly damaging major infrastructure schemes financed from the public purse. In his box, Viktor Zeisel explains how the problem lies solely with government investment. This hurts the construction sector primarily, dragging it down into the red and this situation is further complicated by the problems with Environmental Impact Assessments.
However, we should not rely on public resources alone, as they are not inexhaustible either. Public private partnerships (PPP) have real potential, but are being left untapped in this country, unlike in neighbouring economies. David Kocourek discusses the experience gained with this type of financing in the Czech Republic and in the wider region to date.
Beware, the exit is approaching. Time to hedge!
There is a real sense of déjà vu in the air now. As in August 2015, August 2016 again saw expectations mounting on financial markets of an end to the CNB’s FX floor regime. But there is a big difference this year: both the market and ourselves, on the basis of our new macroeconomic forecast, believe that this time, the central bankers actually will stop this policy within less than a year.
At first glance, the current situation on the spot market feels something like a lull before the storm. But there is a good deal of turmoil under the surface. The inflow of foreign speculative capital is reflected in the Czech crown growing stronger on the forward market. Due to the euro influx, the prices of short-term bonds are surging – a trend, which is likely to continue, as shown by Marek Dřímal in the section on the bond market. The CNB’s Board has indicated that the FX floor regime will not be ended before 2Q 2017. However, according to the CNB Governor, this “hard commitment” will not be moved around anymore. We now expect the exit during the second quarter of 2017.
The presence of speculative capital will result in higher exchange rate volatility following the exit. If needed, the CNB will intervene on both sides, against rapid strengthening and rapid weakening, but volatility will nevertheless be much more severe than we have been accustomed to in the past few months. Before the current FX mode was put in place, the daily change in the EUR/CZK rate on the market was typically around 0.5% and frequently up to 1%. This is likely to rise in the wake of the exit.
Hedging against the expected greater volatility should be in both exporters’ and importers’ best interests. It would be naive to expect the exporter to be faster than the arbitrageur and profit from hedging. Arbitrageurs will always have a head start on exporters in terms of the speed at which they process new reports and their ability to respond to them.