You’ve long been nervous about the rising levels of public debt in the Czech Republic. Why do you think rising CZK interest rates will help?
Because at least in our country I think the budget will not be as ballistic as it was over the past two years. The new government will be very reasonable about subsidies, because handing out money for free isn’t fashionable in the first year. They won’t be just throwing money around. I think there’s a reality check coming. We’ll see if what’s been happening here is sustainable or not. Whether it’s private retail spending, public sector ecological and other subsidies or how much the government can invest in projects or how much additional Covid support it can provide. High interest rates means that any additional debt the government raises will be expensive. And I think sooner or later the same thing will happen in Europe because the with inflation where it is, interest rates cannot continue at zero.
I would think that if the United States goes forward with raising their interest rates and that this would mean Europe can’t ignore that gap forever.
It will raise the rates. And you can see it if you’re watching the interest rate swap curve, meaning short versus long, it continues going up and up. The five-year swap is already at about 0.6% and it was still in negative territory a couple of months ago. So, the sentiment in Europe is changing as well and it’s clear that rates will have to go up sooner or later.
Essentially, low interest rates could have continued indefinitely, until inflation emerged.
Absolutely and inflation has started big-time, though it is largely imported via commodities and energy. Were not talking 2-4% here. We’re talking 6% to 10% for the last year and we’re probably looking at similar levels for 2022. So, somebody has to wake up and I think it will be very political what they do with zero euro interest rates. Because southern Europe is no healthier than it was 10 years ago. And the north is as good as it was before. So, there will be some kind of political game to keep the EMU running relatively smoothly. But clearly rates have to go up in Europe as well.
You’re running a retail investment fund. What sort of pressures and risks do rising interest rates present you looking forward for this year?
We’re running a Czech asset class which is relatively low yield, but our local interest rates went up a lot and they’ll probably continue going further up this year. That’s clearly the biggest pressure point. So, we might switch our loans from Czech crowns to euro because interest rates are very high (even the swaps are very high). It means we would finance our residential income producing projects in euros because the euro interest rates will definitely be more moderate over the long-term.
In the Czech Republic, we’ve actually been living in the eurozone for the past 10 years. We just don’t realize it. We don’t pay in euros, but in fact we are in the eurozone. The entire economy, with the exception of local services, already works in euros. We are part of the big block. The only difference between us and the eurozone is that we have an independent central bank which can play around with the interest rates and exchange rate. What the ČNB is doing now is probably adequate given the extremely high inflation and asset price inflation.
But at the same time, we’ve imported the inflation in the price of raw materials and in the price of energy. So, I’m not sure to what extent our interest rates can fight this imported inflation. If you combine higher interest rates, which then strengthens the Czech crown, you might make imports a little bit cheaper.
So, it ends up being that you’d rather have borrow in a currency (euro) whose central bank isn’t fighting inflation as much as your home currency.
We have to protect the interests of our investors, so we think this is what we should be doing right now. We should be financing ourselves under the best possible conditions. Unless we suspect the Czech crown is vulnerable and there’s potential for the Czech crown to weaken materially, which we don’t believe at this point. [this interview was conducted before the Ukrainian war] We still believe that our currency is long-term undervalued, that the central bank has a huge volume of Euros on its balance sheet, so the current policy of our central bank only helps this case.
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