During much of 2000, the National Bank of Poland tightened monetary policy by hiking interest rates to squash inflation. Towards the end of that year, with the NBP’s 28-day intervention rate having peaked at around 19%, nominal and real interest rates peaked, as did inflation. The result was irresistible to fixed income investors, attracted both by extremely high interest yields and the prospect of capital gains. As the NBP began cautiously to relax its monetary policy, this triggered an increasing tide of capital inflows. Asset managers reduced or even eliminated their currency hedges. Dedicated emerging market investors raised their asset allocation in Polish bonds, while cross-over investors increased their exposure to what was an off-index investment.
Archive for the ‘Capital’ Category
Capital Inflows and Real Exchange Rate Appreciation – theory
July 5th, 2009Under a pegged exchange rate, capital flows are attracted by the perception of exchange rate stability created by the peg itself. Conversely, under freely floating exchange rates, such capital flows are attracted by the prospect of high returns, either of income or capital gain. Fundamental flows are attracted to a currency, attracted both by currency and underlying asset market-related valuation considerations. Such capital inflows force the currency to appreciate and simultaneously force nominal interest rates lower. As a result, during this period, the correlation between the asset markets and the currency increases. Capital flows lead to both nominal and real exchange rate appreciation.