Our monetary strategy has served us well for many years, providing anchor to the overall macroeconomic stability

The proper diagnostic on the inflationary nature is a key in adequate calibration of the policy response – thinks Anita Angelovska-Bezohska, Governor of the National Bank of the Republic of North Macedonia.
Our monetary strategy has served us well for many years, providing anchor to the overall macroeconomic stability

Anita Angelovska-Bezhoska (©NBRM)

Obserwator Finansowy: Can you summarize how the pandemics has changed business and economic conditions in North Macedonia?

Anita Angelovska-Bezohska: The pandemic was a severe and unique crisis bringing societies to their knees by threatening their livelihoods. Macedonian economy, as small and very open economy, was not shielded from this global shock. Although crisis caught us on a relatively strong footing, amidst solid economic fundamentals and absence of significant disequilibria, the magnitude of the GDP adjustment was immense, with a contraction of 4.7%, which is similar to the CESEE average, but five times stronger compared to the global financial crisis. The main channels of transmission, similar to other CESEE economies, included weaker foreign demand that depressed exports, halved foreign direct investments reflecting drop in confidence and risk appetite and reduced remittances (20% on annual basis) that are important source of balance of payments financing and constitute around one fourth of the disposable income.

Yet, no doubt that the shock intensity would have been stronger without unprecedented monetary and fiscal policy support, both in terms of speed and scale, preventing a more devastating outcome and long-term scarring to the economies. From today’s perspective the impact was relatively short-lived, and the scars from that very crisis seem to be shallower than initially expected. After the drop of GDP of 4.7% in 2020, the economy recovered at a rate of 3.9% in 2021, and the growth continued in the midstream of the Ukraine crisis at a more moderate rate of 2.7%. Yet, the recovery seems to be slower compared to the countries in the CESEE region, as their economies returned to the pre-pandemic level swifter and stronger. Still, some of the most affected contact–intensive sectors managed to rebound, remittances recovered very fast and surpassed the pre-pandemic level markedly and labor market did not suffer any major, permanent damage.

At the current juncture, instead of dealing with some of the pandemic “leftovers” and long term structural issues, unfortunately we are faced with a subsequent crisis, i.e.,  pandemics translated itself into energy and cost of living crisis that has to be managed in a proper way, but with much less of policy room than before.  

In December, inflation in North Macedonia reached 18.7 per cent. In our region such figures are being explained by the proximity of the theatre of war and energy prices. What is the explanation in North Macedonia?

Following a decade of low global inflation, since mid 2021, we have witnessed a surge in inflation across the globe that in many countries has reached multi decade high. Similarly, inflation in the Macedonian economy, after hovering around 1.5% in the decade preceding the pandеmics, last year abruptly picked to 18.7% y-o-y. In this high inflation environment, it does not come as a surprise that one of the questions debated by policymakers and academia is the source of inflation as the proper diagnostic on the inflationary nature is a key in adequate calibration of the policy response.

Particular countries have different sources of inflation

In the Macedonian case, given the relatively slower economic recovery and  negative output gap, surge in inflation has been dominantly driven by external shocks. Close to 80% of the overall inflation is due to the direct effect of higher food and energy prices. Still, inflation differential to the EU has widened reflecting a set of domestic factors. The Macedonian economy has the 5th largest trade openness in CESEE region with 140% of GDP (the EU trade openness is 76%), high import dependence in energy sector coupled with high energy intensity, and higher share of energy and food in CPI of about 50% (compared to 30% in the EU). These structural features imply that same global shocks can be propagated faster and with stronger intensity in our economy. Inflation differential can also be explained by the difference in the nature and duration of the policy measures to mitigate cost of living crisis. Last but not least, inflation has proved to be more persistent than expected, more broadbased, thus affecting inflationary expectations and demand for increase of wages. Against this background, the pre-pandemic trend of rising wages has continued and even accelerated reflecting unions demand to compensate for higher inflation, which is a risk that needs to be managed very carefully.

Does North Macedonia want to go the way of Croatia, which had a euro-oriented economy even before the decision was taken to adopt the euro?

The integration of the country into the European Union remains the main strategic priority, and ultimately this implies introduction of the Euro. In fact, our economy has very strong trade and financial linkages with the European Union. About 80% of our exports goes to EU, about 50% of our banking system is owned by EU shareholders, and the main destination of FDI and remittances inflows is from the EU. Strong ties with the European economy, as well as relatively high domestic euroisation, underpin our monetary strategy of targeting exchange rate of domestic currency to euro.  Having in mind the structural features of our economy, this monetary strategy has served us well for many years, providing anchor to the overall macroeconomic stability, which is a precondition for economic growth and wellbeing.

Will Europe and European companies be able to cope with the present energy crisis?

The unprecedented rise of energy prices and energy supply disruptions, occurring on the backdrop of the Russian invasion of Ukraine, without doubts are one of the major threats to the European economy. In early 2022, possible blackouts and bringing some of the industries on a standstill were not tail risks, but rather probable scenarios. They could have dragged the economy into a deep recession. Europe in general has a high-energy import dependence. In 2021, 55.6% of the total energy needs were imported. What was more critical was the fact that around 25% of total imports was from Russia, as a major supplier of natural gas, crude oil and hard coal to EU.

A year since the emergence of the shock, it seems that on a short run, Europe has succeeded to adjust swiftly, preventing deep scarring of the economy. The strategy was twofold, first through rapid diversification of the geographical sources of energy, and second through measures for energy efficiency. On the first front, we saw strong dedication, and in March 2022, EU leaders of the 27 member states jointly decided to phase out the EU’s dependency on Russian fossil fuels. As an illustration of the commitment, the imports of gas from Russia equalled 41% of the total gas imports at the end of 2021, and only 17% in August 2022. The substitution mostly came through imports of liquefied natural gas (LNG), particularly from the US, but also from Qatar, Nigeria, Algeria, and Norway. On the second front, in October 2022, we saw the European Council adopting emergency measures, with energy efficiency/saving specific guidance among them. Overall, Europe managed the energy crisis much better than it was initially expected. Mild winter contributed as well.

We have to make ourselves less dependent on one source

Yet, the storm has not passed, as prices will remain elevated, uncertainty will be a “new normal” for some time, long–term challenges in the energy area will remain, and it will take a while to tackle them. This encompasses further diversification of energy sources (not to forget that in 2022, 40% of the gas storage in the EU originated from Russia), providing conducive environment and investing in infrastructure for more intensive usage of renewables, putting efforts to elevate further energy efficiency, investing in infrastructure for gas interconnectors and electricity networks.

Apparently, this is necessary in a more fragmented world, but also given the climate change pressures that constantly reminds us to put stress on energy efficiency, renewable energy sources, and “smooth” green transition.

Who will cope with inflation and the current problems more quickly – the USA or Europe?

In light of the ongoing monetary tightening, easing of the global supply bottlenecks and stabilization of primary commodity prices, IMF forecasts that inflationary pressures will soften this year in both economies, at a different pace though. For the US, inflation is envisaged to slow down to 3.5% this year and to stabilise at 2% on a medium run. For the euro area, the disinflationary process is expected to be slower, as the inflation is envisaged to slow down to 5.7% and 2.7% in 2023 and 2024, respectively, before reverting to around 2%. The ECB projects even higher medium-term inflationary dynamics.

In the United States, where inflation may have already peaked (since July last year it has been decelerating) and where the tightening of monetary policy began earlier than in most other large advanced economies, it seems that faster progress in bringing inflation back to target can be expected. Yet, given the stronger recovery and tight labour conditions, vigilance by the central bank is needed.

In Europe, which is more vulnerable to energy shock, with the spike in energy costs still working its way through the economy and with monetary policy tightening beginning later than in the United States, both headline and core inflation might remain elevated for a longer period. As noted by the ECB staff, this persistence in core inflation is driven by the lagged indirect effects from high-energy prices and from the past sharp depreciation of the euro, as well as by the robust labour markets and inflation compensation effects on wages, which are expected to grow at rates well above the historical averages in nominal terms.

Can the major central banks bring inflation down to its target without any significant damage to economic growth? How should it be done? Is it possible at all while we face exogenous shocks?

If the lesson for 2021 was not to withdraw stimulus prematurely and to “look through” inflation, the message of 2022 was the need to get back to basics with a return to “normal” monetary focus. Currently we are faced with the most synchronized cycle of tightening of monetary policy in the last 50 years with a pace that is significantly stronger in comparison with previous inflationary episodes. Tightening is the key to preventing potential deanchoring of inflation expectations, undermining policy credibility and thus affecting the wage-setting process. This indicates that central banks are not repeating the same mistakes as in 70’s.

The other side of the coin is that monetary tightening can in procyclical manner affect real economy which in any case is heading for a landing- the question is whether for harder or softer landing. In principle, the sacrifice ratio will depend on the persistence of the geopolitical shock (which is beyond our control), the vulnerability of economies (which can be changed, but in a medium-term horizon), as well as the policy room and policy coordination to mitigate the adverse effects of the crisis. Monetary and fiscal policy must demonstrate alignment against the inflation. Finally, we should not forget that macroeconomic policies are just the first line of defence and not substitute for structural policies, which are key to increasing the resilience and potential to grow.

We are going into new phase of globalization

Is globalisation in the form that existed before the pandemic still possible? Is the world heading towards division into separate economic blocs?

Over the last four decades, globalization has enabled raising income and pulling more than 500 million people out of poverty, reduced global poverty levels (from 43.6% in 1981 to less than 10% in 2019), increased productivity, and contributed to lower global inflation. Still, in the decade preceding the pandemics, there were signs of slowing globalisation as world trade growth no longer exceeded world GDP growth. The pandemics and the war in Ukraine, which exposed the flaws of the global supply chains and emphasized the national security considerations, have tipped the debate on the benefits and drawbacks of globalization, as well as its future trajectory. Although it is expected that recent unprecedented shocks will have a bearing on the global architecture, at least so far, data on international trade and financial flows do not suggest major shifts along those lines. After plummeting during the pandemics, global financial and trade flows have recovered despite the rising number of trade restrictions. Nevertheless, it seems that reassessment of the growth models and their vulnerability to global shocks is taking place, which may eventually lead to changes in the volume and structure of the globalisation.

 

Anita Angelovska-Bezhoska (©NBRM)

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