The latest data are alarming: złoty is losing its value vis-à-vis the foreign currencies. Ask any Pole, and he claims that the domestic currency is incredibly weak. A reason to worry for the National Bank of Poland: according to the previous works of NOBE, widespread opinion about the weakness of the currency normally leads to the significant rise in the inflationary expectations in Poland.

In fact, the situation is much more complicated. Firstly, złoty is weak only compared to the US dollar (60% of devaluation over the last 4 years to September 2000). Devaluation against euro, or the German Mark was much more modest (8% over the same period of time). If expressed in categories of the crawl vis-à-vis a basket of currencies (exchange rate policy abandoned only a few months ago) that implies a 0.5% average monthly devaluation over the last 48 months. In fact, not very much. So, the average Pole is misled: it is not złoty that is so weak, it is rather euro that is dramatically weak and dollar that is dramatically strong.

Secondly, the slow devaluation against euro means that złoty is very strong vis-à-vis the currencies of its major trading partners. The euro area absorbs ca.60% of the total Polish exports. Moreover, on the remaining world markets Polish exporters must compete with the exporters from the EU. Therefore, in fact, the exchange rate PLN/EUR is all but the only important one for the Polish export competitiveness. For the real economy it is the euro exchange rate that matters, not dollar.

Thirdly, the huge inflation differentials that exist between Poland and its major trading partners from the euro zone (say, Germany as the most striking example) imply that the 8% devaluation of złoty against euro in the last 4 years means significant strengthening of the Polish currency. If devaluation falls short of matching the inflation differentials, the currency appreciates in real terms. The CPI inflation differentials between Poland and Germany reached, cumulated over the last 48 months, over 40%. Therefore, złoty strengthened by more than 30% in real terms against the German mark and euro (compare the graph). The only explanation how the Polish exporters managed to withstand such a strong real appreciation of the currency, was the big scale of productivity gains in the Polish industry – the increase by over 50% in real terms. However, such gains could not be achieved without major cuts in employment – by ca.15% - contributing to the strong increase in the unemployment rate.

Unfortunately, the conclusion that złoty is very strong against euro is not enough to make the central bank relax. As our research shows, the inflationary expectations of Poles are mainly linked to the dollar exchange rate, and not to the exchange rate against any other currency. For example. majority of prices on the real estate market are fixed in dollar terms. Therefore, the situation is extremely difficult for NBP: złoty is too strong against euro, that makes the competitive position of Polish exporters worsen, and too weak against the dollar, that makes inflationary expectations rise.