Análisis de las Cogniciones Relativas a la AF

The program of financial stabilisation, actually an anti-inflationary program from the end of 1993, and several waves of crisis and rehabilitation of the banking industry, were the two main characteristics of the development of the Croatian financial system during the 1990s. The purpose of this section is to identify the experience, the customs and the expectations, which market participants collected by navigating through these events.

The anti-inflationary program of 1993 was the most spectacular economic reform in the Croatian transition so far. The program successfully fulfilled its main purpose, i.e. the monthly inflation rate of 25-30 percent was taken under control. The program was in line with the measures recommended by the so-called Washington consensus.3 _{The exchange rate was used as an anchor for the goal of}

suppressing inflation. In 1994 prices even fell and from that time inflation has been low, and the exchange rate has remained at the same level with very limited fluctuations. The authorities declared that the free exchange of foreign currencies on an open market enabled inflation to be taken under control. Therefore my task is to identify the structure that was promoted as a free market.

Under hyperinflationary conditions in the beginning of the 1990s the Deutsche Mark ousted the domestic currency even as a measure of payment.4 _The

Government and banks as well as ordinary citizens used the Deutsche Mark for the quotation of the value of real estate, and of capital goods. It was mentioned earlier that bank accounts denominated in foreign currencies were allowed in Croatia. The domestic currency, which was the only official means of payment, was used only for daily transactions, due to hyperinflation. Prior to the anti-inflationary program the authorities usually determined the official exchange rate. Because it was unrealistic, a black market for foreign exchange flourished. Then it was

3 _{I would like to remind the reader that the Washington consensus was an informal list of}

recommendations for countries in transition, as to how to reform their economies (Williamson 1994, 2004). It was obviously supported by the World Bank and the IMF. The list included privatisation, the liberalisation of trade and of foreign direct investment, deregulation, and fiscal stability and stability of the exchange rate.

4 _{The Croatian monetary system has remained “dollarised” until today. The term is from the}

area of influence of dollar. In Croatia it is today “eurisation”, and in the 1990s it was a period of dominance of the Deutsch Mark.

decided that the market should set the exchange rate. The government allowed citizens and companies to exchange their foreign currency holdings freely for the domestic currency5_.

Under inflationary conditions the domestic currency steadily weakened; banks and citizens were inclined to accumulate foreign currency. When the Government announced a program indicating the limit of the weakening of the domestic currency (the authorities were ready to intervene to support the value of domestic currency), banks were full of foreign currencies and short of domestic liquidity. The banks could collect domestic currency, which was necessary for daily transactions, by selling foreign currency to citizens, to other banks and companies or to the central bank. Some banks - having no money for daily transactions - were ready to decrease the price of foreign currencies steeply. The domestic currency had significantly strengthened. Since the majority of market participants were also short of domestic currency the final buyer of foreign currency was the Croatian National Bank which aimed to increase its foreign reserves; the CNB issued domestic currency only in exchange for foreign currency (this policy of “printing money” is usually called a currency board).

1.1 Organization of the foreign exchange market

Here it will be appropriate to explain a technical aspect of the foreign exchange market. Every morning the banks quoted their purchasing and selling rates for foreign currency for citizens; the banks made the morning telephone calls for trading currencies among themselves. However, most important was their quote for trading currencies with the central bank. They were sending their bids by fax: the price and the amount of foreign currency they were willing to sell. Nobody knew whether the best price was accepted. Banks weren’t able to see what the bids of their competitors were. The average exchange rate was published only the following day. It was calculated by using a method that aggregated all the transactions of the previous day - transactions between banks and citizens, banks and companies and between the banks. Hence, in the first period of the program that relied heavily on the market for foreign exchange, the largest amount of

5 _{I would like to add that only ‘new deposits‘ nominated in foreign currency were freely}

exchangeable, but not ‘frozen deposits’ that were explained in chapter VI, note 13 and 14. However their relative value toward the domestic currency depended on the exchange rate at the moment of the unfreezing.

trade went through two fax machines in the Croatian National Bank.6 _{The effect}

was officially visible to market participants only on the following day. Because the CNB had the responsibility to make sure that the banking system was liquid and stable, it was granted discretion as to which price it took (not necessarily the lowest purchasing price). There was a possibility, because the market wasn’t transparent, that the central bank favoured some big banks by providing them with domestic currency (giving them money for state pensions and so on), regardless of their biding prices. There was also the possibility that some banks took too much risk, and acted irresponsibly by decreasing the exchange rate too steeply and that the Central Bank would reject their bids (not necessarily because of favouritism towards large banks). The market wasn’t transparent, and the non-transparency of the market made it possible for the central bank to abuse its monopsony position. I don’t know whether the Central Bank did so or not, but the possibility was evident. Rumours were widespread. Only later, when the market was fulfilled by the domestic currency and the exchange rate was stabilised, was the monopsony position of the Central Bank weakened. The amount of trade between banks, then between banks and companies and between banks and citizens eventually surpassed the amount of trade with the Central Bank. Protests by the banks that had the impression that they had been treated unfairly faded. I would like to emphasise here the pattern that was promoted as a free market. The authorities argued that market participants must rely on themselves and decide for themselves; no official price of foreign currencies was established prior to trade taking place. That was understood as signifying progress from earlier socialist practice. Since the issue of transparency was neglected, the sense that the treatment of banks was unequal was widespread. The possibility that central authorities could intervene arbitrarily remained. This pattern only changed insignificantly during the 1990s. I will show below that the market for securities, where the second phase of privatisation was conducted, shared important characteristics with the foreign exchange market: low transparency, selective

6 _{The above description of the anti-inflationary program (in sections 1. and 1.1) strongly relies on}

the book The Road To Low Inflation published in 1995 by the Government of Croatia and written by the creators of the program (Anusic et al 1995). It should be noted that at that time I was a financial journalist who followed the implementation of the program and the editor in chief of

Banka, the leading financial monthly in Croatia. Some illustrative details that don’t substantially

affect the meaning of the interpretation are result of my personal experience. For example, it was extensively discussed in the book (Anusic et al 1995) that at the beginning of the implementation of the program the largest amount of trade was between the banks and the CNB. But the detail that the CNB at that time received the bids through two fax machines is mine. In my opinion nothing would be substantially different if there were three fax machines, but there were two.

trading and the arbitrary behaviour of various institutions that monopolised particular market segments.

The anti-inflationary program was probably the most successful Croatian economic reform after the period of socialism. From 1993 the exchange rate of the Croatian currency, the kuna, toward the Deutsche Mark (and later the euro) remained almost fixed and the rate of inflation was under control. It is highly possible that the goal of the program couldn’t have been so successfully achieved without this arbitrary power of the central bank. There was a possibility that some (big) banks might suffer losses. Thus this might have led to illiquidity which could have unleashed an uncontrolled panic which would have undermined the program to control inflation. The point here is not to discuss the monetary aspects of the program but to emphasise the conception that a free market allocates resources efficiently regardless of the level of transparency and the equality of market participants.7