Are the CEE-4 currencies fundamentally undervalued?

In the race towards the euro, the four large Central and Eastern European new EU members (CEE-4) – Poland, Hungary, Slovakia and the Czech Republic – will soon enter the home stretch, says a new paper by Deutsche Bank Research. Despite the rising importance of the potential parities of the zloty, the forint and the koruna, there continues to be uncertainty as to the real over- or undervaluation of the CEE-4 currencies.

Our paper presents an exchange-rate model that examines the competitiveness of these economies in the EU’s single market on the basis of euro wage levels in manufacturing. 

We initially estimate the correlation between productivity and the euro wage level for the EU-15 countries. In a second step we enter the CEE-4 data in the equation and calculate the equilibrium wage level. In doing so, we arrive at the euro wage level these countries could afford in light of their factor endowment if they wish to remain competitive in the single market. 

Our estimates suggest continuous undervaluation of the CEE-4 currencies. Even though the productivity gap between the EU-15 and the new members is large, it is apparently not as large as implied by the current exchange rates. Poland, Slovakia and the Czech Republic exhibit in this sense an undervalued real exchange rate versus the euro. Only the Hungarian forint has reached its equilibrium level over the last few years in the course of substantial wage increases. 

Our main finding of a real undervaluation is compatible with the CEE-4’s ongoing attractiveness for foreign investors. The competitive positions of Poland, Hungary, Slovakia and the Czech Republic in the single market remain strong at the current real exchange rate levels.

To read the paper in full, visit the Deutsche Bank Research website.