Look for crown to be under significant depreciation pressure at year's end
7he Slovak foreign exchange market has been stable since the end of June with the Slovak crown fluctuating in a narrow range between the central mark/dollar basket parity and 1.00 percent on the basket's depreciation side.
The basket's midpoint remains a strong resisting force to the crown's strengthening, and the market believes the National Bank of Slovakia (NBS) will not let the crown firm much further to keep Slovak exports competitive.
The crown gradually neared its basket parity as foreign investors' appetite for crowns was fuelled mainly by a wide interest rate differential against hard currencies, which hovered around 20 percent.
The growing foreign trade deficit and the yawning current account deficit (which totalled totalled $791 million in the January-April period this year) make the Slovak currency vulnerable to speculative attacks, and that could negatively affect the currency's stability in the near future.
Crown depreciation at end of year
The market sentiment is that there is quite a good chance that the crown will depreciate next year, mainly because purchases of crowns by local corporate clients and speculative buys by foreign banks may help the Slovak currency to stay strong to the end of this year. We expect, however, the first closing of crown positions and profit takings to appear at the end of the year which will put the crown under devaluation pressure.
We expect the crown to depreciate three to four percent in the last month of this year.
The foreign exchange market is now fully liquid, yet spreads quoted by local banks remain still wider than before the run on the crown in May and June. The NBS appears to be controlling the crown through its daily fixings. We think the central bank will let the crown fluctuate within its seven percent band on the basket's weak side.
Money market
The Slovak money market has reflected the mismanagement over the past few months of the state budget, which totalled 17.936 billion crowns in the January-June period, up from a 13.209 billion crown shortfall in the first five months of this year. Since the interbank market lacks enough sources to refinance it, it's up to the Ministry of Finance to find other sources to cover the budget shortfall.
The local money market still lacks liquidity. Only short term deposits of up to one week have been quoted over the past month, while trading with longer funds remained very thin.
The daily interbank interest rates fixings (Bratislava Interbank Offered Rate - BRIBOR) has yet to be re-installed and, at present, there is no obligation to quote deposit prices. Also the eight largest money market players, the reference banks, stopped following their agreement on quoting deposit prices. Short-term deposits ranged between 25-28 percent during the last weeks, and bids for longer periods hovered at 21-23 percent.
The Slovak banking sector met its minimum reserves requirement (PMR) at the end of July, after failing five consecutive times to do so in the previous two months. The NBS helped the banking sector meet the reserves requirement by extending funds through one- week repo-tenders. However, the continuing need for the NBS to supply money to the state budget deficit still drains any longer sources from the interbank market through finance ministry treasury bills and state bonds.
The ministry continues to accept high yields in auctions of state securities, with rates in the state auctions gradually nearing the interbank rates. In the last successful auction of state bonds, average yields were between 18 to 20 percent..
T-bills for foreign investors
It is very likely that the budget deficit will drastically widen in coming months (the 1997 budget is projected to have a 36.9 billion crowns deficit) which will force the finance ministry to accept high yields, thus keeping money market rates well above 20 percent.
The ministry said it was looking for other than domestic market sources to drum up funds to feed the deficit, adding it might allow foreign investors buy treasury bills which are issued with maturities of up to one year. It is not yet sure what attitude the central bank will take to this plan, since such a move could undermine its so far successful monetary and foreign exchange policy.
However, foreign participation in treasury bill auctions, if approved, will not solve fundamental problems in Slovakia's economy, but will only delay the final solution, possibly to days after next year's general elections.
The most crucial problem now appears to be the implementation of tight fiscal policy which could help improve the country's economic base.
Government policy makers should reconsider some of the budget spending plans and approve spending cuts. Such an unpopular policy change, however, would be politically very sensitive and appears very unlikely only one year before the elections.
Prepared by Oto Mohňanský from the dealing department at Slovenská Sporiteľňa, a.s. Bratislava.
