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NBS says rate cut possibility still open

Although last month's 25 basis point drop in interest rates was seen by many analysts as the last the central bank would be making for a while, head of the monetary policy section at the National Bank of Slovakia (NBS) Peter Ševčovic has said there could be another cut in the not too distant future.
"If macroeconomic developments go our way, and their development is positive right now, then a rate cut is possible [in the next few months]," he told The Slovak Spectator April 3.
The central bank had surprised the market March 23 with a 0.25% rate cut on its key interest rates - to 6% for one day sterilisation operations, 9% for overnight refinancing and 7.5% for two-week repo deals - after saying only weeks before that there was little room for a cut, cautioning on the effects of the introduction of a February 1 hike of regulated prices for gas, power, transport etc. However, the effect of the hike on February inflation was negligible, and has prompted cautious optimism at the bank that a similar welcome surprise could be in store when data for March is examined.

Although last month's 25 basis point drop in interest rates was seen by many analysts as the last the central bank would be making for a while, head of the monetary policy section at the National Bank of Slovakia (NBS) Peter Ševčovic has said there could be another cut in the not too distant future.

"If macroeconomic developments go our way, and their development is positive right now, then a rate cut is possible [in the next few months]," he told The Slovak Spectator April 3.

The central bank had surprised the market March 23 with a 0.25% rate cut on its key interest rates - to 6% for one day sterilisation operations, 9% for overnight refinancing and 7.5% for two-week repo deals - after saying only weeks before that there was little room for a cut, cautioning on the effects of the introduction of a February 1 hike of regulated prices for gas, power, transport etc. However, the effect of the hike on February inflation was negligible, and has prompted cautious optimism at the bank that a similar welcome surprise could be in store when data for March is examined.

"We will have to see what the effect of regulated prices is on the Producer Price Index in March, and then make a decision. We have some forecasts, and if they are overestimated and the reality of these effects is not as bad, then we could see a lowering of the interest rate," said Ševčovic.

Many economists believe, though, that it will still be some months before the central bank can start dropping rates again.

"The chances for a rate cut in the next two months are low," said Miloš Božek, analyst at J & T Securities. "The central bank will have to watch the development of inflation and foreign trade first, but the opportunities for a cut soon are quite small."

Radek Jač, analyst at Commerzbank Capital Markets in Prague agreed, but added that a rate cut within the next four months was inevitable.

"There's a chance for a small cut in rates at the end of the second quarter, but only at the end. We believe there will be a gradual improvement in inflation, especially in the third quarter. Inflation has developed better than everyone expected since the start of the year," he said. "A rate cut is really a question of whether it will be in three months or four months. The interest rate now is at a good level, and the central bank could cut by a further 25 basis points and see little or no adverse effect on the economy."

However, despite the potential for a rate cut, few economists believe that the NBS' actions will have any real effect on the economy or the corporate sector.

"In reality, given Slovakia's present stage of economic development, monetary policy is not as effective an economic tool as fiscal policy," explained Božek. "Were the government to make a big tax cut or hike taxes that would affect the economy more than interest rates."

Banks have remained reluctant to lend to companies as sector restructuring continues and management at finance houses have refused to drop strict criteria for credits, rendering the effect of any rate cuts on the corporate sector almost negligible, say analysts.

"It's always good for someone borrowing to get loans cheaper, but in Slovakia it is a question of who has access to those loans. Interest rate drops really have little effect on the corporate sector, since no bank in Slovakia is in any way overactive in its lending right now," said Jač. J & T's Božek added: "There is a significant time lag between what the central bank does with interest rates and what happens in the corporate sector."

Though interest rates have dropped from an average of 30% to 12% since late 1998, the total volume of credits provided in 1999 was 412.6 billion crowns. The figure dropped to 407.6 billion crowns ($8 billion) at the end of last year.

"The corporate sector is a jungle where everyone owes everyone else. You can have a good company that sells a product and then it goes to another company which then doesn't pay for this product, leaving the original firm unable to pay its bills. We lack legislation to deal with bad companies, and banks are still hesitant to lend. What we need is to get bad companies out of the economy, through bankruptcies, and take the burden off the corporate sector," said Tomáš Kmeť, sector analyst at Slovenská sporiteľňa, Slovakia's largest bank.

Regardless of the ineffectiveness of the NBS's monetary policy, the central bank is also trying to keep an eye on the development of the Slovak crown, something the International Monetary Fund (IMF) has cautioned against, urging the central bank to stick solely to inflation.

The NBS's Ševčovic, though, believes it would be more harmful for the Slovak economy were the central bank to change from what he said was its present 'implicit' inflation targeting to monetary policy devoted exclusively to price developments, and take its eye off foreign exchange movements.

"In a small, open economy like Slovakia's exchange rates are enormously important, and have to be looked at more closely than say, in the US or Western Europe where foreign turnover has a smaller share on GDP," said Ševčovic.

Slovakia's foreign turnover as a part of GDP is 150%, while that of the US is around 13% and that of the EU as a whole 30%. Any large fluctuations in the value of the crown against the dollar and euro benchmark currencies can have a devastating effect on some Slovak businesses.

Firms like the oil refinery Slovnaft, Slovakia's fourth largest non-financial corporate, which has almost all its contracts for supply of crude oil in dollars, and other firms working in contracts with foreign currencies, would see the worst of any such currency volatility.

"Because of what we do and the contracts we have for crude oil we are probably one of the most fragile companies in terms of what the exchange rates can do to us," said Ľubomír Žitňan, spokesman for the refinery.

"Forex affects not just our supply contracts for crude, but also some of the loans we have taken in US dollars [the firm took a $250 million syndicated loan for a new refining system launched in late 1999 - ed. note], which in turn puts a burden on our provisioning at the end of the year if there is volatility in the exchange rates," he added.

For the NBS, protection of Slovak industry is a must and will involve intervention on the forex market if necessary.

"I don't think it's a case of the Slovak currency being any more volatile than some western currencies - just look at what's happened to the euro since it was launched," said Ševčovic. "But it's a fact that economies like that of America are almost completely closed in comparison with Slovakia. If you look at Slovakia and a standard economic 'basket' of goods and services, almost 60% of them would be affected by exchange rate developments.

"It's for this reason that we have said we will intervene to affect the exchange rate and act against any volatility."

It's a programme that, despite the IMF's reticence, economists believe is understandable.

"Generally, people are happy with what the central bank is doing," said Kmeť. "There is a need to keep forex under control."

Commerzbank's Jač added: "The NBS isn't looking at both inflation and forex equally, but is targeting inflation in fact. But of course, it has to keep on top of the foreign exchange market."

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