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Inflation down, NBS cautious on rate cut

Slovakia's corporate sector lending freeze showed signs of a thaw last week after central bank officials began dropping hints that an interest rate fall was on the cards.
Following the release of encouraging inflation figures for last month, the senior director of the monetary policy department of the National Bank of Slovakia (NBS), Peter Ševčovič, said August 10 that the bank was leaning in the near future towards a 50 basis point cut on the one-day sterilisation rate, a benchmark for dealings between commercial banks and the NBS.
Analysts say such a drop would eventually lead to a fall in prime lending rates at commercial banks, allowing companies access to cheaper loans. The companies, in turn, would see higher profits, which would then be reinvested in the economy.

Slovakia's corporate sector lending freeze showed signs of a thaw last week after central bank officials began dropping hints that an interest rate fall was on the cards.

Following the release of encouraging inflation figures for last month, the senior director of the monetary policy department of the National Bank of Slovakia (NBS), Peter Ševčovič, said August 10 that the bank was leaning in the near future towards a 50 basis point cut on the one-day sterilisation rate, a benchmark for dealings between commercial banks and the NBS.

Analysts say such a drop would eventually lead to a fall in prime lending rates at commercial banks, allowing companies access to cheaper loans. The companies, in turn, would see higher profits, which would then be reinvested in the economy.

Headline inflation dropped into single digits in July for the first time in twelve months, at 9.2% year-on-year. The NBS Bank Board is set to meet at the end of the month, and expectations are high that they will knock rates down in line with the good economic news.

Interest rates were last lowered at the end of May, when the one-day sterilisation rate (at which commercial banks which have extra funds lend them to the central bank) dropped from 7.5 to 7%, the one-day refinancing operations rate (at which commercial banks borrow from the NBS) fell from 10.5 to 10%, and an 8.5% two-week sterilisation repo rate was introduced.

Analysts were quick to respond to the central bank official's comments, saying that the lower rates were more than justified with the recent inflation data, and that companies which already had access to credit lines would soon be able to take advantage of the rate fall to invest more into their own expansion. Analysts have pinpointed growth among larger firms and re-invested profits as key to the revival of Slovakia's flagging corporate sector, and say that while banks may remain reluctant to lend to smaller firms, the extra activity in the corporate sector generated by expanding flagships is expected to have a trickle-down effect.

"There's not likely to be a lending boom because there is still this credit crunch in Slovakia, with banks still very unwilling to lend to companies, but for companies that can get credit anyway, those that have shown good corporate governance, there is now a possibility for them to expand," said Ján Tóth, analyst at ING Bank in Bratislava.

"These firms can grow and re-invest [in the corporate sector] because they can improve their profits. This is especially important for an economy like Slovakia, what we call a sleeping economy. Extra profit in the corporate sector is good for this economy," he added.

Jaroslav Vitazka, assistant portfolio manager at Schroeders in London, said that a rate drop would be a positive follow-up to the recent steps taken by the government on restructuring the banking sector, and would spur further economic activity.

"Low rates are a necessity for the cycle of lower rates/more lending/greater economic activity to take hold," he said. "However, the fantastic news of bank clean ups and privatisation will not lead to increased domestic lending just yet."

With many experts predicting a year-end GDP growth rate of 1.5% and with real inflation running at aroung 4.5 - 5% [the headline rate minus the effect on inflation of oil prices and seasonal effects such as food prices], a rate of around 6.5% on the one-day sterilisation rate has been called for.

The central bank has said that year-end inflation is likely to come in below its original estimates of between 9.5 and 10%, and a revision of its forecast is expected soon.

But although analysts have argued that the relative stability of the economy was such that lower rates could be offered, the NBS has remained cautious. Central bank governor Marián Jusko has said that fiscal pressures in the second half of the year have to be watched closely, and it is this conservatism that makes a drop of more than 50 basis points unlikely.

The second half of this year is expected to be difficult for the government, as subsidy payments to agriculture and government debt repayments should make it tough for cabinet to keep within its 18 billion crown budget deficit target. Were interest rates to fall more steeply, there is a risk that consumption and prices would rise and increase state budget costs for various sectors such as health.

Despite the risks of a major cut, however, the government is firmly in favour of some kind of decline, citing the need for lower interest rates to fuel corporate sector growth. "It would be very positive if interest rates fell. Along with the continuation of bank privatisation, cheap loans are what this economy needs," said Vladimír Tvaroška, advisor to Deputy Premier for the Economy Ivan Mikloš.

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