The Slovak government and the central bank launched a united defence of the crown on the morning of May 20, helping the vulnerable currency to mount a modest recovery after weeks of decline. The central bank intervened directly to support the crown and said exchange rate developments had priority over money market rates.
By late morning the same day, the crown was traded at 46.7 to the euro after hitting a record low of 48.3 on May 19 in a highly illiquid market with only five to seven local banks actively quoting on the market. The next day, the central bank intervened to stop the weakening trend of the Slovak currency as well as to calm down the frantic market.
The central bank decided to spend another several million euros from its reserves after the Slovak government agreed on new measures to bring the budget deficit under control. Government officials said they would increase the value-added-tax, impose an import surcharge and deregulate a wide range of prices.
The money market collapsed with no trading after the central bank decided not to add funds via repo-tenders, and then reopened at much higher levels. The stability that the money market had gained during first month of this year rested on the active refinancing approach of the central bank, as many banks were buying T-bonds and bills and using them in repo-operations to refinance short funding positions. Short maturities shot up to 40-60%, and longer maturities were not traded on an illiquid market.
During the week beginning May 24, the money market calmed down after the central bank started to add some liquidity once again. Short maturities were traded at around 20-25%, and dealers expected another decline, especially after a planned issue of Finance Ministry eurobonds is carried out. However, the market will need some time to gain some stability and better liquidity in tenors longer then 1-2 months. Further stability will be hard to come by on the money market, and dealers are expecting rates to stay volatile and sensitive to any sharp spot moves.
The Slovak foreign exchange market is likely to face another wave of turmoil during the next few months. Analysts do not see any room for stabilisation if the government does not act quickly to implement the measures it has announced. Indeed, while these measures may well be along the right lines, they are also likely a case of too little and too late.
Slovakia's external debt situation is a further concern, and local corporate will seek to hedge or repay their external debt and will remain the main buying source during the coming months. With external debt still exceeding foreign reserves, the central bank could have to spend more to protect the crown and could have to sacrifice the money market again.