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CAPITAL MARKETS

Coalition sends right signals to market

The stock market fell by 5.0% during the past two weeks as positive developments on the political scene did not translate into a change in investor sentiment. The lack of a domestic investor base means that any recovery of the market is dependent on an inflow of foreign funds. However, investors are currently looking for sound macroeconomic figures and Slovakia has little too offer on this front. Furthermore, negative corporate earnings growth expected for 1998 and next year, together with the unlikelihood of interest rate relief, do not provide fundamental support for higher equity prices.

The stock market fell by 5.0% during the past two weeks as positive developments on the political scene did not translate into a change in investor sentiment. The lack of a domestic investor base means that any recovery of the market is dependent on an inflow of foreign funds. However, investors are currently looking for sound macroeconomic figures and Slovakia has little too offer on this front. Furthermore, negative corporate earnings growth expected for 1998 and next year, together with the unlikelihood of interest rate relief, do not provide fundamental support for higher equity prices.

4Q98 will bring slowdown

The new government provided the first positive signals to the market via its Deputy Premier for Economy, Ivan Mikloš. Mikloš said that the priorities of the new government would be restoring macroeconomic and budget balances, a gradual reduction of the tax and social benefits burdens, and a re-evaluation of unlawful privatisation decisions. He has also stated that the cabinet wants to clarify ownership relations and to punish those who have violated laws.

According to Mikloš, the trade balance deficit will not be solved by increases in import duties. While September statistical data show industrial production rising 6.9% year-on-year and retail sales surging 9.8%, an economic slowdown will begin in 4Q98. With Mikloš's appointment, however, and in the light of his first statements, it is reasonable to believe that economic problems will be tackled using systematic measures reducing the current distortions of the market environment.

VÚB in dire straits

One very positive development at the beginning of November was Mikloš's hint that the recovery of the Slovak banking sector should be done in cooperation with large foreign banks, while banking supervision should be strengthened.

The poor 1-3Q98 results of the largest commercial bank, VÚB, provide yet another call for urgent revamping of state-owned banks. VÚB's after-tax profit slumped by 66.2% to 87.6 million Sk ($2.4 million), due to substantially lower income from operations with clients and dealing with securities. That the bottom-line was in the black was due only to a net release of provisions totalling 616 million Sk compared to net provisions creation of 1.6 billion Sk in 1-3Q97.

VúB will face increasing problems in the near future as an expected economic downturn will cause a further deterioration in the bank's loan portfolio. At the end of 1997 only 38% of the bank's loan portfolio was standard, and a further deterioration almost certainly occured in 1-3Q98. When this fact is added to the uncertain value of the collateral the bank holds, the bank maz find itself seriously under-provisioned. VúB needs deep restructuring and potentially a government-sponsored bail-out.

VSŽ Holding confirmed officially that it did not repay a $35 million syndicated loan in time and de facto defaulted.

Based on a government proposal, a meeting of economic ministers and VSŽ Holding's managers was held. The government submitted certain alternative solutions and left the matter up to VSŽs managers to decide. A radical change in corporate governance is a necessary condition for the company's survival, but a state sponsored bailout is probably not on the agenda as the company's controlling shareholders are prominent members of former Premier Vladimír Mečiar's HZDS party. As well, any government bailout would be accompanied by a significant dilution of the ownership stakes of the current owners, which would likely not be acceptable to them. Thus, an agreement allowing banks to carry out an in-depth audit of the company, to implement strict monitoring procedures and take part in management decisions is more likely.

Nafta, the gas and oil drilling and storing company, reported basic 1-3Q98 results. Net non-consolidated profit reached 189.5 million Sk, down 9.4% compared with the same period of 1997. At 463.2 million Sk, operating profit remained virtually flat compared to last year. Nafta's net financial loss increased to 150.3 million Sk, due to increased debt needed to cover capex expenditures and higher interest rates. Production grew 11.3% year-on-year to 2.56 billion Sk, and sales of own goods and services increased 18.9% to 2.54 billion Sk.

The new state administration has already declared that it is going to investigate and subsequently revise privatisation decisions where state interests were damaged. As a flagship example of Mečiar's privatisation methods, Nafta is likely to become a case in point. Hence, ownership relations in the company will be uncertain until the investigation is over.

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