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CAPITAL MARKETS

SAX continues tumble amid currency fall

The most important event of the first week of October was a change of the fixed foreign exchange rate regime into a floating regime. Immediately after the NBS canceled the fluctuation band, the koruna reacted by weakening to 16% below the former parity due to the perception of market participants that the currency had been overvalued.
Problems with financing the budget deficit, the persistently high current account deficit (11% of GDP in 1H98) and the growing indebtedness of the public sector had fuelled depreciation expectations.
Following the change in the currency regime, trading on the equity market was extremely cautious and the SAX experienced a new all-time low of 98.22 on October 2. Later the market continued a downward movement and the index dipped to 95.98.

The most important event of the first week of October was a change of the fixed foreign exchange rate regime into a floating regime. Immediately after the NBS canceled the fluctuation band, the koruna reacted by weakening to 16% below the former parity due to the perception of market participants that the currency had been overvalued.

Problems with financing the budget deficit, the persistently high current account deficit (11% of GDP in 1H98) and the growing indebtedness of the public sector had fuelled depreciation expectations.

Following the change in the currency regime, trading on the equity market was extremely cautious and the SAX experienced a new all-time low of 98.22 on October 2. Later the market continued a downward movement and the index dipped to 95.98. These developments can be attributed to uncertainty about future koruna development, persisting political uncertainty and the adverse affect of currency depreciation on companies with forex denominated debts.

Investors currently show very little interest in Slovak assets because of a lack of transparency and liquidity on the market, inadequate legislation enforcement as well as crises on global financial markets. Disappointments from the Asian and Russian meltdowns, together with uncertainty about the potential damage inflicted upon developed economies, have created a pessimistic sentiment among investors. These will focus on capital preservation rather than capital appreciation in the short-term and hence will stay away from assets with any stigma of risk. A Slovak market recovery is thus unlikely in the short run, and any capital market reform enforced by the new government will improve market sentiment only in the mid term horizon.

Slovakia will most likely have a provisional budget at the beginning of 1999. The government is obliged to submit a budget draft to the Parliament by 15 November, but a new government formed by the current opposition will not meet this deadline. According to Brigita Schmögnerová, an economic expert with the former opposition SDĽ party, 1998's fiscal budget deficit will be 20 billion Sk ($555 million), instead of the planned 8 billion Sk. The reasons for not meeting the target are lower revenues from VAT and excise taxes, as well as pressures on the expenditure side.

Industrial production surged 9.1% year-on-year in August. Real industrial wages increased only 2.1% while labour productivity growth reached 9.9% year-on-year in the same period. However, industrial growth is unevenly distributed, with those sectors which received significant FDI (such as the automobile industry and TV production) contributing most of the growth.

Other industries, especially those producing semi-finished products, are coping with fierce competition from Asia, Russia and ex-CIS countries, and are finding it increasingly difficult to secure financing. Their export sales are stagnating or declining, and their fundamental problems, along with the fiscal tightening that will reduce domestic demand, will be the primary forces behind the expected economic slowdown in 1999.

Slovakofarma posted sales of 2.875 billion Sk ($80 million) for the first nine months of 1998, of which 36% went to domestic customers. Depreciation of the Slovak crown will have a positive impact on the company due to its high export exposure (65%), while imported inputs do not exceed 35% of sales. The secondary insolvency in the health care sector, with its large amount of overdue receivables, remains a major problem. Slovnaft will face a forex loss at the end of 1998 due to its debts denominated in foreign currencies. However, thanks to its ability to raise prices on the domestic market and given its export exposure (50% of sales) Slovnaft should partially compensate for these forex losses.


Tomaš Kvet and Vladimír Zlacký are equity analysts for ING Barings

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