One year after an emerging market currency crisis hit the Slovak crown and sent it into sharp decline, the Slovak currency has suffered another blow, this time from the Russian financial crisis. Over the last two weeks, the Russian malaise spread across the region and prompted nervous foreign investors to leave risky emerging markets.
The crown, which is pegged to a 60%-mark/40%-dollar currency basket, weakened by more than 2.0% against the midpoint, repeatedly falling to its year-low level of 5.5% on the depreciation side of the plus/minus 7.0% fluctuation band around the basket parity. But many traders remained cautiously optimistic about the Slovak crown's fate.
"The central bank controls the crown situation," said a foreign exchange dealer at a big international bank who declined to be named. "There have been renewed signs of some crown buying by foreign investors, as they now seem to believe again that the crown will not get outside the fluctuation band. It may be difficult [for the crown] to be strengthened significantly, but it should not fall rapidly either."
But other traders warned that the crown would probably remain sensitive to outside factors for some time to come, and could depreciate if the situation in Russia deteriorated further. "A lot now depends on what happens in Russia and subsequently on other emerging markets," said Jozef Petrovic, Tatra Banka's senior dealer.
The Russian financial crisis had been building steadily over the past few months amid concerns that Moscow would encounter problems repaying its obligations to foreign investors. Events came to a head on August 17 when Russian authorities announced a de facto devaluation of the ruble and imposed a 90-day moratorium on repayment of the principals of some foreign debts. Interest on these debts was also supposed to be paid according to schedule, but some Russian banks may prove unable to meet even their interest payments, and default as a result.
In the wake of the crisis, a massive outflow of foreign investors from emerging markets to the safe haven of US dollars sent tremors across central and eastern Europe, plunging most regional currencies into a sharp decline.
"The impetus for the Slovak crown depreciation was the escalation of tensions on Russian markets," said Branislav Matušek, a foreign exchange dealer at Slovakia's largest bank Slovenská Sporitelňa. "We saw a big wave of foreign investors closing their positions on other emerging markets. The Polish zloty fell more than 9%, and the Czech crown weakened sharply as well."
Foreign investors that held large positions in Slovak crowns and crown-denominated government bonds used low interbank interest rates to borrow crown funds on the money market, which they subsequently exchanged for hard currencies to close their Slovak positions. Market sources said one foreign bank had sold more than 30 million dollars worth of crowns to close its government bond positions. Since liquidity on the Slovak market is much lower than on neighboring markets, similar deals often represent strong impulses for significant crown moves.
The National Bank of Slovakia (NBS) stepped into the interbank market on August 20 and 21 and supported its ailing crown currency by setting the daily fixing stronger than market levels - both days at minus 4.5% against the midpoint. NBS officials said the stronger fixing was aimed at slowing down the crown's depreciation since the central bank saw signals of a possible further weakening .
Although the present decline has been as sharp as the fall the crown experienced during the world currency crisis a year ago, one significant aspect is different: the crown is not suffering from speculative short-selling. "Speculative selling is not here at present. Foreigners are just closing their positions by selling crowns they have deposited," Matušek said.
When foreign exchange speculators feel that some currency is vulnerable to outside attack and expect a depreciation, they borrow local funds heavily and sell them against hard currencies to pick up profits when the local currency devalues. This short-selling was a strong factor behind last year's currency crisis on emerging markets across the world.
NBS vice-governor Marián Jusko said earlier this month that he did not expect pressure on the Slovak crown from a sudden outflow of foreign investors. Foreign exchange dealers said they expected a period of crown stabilisation in the coming days, after the central bank made it clear that it was determined to keep the currency within the current fluctuation band.
Although the run-up to elections often creates the potential for pressure on the currency, especially when the outcome of the polls is uncertain, traders said any strong run on the Slovak crown is not likely before September's general elections since the central bank appears to be holding the crown situation in its hands. With hard currency reserves of 3.74 billion dollars and tight control over the money market, they said, the NBS should have enough weapons to fend off any potential speculators.