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FOREX MARKETS

Big issue: How long will Finance Ministry accept high yields?

The Slovak money and foreign exchange markets were influenced mostly by very high interest rates which hovered between 24-27 percent for the past two weeks on the interbank market.
The main event is the Finance Ministry's continuing difficulties refinancing the budget deficit due to the money market's liquidity shortage and the National Bank of Slovakia's (NBS) strict monetary policy.
The question now is whether the ministry will continue to accept very high yields in auctions of T-bills and state bonds. At recent auctions, the ministry accepted yields up to 26 percent, which is the major reason why local interbank rates are so high.

The Slovak money and foreign exchange markets were influenced mostly by very high interest rates which hovered between 24-27 percent for the past two weeks on the interbank market.

The main event is the Finance Ministry's continuing difficulties refinancing the budget deficit due to the money market's liquidity shortage and the National Bank of Slovakia's (NBS) strict monetary policy.

The question now is whether the ministry will continue to accept very high yields in auctions of T-bills and state bonds. At recent auctions, the ministry accepted yields up to 26 percent, which is the major reason why local interbank rates are so high.

The ministry organized an auction of 273-days T-bills on September 24. Bids worth 1.8 billion Slovak crowns (Sk) were snapped up out of total demand of 4.04 billion Sk, with an accepted maximum yield of 26 percent (average 25.03).

This did not quench the state budget's appetite, though, so the ministry quickly organized another auction of 4-week T-bills, on which it accepted yields up to 27 percent.

Only a few days remained to the NBS-set deadline for commercial banks to fulfill the minimum reserves requirement (PMR), when the ministry drained out 4.683 billion Sk from the sector, pushing rates in the shortest periods to 27-30 percent. The high interest rates boosted banks' appetite for crown purchasing, so the crown slowly came closer to its parity level of 1.0000 on the Slovak currency's basket index.

In all, the Slovak crown gained more than one percent during the past two weeks and approached levels close to parity. However, reaching that parity seems to be too tough. Now it depends on whether the NBS will move the fixing to the appreciation side of the dollar-mark basket band or keep the parity level untouched.

The latter would mean the NBS does not want the crown to firm further. Over the past week, NBS fixings kept around basket parity. While most traders believe that the crown's appreciation is only short-term, they do not expect a radical weakening in the near future either, since high interbank rates will support the currency.

On October 1, a new auction of 182-day-long T-bills was held. It was the first Dutch-style auction organized in a long time, but had no impact on yields demanded by commercial banks. The ministry said it rejected all bids due to the unacceptably high yields banks were demanding at the sale.

The money market at that point was over-liquid due to some T-bills' maturity, but bids in auction totalled only 1.608 billion Sk. This showed again that Slovak commercial banks have started to heavily protect their longer fund resources, indicating that even a half-year T-bill is too long for them.

The scenario repeated the next day when the ministry organized another auction of 4-week T-bills.

In another Dutch-style auction, they satisfied bids worth 1.53 billion Sk on a 4.11-billion Sk total demand and a 26 percent yield. Interest rates eased to 20 percent for one-day deals and 22-24 percent for longer spreads.

On September 25, the NBS, which conducts auctions of state securities, published a long schedule of T-bills and state bonds planned for the rest of the year. Meanwhile, the 1997 budget gap widened to 27.9 billion Sk as of September 30, up by 10 billion Sk from a 17.983-billion deficit as of August 25, the Finance Ministry said in a statement on October 2. We think the ministry may encounter even bigger problems with refinancing the budget deficit in the coming months.

The measure allowing domestic companies to buy state securities is designed to help. It will widen the corporate market for deficit patching, but it's hard to say whether this will cause the yields at primary auctions of state papers to drop. One thing's for sure, though: these high rates will make it even more difficult to project next year's budget. The 1997 budget originally expected the deficit would be refinanced at an interest rate of some nine percent.

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