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Central bank weighs whether to depreciate the crown

Tailing strong downward pressure on the Czech crown, the Slovak currency experienced a similar attack in mid-May. The National Bank of Slovakia (NBS) managed to defend the crown (SKK) against foreign speculators. The question remains whether it can defend it against the bullish trade deficit. After all, it was this indicator that invited foreign speculators to gamble with the crown in the first place. NBS officials admit that if the deficit doesn't improve soon, the central bank will have to let the crown slide within its fluctuation band and perhaps even let it flow like its Czech counterpart.
In May, the NBS sustained the most massive attack on the currency in its short history. Foreigners borrowed the crown for BRIBOR (Bratislava Interbank Offered Rate), changed it into hard currencies and waited for the crown's depreciation to change it back. A wave of trading left domestic banks without crowns, which they expected to get from the NBS. The central bank refused to sponsor such an attack on its currency and temporarily abolished REPO refinancing.

Tailing strong downward pressure on the Czech crown, the Slovak currency experienced a similar attack in mid-May. The National Bank of Slovakia (NBS) managed to defend the crown (SKK) against foreign speculators. The question remains whether it can defend it against the bullish trade deficit. After all, it was this indicator that invited foreign speculators to gamble with the crown in the first place. NBS officials admit that if the deficit doesn't improve soon, the central bank will have to let the crown slide within its fluctuation band and perhaps even let it flow like its Czech counterpart.

In May, the NBS sustained the most massive attack on the currency in its short history. Foreigners borrowed the crown for BRIBOR (Bratislava Interbank Offered Rate), changed it into hard currencies and waited for the crown's depreciation to change it back. A wave of trading left domestic banks without crowns, which they expected to get from the NBS. The central bank refused to sponsor such an attack on its currency and temporarily abolished REPO refinancing. As a result, BRIBOR rates skyrocketed and the BRIBOR quoting mechanism collapsed, with the last official deposit rate announced on May 28.

The crown was offered for 1,000% p.a. Since speculators would have had to pay 2.7% a day, the expected depreciation would not have brought them any more profits. The sales of SKK into hard currencies therefore ceased. The NBS also supported the crown with indirect purchases of SKK through fixing, helping the exchange rate, which approached the edge of the 7% fluctuation band several times.

At this point, several foreign banks bought back the crown, pushing it towards its central parity. Despite high volatility on the interbank currency market, the NBS stubbornly fixed the crown for several days at 0.67% on the fluctuation margin's depreciation side. Ultimately, speculators began closing their short crown positions with losses and returned some of the hard currency. On June 4, the country's forex reserves totaled $4.85 billion and on July 2, they reached its 1997 high of $5.78 billion.

Other foreign players were attracted by high deposit rates. Seeing the NBS's commitment to keep the SKK exchange rate stable, they began buying the crown, depositing it and enjoying a wide interest rate differential between LIBOR and the Slovak rates.

The NBS has received a lot of praise for defending the crown against depreciation. Ironically enough, now that the danger is over, the NBS may let the crown slip after all, with the knowledge that it was not forced to do it but did so willingly. The country's trade deficit indicates that this is a measure worth considering.

In 1996, the trade deficit hit 64.54 billion Sk, or 11.1% of GDP. The NBS's 1997 target is 5%, but the 1Q97 showed a figure matching the 1996 level. Moreover, in the 2Q97 the deficit widened significantly, amounting to 29.859 billion Sk for the first five months of the year.

For this period, 27.9% of Slovakia's exports and 23.3% of its imports were traded with the Czech Republic. With its depreciation, the Czech crown slid by 10% in relation to its Slovak twin. This shift can easily add another 2.5 billion Sk weight to the already obese trade deficit by the end of the year.

Depreciation may not be the best solution. One reason is Slovakia's import-intensive production, which adds only meager value to exported products. Therefore, depreciation would help the trade balance only marginally, but it would help whip up domestic companies' efforts to manufacture more competitive products, a capacity essential for ultimately erasing the trade deficit.

Together with other measures to support exports and lower imports, depreciation could be effective. Currently, the cabinet is preparing a package of such measures, including wage regulations, budget cuts, excise tax raises, and energy and transportation cost increases. Slovakia has introduced import deposits, copying the Czech protectionist move, and the attack on the crown further helped to restrict loan provision, a target the NBS has been aiming for over the past year.

Unfortunately, all these tools strangle consumption and lower imports, while neglecting the export side, where the desired effect of the recently established Exim bank and the export fund have not been reached.

How soon these measures bring the desired effects is critical. NBS officials have declared that if the current situation persists, they will have to let the crown slide in the fluctuation band and perhaps even let it flow.

Andrej Čop is an analyst at Slávia Capital brokerage firm, tel. +421-7-396-448.

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