Trading on the Slovak foreign exchange and money markets was heavily influenced by the situation in the Czech Republic during the past two weeks, which resulted in constant downward pressure being applied to the Slovak crown (Sk) since May 19.
The central bank intervened by fixing the slovak currency throughout the May 19 week at the index 1,0078 in an attempt to keep the Sk from weakening further. One impact of this action was that it opened up the possibility for commercial banks to buy foreign currencies at below-market rates. Another impact was that dealers, uncertain about the future, only gave quotes for relatively small amounts and with wider spreads.
The central bank's battle with the Sk had direct repercussions on the money market.
It is estimated that Slovak commercial banks bought about $500 mln, creating a shortage of SK in the market. In an attempt to keep interest rates high, the national bank limited its refinancing through repo tenders. The Situation worsened through May 22, truly a black day for the Slovak market.
After that, NBS decided to refinance the banking sector with 3.5 bln Sk, which was still less than the 5 bln Sk the banking sector needed to meet their average minimum reserve requirements (PMR) for the May 16-31 period.
The dire situation brewing in the Czech Republic gave traders no reason for optimism here, as short-term interest rates jumped from 100 to 500 percent. This caused the market to panic, as short-term interest rates shot up to 43-48% for one-day deposits, 43-44% for one-week and 40-41% for two-week deposits. The upswing was also cause by the central bank's penalties for banks' failure to meet their PMR, which is three times the discount rate of 8.8 percent or 26.4%, equivalent to an after-tax rate of 44%.
After the deposit rates shot up, the reference banks stopped quoting for deposits and the market became illiquid. Only a few banks were willing to quote, giving wide spreads of more than 20%. A few foreign banks speculated against the Sk, offering 200-300 percent for short-term Sk deposits.
Reference banks decided after a hastily-organized meeting to quit offering Sk deposits to foreign speculators, who would have been able to use these funds to speculate against the Slovak currency. The banks also decided to penalize foreign banks that had negative Sk holdings with a 1,000 percent fee on their debit balance, forcing them to close their positions by selling foreign currencies.
On the foreign exchange market, Slovak banks decided to quote in amounts of $1 mln or 1.5 mln DEM or less, with a 10 haller spread. Since May 22, the NBS halted refinancing the Slovak banking sector by repo tenders.
On May 26, the board of the Czech National Bank decided to allow the Czech crown (Kč) to float freely, cancelling the DEM/USD exchange-rate basket mechanism that had controlled the Kč's rate for the past several years. The Czech bank increased the discount rate to 13% from 10.5% and left the Lombard rate, set two weeks ago, at 50%.
It also decided to monitor the development of the relationship between the Kč and the German mark. The next day, Kč trading was hectic as it weakened to 12.5% below the previously-set parity, a decline in value of more than 8% in the space of just a few hours.
The Czech National Bank fixed the Kč at the market level, 19.500 CZK/1 DEM and 33.082 CZK/ 1 USD. Here in Bratislava, there was concern that the same developments could take place on the Slovak financial markets, so the market index increased to 1.0800, a weakening the Sk by more than 5%. The NBS fixed the basket index at 1.0067, the same as on May 19, again selling foreign currency low on the market.
At the reference banks' next meeting on May 28, they decided to stop setting the BRIBOR, deciding instead only to provide certain indicative rates.
The Sk continued to fluctuate between 1.0550-1.0700, right at the border of the devaluation range. Throughout the second week, the NBS fixed the index at 1.0067, and the Sk gradually strengthened until on Friday May 31 the market rate reached 1.0150.
The future for Slovak financial markets is unclear at the moment and will remain so until what the NBS will do. We expect that the central bank will not ease its monetary policy, and that it will keep interest rates high to support the Slovak crown.
According to NBS representatives, it is possible to maintain the crown at this rate, as long as the government adheres to a strict monetary policy. The NBS insists it has adequate foreign currency reserves to carry its policy out and many believe that a foreign central bank is prepared to assist.
From January to April, the foreign trade deficit increased to 27.9 bln Sk. To protect the crown, it is necessary to stop this trend. Starting on June 1, the banking sector begins a period in which banks hold only 69% of the reserves level required by the NBS, which translates to a deficit of 12.2 blnSk. There are political pressures to maintain the Sk's strength. It will be very difficult for the NBS, however, to maintain this level, because in this atmosphere of economic and political uncertainty, we cannot expect an inflow of foreign investments. Nor can we expect to renew currency dealers' trust in the Sk after recent events in the Czech Republic.
Prepared by Braňo Matušek and Oto Mohňanský from the dealing department at Slovenská Sporiteľňa a.s., Bratislava
5. Jun 1997 at 0:00