As the high level of deposit rates on Slovakia's interbank market continues to lure short-term investors, officials at the country's central bank, the National Bank of Slovakia (NBS), have come up with a measure they hope will keep the embattled crown viable over the long run. Perhaps surprisingly, NBS officials decided to expose the crown to higher volatility in an attempt to shake the tree of speculative investors, so that only the serious ones nest in the branches. Market analysts seemed to endorse the move, saying they don't expect this mild tremor to uproot the tree by threatening the crown's stability.
The main reason why investors are streaming onto the Slovak currency market lately is due to the lure of big profits in the wake of the central bank's cancelling of the repo and reverse repo rates, which caused the interbank rates to go haywire. "Investors are looking at the interest rate differential," said Miroslav Nespala, a dealer at Československá Obchodná Banka.
What these investors are doing is borrowing free exchangeable currency for LIBOR (London Interbank Offered Rate) and trading it for the Slovak crown which they deposit in commercial banks for BRIBOR (Bratislava Interbank Offered Rate), Nespala explained. In return, they receive a high interest rate differential between the two rates. At peak days during the BRIBOR's rollercoaster ride in January, the differential amounted to 23 percent p.a.
Capitalizing on such favorable conditions, foreign investors in January pumped in between $250-$300 million. This stash stayed only a few days, however, and left as soon as the crown appreciated.
But interest rate differential isn't the only reason for foreign investors to come. "Foreigners open positions [also] because they expect the crown to appreciate," Peter Koprna, a foreign exchange dealer at Slovenská Sporiteľňa.
The NBS watched this development with more and more consternation, though, because, as Nespala explained, "foreign investors' profits put pressure on the hard currency reserves."
To alleviate this pressure and diminish speculative activities, the NBS allowed the crown to flow more freely within its prescribed fluctuation margin of +-7 percent. On February 18, the NBS fixed the crown well on the devaluation side of the deviation range, setting the exchange rate at 33.502 Sk per USD, thus implying a 3.4% month-to-month depreciation. Exactly a week later, central bank officials posted the crown back towards its midpoint, setting the exchange rate at 32.891 Sk per USD.
"We began to move the crown more than investors expected," explained František Szulényi, director of NBS's treasury department. "Last year, NBS used only 1.5 percent of the fixing spread to parity while this year it is 3 percent already. If that doesn't turn out to be effective enough, the central bank is willing to use the current +-7% fluctuation band even more flexibly."
Higher crown volatility is not the ultimate obstacle to speculative foreign capital, said Tim Stephens, a deputy treasurer at Tatra Banka. "The majority of incomers stay from a day to a week, and therefore, the currency risk is not so big," he said. On the other hand, a more volatile crown "makes it hard for businesses to predict the future," Stephens continued. "It creates extra risks."
He is not alone to think so. "The NBS is capricious," Koprna said about the national bank's pegging of the exchange rate. "Sometimes it moves [in accord] with the interbank market, sometimes it turns in the opposite direction," he explained.
Nevertheless, Koprna is sure that the currency tree will not be uprooted by newcomers to the market, because enough traditional investors are opening positions with longer maturities, thus expressing their belief in the crown. "Such behavior is very positive," Koprna said. "The Slovak crown gains credibility and the market [gains] liquidity."
According to the NBS's Szulényi, the greater currency risk also makes it harder for domestic entities to borrow from abroad, which is right in line with the central bank's policy to tame the M2 money supply aggregate. That may fortify the crown even further.
But in the long run, many see the crown lower than today. "On the crown, there is more pressure pushing down than pulling up," Stephens said. "The question is how far down will it go." "At present, we forecast the crown to weaken gradually to around four percent cheap in its [fluctuation] band this year," according to an analysis by the international investment bank Merrill Lynch carried by Reuters.
Merrill Lynch representatives justified their predictions by pointing to Slovakia's burgeoning trade deficit, which in January stood at 7.061 billion Sk - compared to 2.125 billion Sk for the same period last year.
But most dealers do not expect an official devaluation move anytime soon. "I am sure the crown will not break the boundaries of its fluctuation band," Nespala said.
13. Mar 1997 at 0:00 | Andrej Čop