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WHILE THE CENTRAL BANK THINKS THE STRONG CROWN IS THE RESULT OF SPECULATION, ANALYSTS SEE THE GROWING ECONOMY BEHIND ITS RISE

The NBS takes on a windmill

THE NATIONAL Bank of Slovakia thinks the Slovak crown is too strong and would like to take some strength out of the currency.
Despite the central bank decreasing its key interest rates, which was supposed to stop the currency from strengthening, the crown was remained buoyant and climbed to even stronger numbers.
The central bank says the stronger crown is only a result of financial market speculation and could harm Slovak companies through their more expensive exports.

THE NATIONAL Bank of Slovakia thinks the Slovak crown is too strong and would like to take some strength out of the currency.

Despite the central bank decreasing its key interest rates, which was supposed to stop the currency from strengthening, the crown was remained buoyant and climbed to even stronger numbers.

The central bank says the stronger crown is only a result of financial market speculation and could harm Slovak companies through their more expensive exports.

However, some analysts think that the crown's value is based on the good performance of the Slovak economy, and further efforts by the national bank to stop the strengthening process could be in vain.

"The National Bank of Slovakia (NBS) does not consider this pace of strengthening [of the crown] adequate to the state of the economy and will judge the use of all available measures to stop that process [of the strengthening]," Igor Barát, the spokesman of the NBS, told The Slovak Spectator.

At the end of June, before the central bank lowered its key interest rates, the Slovak crown stood at Sk39.90 - 40.00 per euro. On June 30, the NBS decreased its key interest rates by 0.5 percentage points. It was the third key interest rate cut this year.

The overnight sterilisation rate is now set at 3.00 percent, overnight refinancing rate at 6.00 percent, and the two-week REPO tender limit rate is set at 4.50 percent.

The Slovak key two week interest rates became higher by only 2.5 percentage points compared to those in the euro zone. The interest rate differential has thus lowered, which should, in theory, make the crown less attractive for investors.

Paradoxically, after the measure was adopted, the demand for Slovak crowns continued to rise and its exchange rate lowered to Sk39.75 per euro, creating the new record high of the Slovak currency against the euro.

"We evaluate this as the first reaction [of the market], we will see the development in forthcoming days. We will assess it and adopt adequate decisions," Marián Jusko, the NBS governor, told the press.

Analysts point out that the interest rates are only one factor influencing the movement of the currency. They also emphasise the need to take into consideration the role of the economy, which has been recording significantly favourable performance.

According to them, the fact that the crown did not weaken after the key interest rates were cut is evidence that it is also the economy, and not only speculation, that supports the strong crown. If the central bank wanted to use cuts in interest rates to stop the crown, it probably should have decreased the rates by more than just the 0.5 percentage point.

"The National bank announced its intention to cut the interest rates a week before it actually did so. In the meantime, the money market lowered all market interest rates by about one percent. Apparently, the market expected a larger cut. In light of this, the 0.5 percentage point cut did not weaken the crown," said Mário Blaščák, analyst with Ľudová banka.

He also thinks that economic growth, standing at 5.5 percent, along with other favourable indicators of Slovakia's economy, support the belief that the crown will strengthen in the long term in spite of the lower interest rate differential.

Marek Gábriš, an analyst with ČSOB, added that it was very difficult to imagine the currency doing anything other than strengthening when "Slovakia has a solid economic growth, improving fiscal position, excellent export results, a surplus of the current account and an increasing volume of foreign direct investments."

"Among all the figures, it would be difficult to find even one which would indicate that the crown should not be strong," said Juraj Kotian, an analyst with Slovenská sporiteľňa bank.

"Apart from GDP growth and the favourable current account, the unit costs are the lowest in the region yet, at the same time, productivity is growing the fastest in the region. Slovakia attracts the largest investments in the region. Together with EU funds, it will hold the balance of payments as surplus in 5 years. Sooner or later the resistance of the NBS will be broken," he added.

Slovak exporters are those who would, for certain, welcome a weaker crown. The strong crown makes the goods they sell abroad more expensive and thus less competitive on foreign markets. Slovak producers also may feel negative impacts as they will have to face cheaper imports.

Tibor Gregor, the executive director of Klub 500, an association of Slovak companies, told the Národná obroda daily that the strengthening crown was not based on the efficiency of the Slovak economy but only on the positive expectations of investors. He emphasised that the strong crown decreases the revenues of Slovak exporters.

However, some analysts add that according to the latest data, Slovak exports post very favourable results. They show 30 percent year-on-year increases despite the strong crown, which reached historical maximum levels for a long period this year.

"Labour productivity in the Slovak industry reaches, on average, approximately 60 percent of the EU15 level. The overall labour costs represent only 20 percent of the EU15 average. A strengthening currency might lower the competitiveness of the Slovak economy, but the competitive advantage of low costs will still be significant in Slovakia," said Kotian.

In light of strong exports, Gábriš believes that the strong crown is justified, and that stopping this process could weaken the pressure on some industries to restructurise and modernise. "The only way of surviving is by increasing productivity, not by creating a pillow to intervene against the strengthening crown," he said.

Additionally, efforts of the NBS to hold the crown at artificially weak levels could in actuality have negative impacts on the economy. A weaker crown could lower the purchasing power of inhabitants and make imports of investments (new technologies, equipment) more expensive. Easing monetary policy through interest rate cuts can also increase inflation, slow down the salary convergence to EU levels, and devaluate people's savings.

However, the analysts agree that the process of further strengthening of the crown is natural and will continue. Only an unexpectedly poor performance by the economy or a political crisis could change the situation to negatively impact the crown.

"The central bank has very limited possibilities for correcting or even reversing the development. Interest rate cuts or direct interventions have their costs and now there lies the question as to whether or not the costs of this monetary policy are at least partially justified," said Kotian.

"The market expectations will finally beat the central bank. If the economic outlook of the country is positive, no matter what the interest rate differential will be - whether 3.5 or 5.5 percent - traders will be interested in buying Slovak crowns," added Blaščák.

"There are countries like Poland or Hungary where the interest rates are higher and are much more attractive for speculators. However, I think that there is no other country in the region with such a favourable economic outlook as Slovakia," he continued.

According to analysts, the exchange rate of the Slovak crown could reach Sk39.50 per euro by the end of the year provided the economic outlook of the country does not change.

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