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CROWN GAINS MAY NECESSITATE HEDGING

Currency seesaw muddles accounting

THE STRENGTHENING crown is keeping money market analysts busy with predictions about the development of the SKK-EUR exchange rate.
The National Bank of Slovakia (NBS) has not yet "disciplined" the crown by pushing down interest rates; instead, it has merely moderated the mighty crown by refusing to withdraw superfluous money from the market.

THE STRENGTHENING crown is keeping money market analysts busy with predictions about the development of the SKK-EUR exchange rate.

The National Bank of Slovakia (NBS) has not yet "disciplined" the crown by pushing down interest rates; instead, it has merely moderated the mighty crown by refusing to withdraw superfluous money from the market.

The central bank, however, still considers the crown's current firming as disproportionate to the strength of the Slovak economy, and is willing to use other available tools if the crown rises further.

"The NBS is dissatisfied with the crown's development, as it has firmed by 1.9 percent since the beginning of 2005," the bank's statement says.

The crown's steady surge against the euro opened the door for speculation that the continued appreciation could curb the value of the €840 million that Italian Enel is paying for the purchase of a 66-percent share in power utility Slovenské elektrárne.

The daily SME claimed that the value of Enel's offer has dropped by Sk1.7 billion (€43.8 million) because of the crown's development.

However, the Finance Ministry says that SME has misrepresented the facts.

"Currently, no exchange rate losses have been reported, as the state has a reverse foreign exchange position open. Any SKK-EUR exchange rate movement loss on one side is compensated by gains on the other," advisor to the Finance Minister, Peter Papanek, told The Slovak Spectator.

According to Papanek, the Finance Ministry has been monitoring potential exchange rate risks regarding the Slovenské elektrárne sale since the power utility tender outcome was announced. To this end, the ministry has been working with the Debt and Liquidity Management Agency (ARDAL).

ARDAL uses a financial risk-deterrent measure called hedging. According to Papanek, hedging and subsequent crown non-conversion will be used to pay down the total volume of Slovak euro obligations, which currently exceeds €2 billion.

The Economy Ministry does not fear eventual losses either. Spokesman for the Economy Ministry, Maroš Havran, told The Slovak Spectator that his ministry and the Finance Ministry discussed whether it was necessary to insure the deal against the currency loss.

"We have state bonds denominated in euro worth €750 million that are maturing in May. These bonds are a natural protection against exchange rate losses until May," Havran told The Slovak Spectator.

Havran says that in May, the Economy Ministry will have a clearer idea on when the Slovenské elektrárne transaction will be concluded, and when Enel will pay the whole sum owed.

"After signing the transaction documents, 30 percent of the sum will be allocated to the account of the National Bank of Slovakia. The whole sum will be allocated only after the completion of the whole transaction. In May, it will become clear when the deal will close - whether in August or at the end of the year" said Havran.

He said that the state would decide in May whether to insure itself against potential exchange rate losses.

As for privatization receipts and potential Forex losses due to crown appreciation, the state will have a harder time securing itself against losses, says VŮB Chief Analyst Zdenko Štefanides.

"To hedge Forex privatization, one has to know when the payments will actually arrive. The way I understand it, this is difficult to foresee in privatization deals. Hedging may be an expensive exercise, especially given the present one-way movement of the Slovak currency (and indeed for all the currencies in the Visegrad Four region).

"Put simply, to hedge against crown appreciation you have to find a counter party, someone who does not believe the crown will continue to appreciate. Such people - investors or market participants - are increasingly difficult to find. Indeed, note that forward Forex rates on the Slovak crown have recently collapsed," Štefanides said.

According to him, the possibility of the state finding a counter party to hedge such a large sum seems next to impossible.

"The Slovak Forex market is too small for deals like Enel-Slovenské elektrárne, and the Forex forward/options market is even smaller."

Štefanides thinks that one option in the Enel-Slovenské elektrárne deal could have been to ask Enel to pay for its stake in Slovenské elektrárne directly in crowns.

"In this case, it would have to be the buyer who hedges the exposure. However, the buyer would surely go through the market, thus further strengthening the appreciation pressure on the crown. If they pay in euros, the state would convert the euros to crowns with the central bank, thus bypassing the market and potentially alleviating undue appreciation pressure," he added.

Documents on the sale of the 66-percent stake in Slovenské elektrárne should be signed February 17. The Slovak cabinet is expected to give their final approval to the privatization deal February 16.

After signing the documents, the investor will transfer 30 percent of the purchase price, or €252 million, to the Slovak state's coffers. The remaining €588 million will be paid after all contract conditions are met.

Altogether, Enel will pay €840 million (Sk32.8 billion) for the stake in Slovenské elektrárne.

The time between signing the agreement with the investor and actual payment can be stretched to as long as six months.

In the past, the state lost considerable sums due to exchange rate fluctuations. On the sale of gas utility Slovenský plynárenský priemysel, for example, the state lost billions of crowns. In mid-January, Enel agreed to the wording of the contract that would give it a 66-percent stake in Slovenské elektrárne. The Slovak government expects Enel to submit an investment plan by the end of June that would include a sum that the power company intends to invest in Slovakia in the upcoming years.


(Magdalena MacLeod contributed to the report)

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