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THE SLOVAK CURRENCY’S APPARENTLY INEXORABLE RISE

Euro euphoria feeds the crown

THE SLOVAK currency has been riding a wave of euphoria over the past two weeks, hitting new highs against the euro almost every day.

THE SLOVAK currency has been riding a wave of euphoria over the past two weeks, hitting new highs against the euro almost every day.

Its performance has been fuelled by the European Commission’s approval of Slovakia to enter the eurozone, and Slovak Prime Minister Robert Fico’s call for the strongest possible conversion rate.
On May 14, the Slovak crown traded at Sk31.61 to the euro, with market watchers predicting that the currency is likely to strengthen further.

“The position of the Slovak government is unambiguous: the strongest possible exchange rate,” Fico told the public service broadcaster Slovak Television (STV) on May 12.

The prime minister said the government wants Slovaks to pay the least possible number of Slovak crowns for each euro, and trade unions have joined Fico in his campaign for a strong conversion rate.

Anything under Sk32 will be positive, President of the Confederation of Trade Unions (KOZ) Miroslav Gazdík told STV.

Speculation about the possible level of the conversion rate has provided a fillip to the crown, Viliam Pätoprstý chief analyst with the UniCredit Bank told The Slovak Spectator.

“The positive evaluation of Slovakia by the European Commission has set off a wave of appreciation in the value of the Slovak crown,” Juraj Valachy, analyst with Tatra Banka, told The Slovak Spectator.

The first strong boost came in late April when the European Commission published its spring macro-economic forecast, erasing concerns about the sustainability of the inflation and fiscal criteria in Slovakia, said VÚB Bank analyst Martin Lenko.

This moved the crown up to a new maximum of Sk32.17 to the euro on April 28, Lenko told The Slovak Spectator.

By May 5, two days before publication of the European Commission report, the crown had started gaining more strength since the media had already begun speculating about EC approval, said Valachy.

“What came as an even stronger impulse was the publishing of the EC convergence report itself, which, on May 7, confirmed that Slovakia had met all the Maastricht criteria to adopt the euro,” Lenko told The Slovak Spectator.

The report, and Fico’s subsequent comments about his intention to achieve the strongest possible conversion rate, contributed to the Slovak crown further strengthening against the euro, by 1.5 percent over the next four days, reaching a new high of Sk31.61, Lenko added.

“The strengthening was also fuelled by the silence of the National Bank of Slovakia, which in fact gave a greenlight to him [Fico],” said Valachy.

Favourable conditions on international markets - along with the Slovak crown, the whole region is strengthening - also support this development, Valachy added.

The analysts said that it is difficult to guess the limits of the Slovak crown on the short-term horizon, but political statements do have the potential to push the crown further up.
“The market will react sensitively to any further comments by the government or the central bank,” said Lenko.

Even given the strong levels at which the Slovak crown is trading against the euro now, if the government repeats its interest in the strongest possible fixed rate, there is still potential for the Slovak crown to strengthen further, according to Lenko.

“Probably we will see some new records broken,” Valachy added.

Strong or stronger is the question for conversion rate

In the light of current developments in the exchange rate market and the prime minister’s public statements, Valachy sees a growing chance that the conversion rate will be set at Sk32.00 to the euro. Pätoprstý said that the market exchange rate, and subsequently the conversion rate, could be in the band of Sk31-31.5 per euro.

“However, there is a possibility that the conversion rate will be just under Sk31.0,” Pätoprstý said.

It is important to see whether future development of the economy will be considered when setting the conversion rate. If it is, the rate should probably be stronger, said Lenko. However, if the current state of economy is used to judge to set the rate, it will be set at the so-called current equilibrium exchange rate, said Lenko.

“In fact, the current exchange rate, at Sk31.70 per euro, already incorporates expectations of the future development of the economy,” Lenko said, adding future developments should thus be included.
However, according to Lenko, experience of other countries that have adopted the euro suggests that the rates abroad were set without including future development expectations for national economies.
If the future development of the Slovak economy is not included, Lenko estimates the conversion rate would stand at Sk33 to one euro, or in a range of Sk32.5-33.0.

The market clearly assumes that Slovakia will adopt the euro at a stronger exchange rate than the current central parity of Sk35.4424 per euro. Central parity is the rate around which the currency can oscillate, plus or minus 15 percent, within the European Exchange Rate Mechanism (ERM) II. Central parity is often understood as indicative of the final conversion rate.

Slovakia has already revalued its central parity - by 8.5 percent, to Sk35.4424 per euro in March 2007 – allowing a new fluctuation band of Sk30.1260 – Sk40.7588 per euro. The market thus expects a second revaluation.

Lenko said that there is a 65 percent probability of a second revaluation of parity, though he said that defining the timing might be quite complicated.

According to Lenko, an earlier re-setting of parity would stabilise expectations and reduce the volatility of the Slovak crown. But it could well happen, Lenko said, that the revaluation of parity would happen only shortly before announcing the conversion rate on July 8 at the session of the EU finance ministers.

Pätoprstý expects revaluation to occur in mid June.

On the other hand, Valachy said that if Slovakia wants to negotiate a strong rate, it would wait for as long as possible before a revaluation of parity.

“The new parity will most probably be set somewhere close to the market exchange rate and by waiting the NBS would gain a greater chance to negotiate a better rate, since we expect the market level of the exchange rate might strengthen,” Valachy said.

Who will benefit and who won’t?

Consumers, savers, creditors and debtors who receive their income in Slovak crowns and spend their money in crowns will, practically speaking, not have to deal with the question of where the conversion rate is set, said Lenko. Along with the conversion of all prices, receivables and obligations, all their income will be converted into euros as well.

Debtors who owe money in euros but receive their income in crowns might benefit most from the stronger conversion rate since converting their income at a stronger rate while continuing to settle their debt in euros will leave them with a higher disposable income in euros, according to Lenko.

“The stronger crown benefits importers and puts exporters at a disadvantage,” Lenko said.

(Marta Ďurianová contributed to the report)

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