Slovak Currency Continues Unprecedented Rise After Rate

UNCLAS BRATISLAVA 000165 SIPDIS SIPDIS TREASURY FOR AALIKONIS USDOC FOR MROGERS E.O. 12958: N/A TAGS: ECON EFIN EINV ETRD LO SUBJECT: Slovak Currency Continues Unprecedented Rise After Rate Change REF: Bratislava 144 ¶1. SUMMARY: At the request of the Slovak government the European Union lifted the Slovak koruna's central parity rate 8.5 percent to 35.44 against the Euro from March 19. The koruna is allowed to trade 15 percent above or below the rate under conditions Slovakia must meet before it can join the 13-nation euro region. This change was not unexpected given the robust economic growth, rise in productivity and more stable inflation. It does, however, make life more expensive for us. END SUMMARY. ¶2. The koruna has strengthened by more than 10 percent against the Euro since Slovakia entered the Exchange Rate Mechanism II (ERMII) in November 2005, more than any other currency, as companies including PSA Peugeot Citroen and Kia Motors Corp. opened factories and real economic growth accelerated to a record 8.3 percent in 2006 (Reftel). However, the Slovak Central Bank does not have resources to continue the interventions against the persistent currency growth and therefore requested the revaluation. The Slovak Republic currently holds $14.7 billion in foreign-currency reserves to defend its exchange rate, equivalent to the cost of about four months of imports. ¶3. The European Central Bank (ECB) decision to adjust the central parity was announced following a meeting of the Economic and Financial Committee in Brussels last week. The revaluation is based on a firm commitment by the Slovak authorities to pursue appropriate supportive policies including tackling wage pressures and credit growth. The panel includes representatives from the national banks in the Euro region as well as the other countries in the ERM and finance ministries and the European Central Bank. Greece was the last country to revalue within Europe's exchange-rate mechanism in ¶2000. The exchange-rate mechanism is one of the five conditions for aspiring members of the Euro region and is designed to test the stability of their exchange rates for at least a two year period. Slovakia remains on target for a January 1, 2009 Euro adoption, which would make it the second former-communist country to join the 13-member Euro-region after Slovenia, which adopted the currency this year. ¶4. Slovakia's 12-month inflation rate was 3.9 percent in February and to qualify it will need to squeeze the rate further. The estimated ceiling for euro adoption was 2.9 percent in February and a country's 12-month inflation rate must be in line in the year it files a bid, along with an outlook that inflation is not expected to rise. Annual inflation in Slovakia fell to 2 percent in February from 2.2 percent the preceding month as the effect of last year's increases in global energy prices waned. The central bank estimates the rate will fall to 1.5 percent by December. ¶5. Following the March 16 announcement the Koruna has set new records against both the Euro (32.84 SKK/EUR) and the Dollar (24.69 SKK/USD). This is a rise of more than three percent over the last four days. Both the Finance Minister and the Central Bank Governor released statements on March 19 noting that the growth over the weekend was overstated and that they would use "all tools available" to keep the development under control. The Central Bank did not intervene in the markets on March 19, but are reportedly taking measures beginning March 20. Slovak exporters, led by Klub 500, which represents large employers in Slovakia, stressed that the strengthing Koruna is hurting the competitiveness of exports and called on the government to take immediate measures to rein in the growth. ¶6. Against the dollar, the koruna has strengthened by 25 percent since Slovakia entered ERM II in November, 2005. Slovak government bonds have risen 26.8 percent in dollar terms, second only to Thai debt, according to indexes of 27 emerging-market debt securities compiled by JPMorgan & Co. ¶7. COMMENT: The revaluation of the central parity was not unexpected given the strong GDP and productivity growth and drop in inflation. In fact, many analysts felt at the time that the initial parity of 38.455 SKK/EUR in November 2005 was too weak given the economy's growth potential. The change came sooner than most analysts had predicted, but the new rate is generally considered "well-reasoned" and should support macroeconomic stability, price stability and external competitiveness of Slovakia. The key objective remains fulfilling the Euro convergence process and maintaining fast and sustainable growth of standard of living in Slovakia. End Comment. VALLEE