By Peter Laca
BRATISLAVA, March 5 (Reuters) - Slovakia will be forced to
revalue the crown's rate in the ERM-2 exchange rate mechanism
after its surge to record highs this week, but doing so at an
even higher rate in the summer to create a bigger buffer against
inflation would have long term benefits.
The crown hit a record high of 32.250 per euro on Tuesday,
partially driven by speculation Slovakia might try to negotiate
with the EU a revaluation of its central rate in the ERM-2
exchange rate mechanism.
Euro zone candidate currencies are required to spend at
least two years in the ERM-2 to assess their suitability for
membership. The exchange rate has to be kept within 15 percent
above or below an agreed rate against the euro, the so-called
'central rate' or 'parity rate.'
Slovakia aims to join the euro in 2009. It raised the
crown's central rate by 8.5 percent to 35.4424 per euro last
March as the economy, productivity and foreign investment grew
strongly.
Another increase in the central rate appears inevitable, and
would help keep inflation in check. The crown is 9 percent above
its central rate and 5.4 percent above the 2008 lows of 34.120
seen in January.
"We expect the central parity to be revalued again to keep
monetary conditions restrictive," Citibank analyst Jaromir
Sindel said.
"We view an unchanged central parity as an inflationary
factor... We believe the inflation issue is likely to prevail
over keeping the exchange rate at a more competitive rate."
A poll of 15 Slovak economists showed that an exchange rate
of around 31 crowns per euro was a "theoretically optimal"
level.
Slovakia's EU-harmonised inflation reached a 13-month high
of 3.2 percent in January. While the market sees inflation
remaining below the threshold needed for euro adoption, few
would be surprised if it picked up after the crown enters the
euro zone.
Economic growth reached a record 10.4 percent in 2007,
exports rose 15 percent and the trade deficit fell to 19.7
billion crowns ($919.7 million) from 75.3 billion crowns in
2006.
LATER RATHER THAN SOONER
Last week Finance Minister Jan Pociatek said he could not
rule out another revaluation of the crown, while Prime Minister
Robert Fico said the rate at which it joins the euro should be
one that will not boost inflation.
This was taken to mean that he would back those central
bankers who favour a strong euro conversion rate which will curb
price pressures after the euro entry, when Slovakia gives up the
exchange rate whose firming has kept lid on price growth.
The market expects that the rate at which the crown enters
the euro zone will be the same as the ERM-2 central rate
existing at the time. This would be in line with previous
practice when other currencies have entered the euro zone.
Slovakia is likely to have to cut its main interest rate,
now at 4.25 percent, to align it with euro zone rates, currently
4.0 percent.
If it joins the euro with a weak conversion rate and then
cuts rates, it could boost inflation.
Analysts say high past and future economic growth justifies
one more revaluation of the central rate, but it should not be
rushed.
The likelihood higher inflation after Slovakia stops setting
its own interest rates and euro adoption removes the influence
of a firming crown means it should delay revaluation.
"The later the conversion rate is set, the better the
position to negotiate a level that is near the real equilibrium
rate," said Viliam Patoprsty, Chief Economist at UniCredit Bank
in Bratislava.
Most market watchers believe the revaluation should be made
shortly before the euro entry rate is formally agreed with the
EU in June or July.
"Another revaluation will be a procedural move to follow the
norm that the conversion rate should be near parity," said
Volksbank economist Vladimir Vano, who expects the move in June.
