By Jan Lopatka and Marek Petrus (Reuters, 15.2.2002)
CZECH CBANKER TRAINS GUNS ON CROWN.
PRAGUE, Feb 15 (Reuters) - Excessive Czech crown strength is the economy's largest problem and the central bank is determined to fight it with all means, including interventions and rate cuts, Czech National Bank Vice-Governor Oldrich Dedek said on Friday.
The unusually strongly worded remarks, made in an interview with Reuters, sent the crown tumbling to as low as 31.895/925 to the euro from a previous 31.63/66, the lowest level since February 6, before recovering to 31.83/86 at 1455 GMT. Bonds jumped on the interest rate comments.
Dedek said the crown should drop to around 33 to the euro, and that the central bank had plenty of scope for direct interventions against the currency.
"The exchange rate is constantly firming, is breaking away from fundamentals and does not correspond to labour productivity gains," he said in an interview, laced with comments underlining the banker's unease at the strong currency.
"I believe the scope for intervention is not exhausted by far," he said. "A return to levels around 33 per euro could be interpreted as the elimination of the initial abnormal deviation and return to some kind of normality."
The crown has gained 12.6 percent against the euro in the past 12 months, with sharp gains coming in December when the government completed two large privatisation deals. The market expected the sale receipts to be converted into crowns.
The CNB believes that while the crown has a long-term tendency to appreciate on improving productivity and foreign direct investment inflows, recent jumps are excessive and hurt exporters at the time of faltering foreign demand.
Hungary and Poland, the two other large eastern European countries on track for European Union entry, are also struggling with currency strength as markets seek profit in their economic convergence with wealthier Western Europe.
In January the Czech bank cut a deal with the government to limit the crown boosting effect of privatisations by agreeing to place revenues into central bank reserves, bypassing the market.
"IRRATIONAL" BEHAVIOUR
Dedek said investors were being irrational in failing to comprehend that all privatisation inflows, estimated at over 10 billion euros this year, will go nowhere near the market, either being stashed in euros or sold into the CNB's reserves.
"Unfortunately the markets have not yet fully appreciated the significance of this deal," he said. "The markets continue to anticipate firming and do not take into account the impact of this deal and I see this as a little bit irrational." Traders said Dedek's comments showed the central bank was really determined to knock the currency down, and that threw the market off. "I think the market finally got the message that the central bank is serious," said one Prague dealer.
But analysts said the currency would remain well-padded, and while no big appreciation could be expected, the crown was unlikely to drop close to 33.
"Few people were short in the crown, so the verbal intervention had a larger effect," said Martin Hlusek, an analyst at Standard Bank in London.
"I doubt the CNB will dare intervening directly," he said. "We can expect verbal intervention, I would not exlude another rate cut if the crown remains strong."
MARKET PREDICTS STRENGTH
A Reuters poll of analysts earlier this month saw the crown at 31.4 at the end of this year and at 30.8 in 2003.
Dedek said that when the expected privatisation flows are factored out, remaining foreign direct investment inflows simply balance out the deficit on the current account and present no justification for crown strengthening. The central bank was surprised the crown did not weaken after its deal with cabinet was signed in January, prompting it to slash interest rates and intervene against the currency. But the measures had little success in curbing the crown.
It dipped briefly but quickly returned to previous levels around 31.80 to the euro.
"This showed the problem is much stronger than we had believed it to be," Dedek said.
RATES COULD BE CUT
Dedek said January's two cuts in the key two-week repo rate - by a combined 50 basis points to an all-time low of 4.25 percent - presented no danger to inflation targets. Further cuts may still be on the cards, he said.
"I am on the more cautious side but in no case am I closing the door for myself (to lower rates), especially when I see what the crown is doing at present," he said. The last cut was questioned by some analysts who said it may be excessive.
A drop in the crown to around the 33 level would be consistent with inflation goals and not require a monetary policy response, he said. Traders said bonds jumped on the rate comments, with 10-year government paper gaining 50 basis points at 109.00/30, to yield 5.32/29.
Dedek said "natural" crown appreciation would be about four percent annually in real terms, as the economy catches up with western Europe in terms of productivity. His remarks paralled those of Hungarian Prime Minister Viktor Orban, who said on Thursday the forint would be rising three to five percent annually in the next years.
CZECHS SHOULD JOIN THE EURO QUICKLY - C.BANKER.
The Czech Republic should adopt the euro as soon as possible to protect its economy from external shocks, Czech central bank (CNB) Vice-Governor Oldrich Dedek said on Friday.
"I am personally inclined to those who argue the sooner the better," Dedek told Reuters in an interview.
"Even if we decide not to join the EMU this would not help us, it would not allow us to have a profligate fiscal policy and higher inflation because the markets would punish us. This is not an option for a small, open economy."
He said the Czech crown should join the single currency two years after joining the EU, the earliest date possible, implying the country could become a member in 2006.
The Czech Republic is one of the leading candidates for EU membership and may join in 2004. Most central European EU candidate countries favour early eurozone entry to shelter their economies from foreign exchange and other risks.
LIMITED SCOPE
Some EU officials have argued against the quick adoption of the euro by EU candidates, saying they should first achieve higher levels of convergence in wealth and price levels.
Dedek said the bank had been working on a unified strategy for entry to the euro-zone, though the seven-strong policy-making board had been slower than he would have liked to reach a consensus.
He said that the Czech economy had very limited scope for an independent monetary policy. World commodity prices and euro/dollar movements were a key influence on domestic inflation.
The floating crown currency, which is much stronger than the central bank would like, was not helping monetary conditions, he said.
"I say the exchange rate, a supposed absorber of asymetric shocks, now generates them. It complicates the (economy's) position and our exporters would have been much happier if the crown had not been firming," Dedek said.
"How does the crown help us at the moment? I don't know."
The crown dropped sharply against the euro on Friday after Dedek told Reuters it was overvalued and that the central bank was ready to use all instruments it has to weaken it.
It dropped to 31.860/890 to the euro at 1410 GMT from 31.63/66 after Dedek told Reuters the bank wanted the crown to fall to around 33 crowns per euro.
Dedek also said a swift overhaul of the fiscal system was needed to cut the unsustainably high public budget deficit, seen at around six percent of GDP at the end of 2002.
This is twice the maximum size allowed by the Maastricht Treaty for euro-zone members.
ERM PROBLEM
Dedek said the EU's requirement for all applicants to join the EU's Exchange Rate Mechanism (ERM) was not ideal because the central bank only targeted inflation and not the exchange rate, but said the Czechs could live with the crown being tied to the 30 percent-wide ERM band.
He said the band was wide enough to allow the crown to appreciate as the Czech economy cathes up with the EU.
Under current rules, all euro candidates would have to spend at least two years in the Exchange Rate Mechanism for candidate countries (known as ERM-2) prior to adopting the single currency, during which time they would have to meet Maastricht Treaty economic convergence criteria.
(C) Reuters Limited 2002.