Slovaks revalue koruna ahead of euro entry

The Slovakian koruna jumped to a record high on Thursday after a surprise revaluation of the currency's peg against the euro, aimed at containing inflationary pressures ahead of Slovakia's entry into the single currency next year.

The European Commission announced a 15 per cent revaluation of the Slovakian koruna's Exchange Rate Mechanism-II central parity rate against the euro to Sk30.1260, from the previous level of Sk35.4424.

Under the terms of ERM-II, a two year currency stability test ahead of acceptance into the eurozone, the Slovakian koruna can trade 15 per cent higher or lower around the central parity band.

The Slovakian koruna has risen nearly 6 per cent against the euro since the European Commission earlier this month approved the country's bid to join the eurozone in 2009. Yesterday the currency jumped 2 per cent to a record high of Sk30.095.

The decision to revalue the koruna's trading band received strong backing from the European Central Bank. The ECB was concerned that Slovakia would witness a spike in inflation after swapping the koruna for the euro.

The move was also welcomed by the Slovakian authorities, who have said that a strong conversion rate with the euro is needed to help the bridge the wealth gap between its citizens and rest of the eurozone. Slovakia will be the region's poorest member with about 70 per cent of average Eurozone GDP per capita when the country joins the currency bloc next year.

Robert Fico, Slovakian prime minister, has said the koruna's final conversion rate into the eurozone, which will be set at a meeting of EU finance ministers on July 18, should be as strong as possible.

Analysts expect the conversion rate to be set around the new parity of Sk30.126 , or perhaps even a little stronger.

However, Lars Rasmussen at Danke Bank said such a strong conversion rate would fuel pressure for a significant tightening of Slovakian fiscal policy going into 2009.

He said If the ECB kept interest rates unchanged at 4 per cent during 2008 the Slovakian central bank would have to lower rates by 25 basis points before the end of the year. This would bring monetary easing into an economy which was growing briskly and where inflationary pressures were clearly rising.

"Hence the need for fiscal tightening and structural reform will become more evident in the coming years," said Mr Rasmussen. "Otherwise inflation will rise rapidly, which, in combination with a strong conversion rate, will seriously erode Slovakian competitiveness."