Download Monetary policy outline: - International Policy Fellowships

Slovakia
(Prepared by Roland Straub and Klara Simon)
1. Legislation of the National Bank of Slovakia
The National Bank of Slovakia (NBS) has been established in January 1993 before the split of the
former Czecho-Slovak currency in February 1993. After more than a decade of its existence the
NBS performs practically the same basic functions as it did upon its creation. However, several
constitutional arrangement changed the legal status of the NBS in the recent years. Until July
2001, the Slovak constitution did not contain any explicit statement on the legal position of the
central bank, but only a general note of an issuing bank being established. In July 2001, in the
amended Article 56 of the Constitution it was stipulated that the NBS is an independent central
bank and that, within the scope of its authority, it may issue generally binding legislation. The
authority to issue such legislation is currently documented in the Act on the National Bank of
Slovakia, the Foreign Exchange Act, the Banking Act and the Act on Payments. Without this
amendment Slovakia would not be able to comply with requirements made by the European
Union in respect of the status of national central banks.
2. Brief Overview of Economic Developments from 1993 to 2003
Over the period 1993-2003, macroeconomic development in Slovakia was marked by
disproportions in the achievement of macroeconomic objectives. On the one hand, Slovakia
reached a relatively high rate of economic growth at a lower rate of inflation in comparison with
under transition economies, while on the other hand the external disequilibrium and increased
unemployment persisted. Slovakia’s relatively good inflation performance during transition
reflected moderate wage pressures, facilitated by high unemployment and tripartite consensus
between business, employees and government. Postponement of administered price increases
further moderated price pressures. After inflation of 25 percent in 1993 (the first year of
independence) on the heels of the introduction of the VAT and a 10 percent devaluation, inflation
fell gradually to some 7 percent at end 1995 and remained at about this level until mid 1999,
despite considerable turmoil in the foreign exchange market. The absence of structural reforms,
economic growth became increasingly unsustainable. Poor governance in the public and private
sectors led to rising levels of inefficient investments and macroeconomic balances worsened after
1996. With three years of current account deficits at 10 percent of GDP during 1996-98, partly
reflecting a lax fiscal stance, capital flows variability led to a stepwise widening of the fluctuation
bands for the peg to DEM/USD basket. Persistent pressures on the foreign exchange market led to
the floating of the koruna in 1998, despite very tight monetary stance. The tight monetary policy
that can be considered as a response to the loose fiscal stance caused debt servicing problems for
the enterprise sector and a deterioration in the loan portfolios of banks. In 1999-2000,
administered prices were raised in the context of tightening fiscal stance, temporarily boosting
headline inflation, but with the weak domestic economy, core inflation remained subdued at 5-6
percent, subsequently falling below 4 percent in 2001.
Current account pressures resurfaced during 2001. In 2002, real GDP grew by 4.4 percent. Core
inflation reached a historical minimum of 2 percent . Fiscal and external balances remain high but
1
both are starting to improve as a result of better export performance, as well as the
implementation of a fiscal moderation package. Large capital inflows contributed to a significant
appreciation of the national currency. There has been a good progress on the structural
reorganization in recent years. The main banks and utilities have been privatized, fiscal
transparency and control have improved. In 2003, the Slovak government approved an extensive
tax reform to be implemented from 2004 to 2006. This contains a uniform corporate, personal and
valued added tax rate of 19%. Regarding the tax base, the new law rules out any kind of
exemptions, exceptions or special agreements. Growth of 4.2 percent in 2003 was driven by good
performance of the export sector, which offset a significant decline in domestic demand. Fiscal
tightening (especially indirect tax and administered price increases) and the associated fall in real
wages dampened private sector consumption; and fixed investment, which had grown strongly in
the past, declined modestly. The outlook remains for strong macroeconomic performance in
2004, with the composition of growth shifting gradually to domestic sources.
3. Monetary Policy of the NBS
The main objective of the monetary policy during this period was to maintain the stability of the
exchange rate. Exchange rate stability was defined towards a synthetic currency basket that
composed 5 currencies (USD, DEM, Austrian Schilling, Swiss Franc and French Franc). The
policy was conducted by controlling the growth of the M2 monetary aggregate. In 1993, in the
first year of independence of the Slovak Republic, the monetary policy was accompanied by a
number of one-o. factors like the breaking up of the federation, the currency split, tax reform, and
outflow of foreign exchange reserves triggered by devaluation fears. The monetary policy makers
were faced with the task of restoring balance to the foreign exchange economy, eventually
achieved by introducing administrative measures as cross-border payments and a 10%
devaluation of the Slovak crown in July 1993. Under the improving conditions in 1994 some of
the foreign exchange controls have been relaxed and the number of components in the currency
basket have been cut from five to two (USD and DEM). Also, a new foreign exchange rate law
removed remaining obstacles to current account operations in the balance of payment. In 1996,
the NBS focused its monetary policy on creating sterilization opportunities, by encouraging
withdrawal excess liquidity from commercial banks through issues of NBS bills. Doubts about
the effects of this policy on the lending activities of the commercial banks, caused by soaring
imports and high growth rate of the relevant monetary aggregates, induced a change in policy.
The NBS decided to lift the ratio of required minimum reserves, to introduce foreign exchange
positions that commercial banks were obliged to observe (in order to exert some control over
foreign currency loans that banks were selling to residents), to increase the Lombard rate to 15%
and to expand the fluctuation spread for the Koruna to ±5%. In 1998, the fluctuation band has
been even widened to ±7%. All these measures were designed to rein the excess liquidity and to
control the lending activities of the commercial banks. Quantitative control over liquidity in the
banking sector helped the NBS to meets its money supply and net domestic assets targets in 1997,
in keeping with its main objective the stability of the exchange rate. In 1998, due to the contagion
effects of the financial crisis in Russia, there was a pressure on the exchange rate of the Slovak
Koruna. The NBS intervene indirectly in favour of the koruna, by setting the exchange rate above
the market value. Commercial banks had the opportunity to replenish their foreign exchange rate
reserves by purchasing funds fixed at the announced rate, which generated a fall of the NBS
foreign exchange rate reserves by almost US$ 1 billion.
Finally, the ongoing pressure on the exchange rate and the fall in foreign exchange rate reserves
led to a change in the stance of the monetary policy. In October 1998, the NBS decided to let the
2
exchange rate float. The exchange rate depreciated significantly during the year without a
negative effect on inflation. In 1999, in connection with the price deregulations conducted, the
NBS began to monitor net inflation. The ultimate goal was to stabilise public expectations and to
counteract possible second round effect of price liberalizations. Measurements like the previously
required foreign exchange position for domestic banks and branches of foreign banks has been
abandoned. In the same year, the euro became the reference currency of the koruna. In 1999,
despite the fact that the inflation rate remain stable, the exchange rate depreciated steadily. This
prompted the central bank to intervene in the foreign exchange rate market. The turnaround came
finally after the government adopted an austerity package that improved public finances and curb
domestic demand.
The favourable trend in economic development in 2000 made possible transition from a
quantitative to qualitative monetary control. On 1 February 2000, the NBS commenced setting
overnight rates for sterilisation and refinancing purposes, followed by a limit rate for two-week
repo tenders in May. The introduction of official NBS rates contributed significantly to the
stabilization of the interbank rates. Since 1 January 2000, the NBS has begun to monitor core
inflation, in addition to consumer price index. In comparison with net inflation, core inflation
includes the effect of food prices, while the direct effects of changes in excise duties, VAT rates
and subsidies for consumer prices are fully eliminated from the value of core inflation.
As discussed in the last section, in 2001 the legal framework for the implementation of monetary
policy has been modified. The NBS became a fully independent central bank and any kind of
financing of public debt was prohibited.
In November 2002, there was a remarkable pressure for appreciation on the exchange rate, mainly
reflected by the improvement of the country’s rating, which was also connected with an inflow of
foreign capital. The situation required relatively intensive central bank intervention in the foreign
exchange rate market, backed by a 1.5 percentage point cut in the key NBS interest rate. In line
with the harmonization of the Bank’s monetary policy instruments with EMU and ECB standards,
the ratio of required reserves for commercial banks was reduced from 5 to 4 percent with e.ect
from 1 January 2002. At the same time, the Lombard loan, the Lombard rate, and bills of
exchange transactions were cancelled. The method of calculating the discount rate was also
modified (with effect of 1 January 2002). Its value corresponds to the limit rate for standard twoweek NBS repo tenders.
In the course of 2003, the Slovak Koruna on the average nominally appreciated against the EURO
by 2.8%, which can be seen in the context of the favourable trade balance development. The Real
Effective Exchange Rate) appreciated by 10% on the CPI basis in the course of eleven months of
the previous year. On the PPI manufacturing basis, the REER appreciated by 4%, which may be
considered as adequate in order to have some pressures in the economy towards restructuring of
less effective productions, however without having a negative impact on the competitiveness of
other production. As reaction to these developments, the NBS decided to cut interest rates in
September (by 0.25%) and December (by 0.25%). Due to the continuing appreciation of the
exchange rate of the koruna vis-à-vis the euro, the Bank Board of the NBS decided on lowering
further the key interest rates in the period of January-June 2004 (One-day sterilization rate from
4.50% to 3.00%, the one-day refinancing rate from 7.50% to 6.% and the two week reverse
REPO rate from 6% to 4.50%). The lowered interest rates should support recovery in domestic
demand, which should fuel the economic growth in 2004 along with expected lower contribution
of net exports. The Bank Board also stated that the cut in interest rates would further help the
NBS in its efforts to ease pressures on the exchange rate appreciation.
3
4. Research Activities of the NBS
Demand for research at the NBS arises from the need to highly support policy decision making of
the bank board. Topics of research cover several issues, as follows: optimum currency area
issues, transition mechanism of the monetary policy, lags and efficiency of monetary policy in
small open economies, equilibrium exchange rate estimation, modelling and forecasting of
inflation, capital flows and unemployment etc.
Research at the NBS is carried out by two independent departments:
Monetary Division focuses on more practical issues, regular forecasts, projections and publication
of regular reports —performs applied and needs based type of research, which is heavily used in
the monetary decision process.
The Institute of Monetary and Financial Studies performs rather theoretical and long-term
research, currently concentrating on the euro adoption strategies and consequences. The main
function of the Institute is to promulgate objective information on economic development both
inside of the country and abroad, to establish a theoretical background, and create conditions for
the executive bodies of the NBS to make objective decisions. The Institute is to be engaged
predominantly in the area of monetary and fiscal policy to stabilize the development of the
economy and currency stability.
Sources of research at the NBS are fairly limited in both quantity and quality; therefore the bank
relies on international and domestic organisation’s ideas and methods as well. Mostly used
sources are working papers, reports and official publications coming from the ECB, IMF, EC,
CEPR, WB, OECD, Academy of Science, several commercial banks and partner central banks.
However the Bank most often relies on its own research. Regular publications are available for
the public, both in Slovak and English, and downloadable from the bank’s website, these are:





Monetary survey,
Monetary Programme of the NBS,
BIATEC — monthly banking journal,
Annual reports,
Some information brochures and legislation documents. The Institute of Monetary and
Financial Studies publish occasional research publications. However, most of the research
that supports policy decisions stays within the bank and is not published.
4