In a year of inflation overshoots in eastern Europe and financial market turmoil worldwide, Slovakia’s success in meeting the Maastricht criteria to join European Economic and Monetary Union (EMU) on January 1, 2009, is a beacon of hope for the region. “As a bank, and as a group, we are very happy that Slovakia is going to enter euroland. It makes our life much easier within the group,” says György Surányi, chairman of VUB Bank in Slovakia, and head of central and eastern Europe for VUB’s owner, Banca Intesa Sanpaolo.
While nearby Slovenia had already joined EMU on January 1 , 2007, its population of two million is smaller than Slovakia’s 5.5 million, and it was far wealthier at the time of entry, making the fundamental challenges of convergence less marked.
“Slovenia had a fixed exchange rate regime, and they froze prices through administrative measures that were released after membership, so prices shot up,” says Juraj Kotian, chief economist at Slovenská sporitelna. By contrast, exchange rate appreciation has played a major part in curbing inflationary risks in Slovakia in the run-up to euro entry.
Standard bearer
Slovenia’s economy also has a narrower base focused in the services sector, without some of the large-scale industrial activities in Slovakia that are more affected by the country’s exchange rate situation. Consequently, Slovakia is the single currency standard bearer for the larger and more diversified eastern European economies, including the Czech Republic, Hungary, Poland and Romania. Banks in those countries will be watching closely to see how the Slovak financial sector manages the entry process, and derives benefit from it.
The advantages for the economy as a whole are not in doubt, with the National Bank of Slovakia (NBS) estimating that euro adoption will add about 0.7% per year to the GDP growth rate. How this translates for specific corporate clients will be more varied, says Regina Ovesny-Straka, chair of the board and general manager at Slovenská sporitelna. “Price comparisons will, for sure, be easier, but that can have both positive and negative implications. Food is cheaper in Slovakia overall than in Austria, but if you look at luxury items like sportswear, they are cheaper in Austria than in Slovakia,” she says.
However, she expects widespread cost savings for Slovak companies on items such as the costs of accounting and financial reporting. Exporters will also have less exchange rate risk where the eurozone is their target market, and this is especially beneficial for smaller companies that have less capacity to absorb costs.
“For a small business, operating in a foreign country is itself a barrier, and if it has a different currency, then that is a second barrier. So there is a positive psychological effect of not having to make that calculation,” says Ms Ovesny-Straka.
Stronger currency
One complicating factor unique to Slovakia is the one-off 16% revaluation of the Slovak koruna before entry. This was agreed by the government and NBS in May 2008 to help stem inflation after control over interest rates passes to the European Central Bank (ECB). “There was a huge cushion for Slovak companies from unit labour costs, which are still lower than any other EU countries except Bulgaria and Romania, and exporting companies had partly hedged their exchange rate exposure by borrowing in foreign currency, so their debt servicing costs will become lower,” says Mr Kotian.
He adds that many exporters hope eurozone membership will provide relief after several years of nominal exchange rate appreciation, which drove up the cost of Slovak goods in euro terms. However, Dr Surányi warns that “only history will tell us” whether the new rate will cause problems for Slovak competitiveness in the long term.
Moreover, even after the nominal exchange rate has disappeared, domestic price and wage inflation are instead likely to drive the real exchange rate higher in the eurozone. Interest rates will be set by the ECB on a pan-eurozone basis and may be lower than appropriate for Slovakia itself.
“For countries entering at lower price levels, such as Portugal, Spain and Greece, inflation was higher than the eurozone average, and real interest rates turned negative,” says Mr Kotian. Negative real rates pose challenges for banks, making it harder to attract deposits fast enough to meet growing credit demand, but he believes that the risks for Slovakia are no worse than for Portugal, Spain or Greece when they joined.
Capital markets boost
While Spain and Portugal both entered the euro at its outset in 1999, Slovakia should also benefit from joining a more established single currency capital market, opening up new financing possibilities. “VUB can, together with Banka Koper in Slovenia, play a more active role in the wider region, because national currency risk disappears,” says Dr Surányi.
The banking sector is already competitive. It is dominated by eurozone-headquartered institutions, such as Intesa Sanpaolo; Austria’s Erste Bank, which owns Slovenská sporitelna; Raiffeisen, which owns Tatra Bank; and Italy’s UniCredit, operating under its own brand.
Even so, the removal of currency risk could intensify competition by helping new entrants from existing eurozone countries break into the market for the first time. “In this market, it is difficult to build up a retail position quickly. In corporate banking, it might be different, because clients are shifting more easily. In retail banking, a new entrant might build an opportunistic business by overpricing term deposits, but to create a stable market position would be quite difficult,” says Ms Ovesny-Straka.
Meanwhile, she sees a range of possibilities for widening financial market offerings. Slovak companies will be able to increase their investor base by issuing equity in euros without taking exchange rate risk. However, Ms Ovesny-Straka is doubtful whether this will immediately lead to increased volumes on the Bratislava Stock Exchange. “The stock exchange is sleeping quite deeply. It might wake up, but for many enterprises, joining the euro will make it easier to list in stock markets outside Slovakia,” she says.
The euro syndicated loan market is already well established in Slovakia and has been operating since the start of the euro itself a decade ago. Consequently, it is in the corporate cash management sphere that Ms Ovesny-Straka initially expects the bank to expand its product offering and services most significantly after euro entry. In particular, it will be easier for companies that currently hold accounts in more than one currency to switch to cash pooling as a means to cut transaction and balance fees. Slovakia will not join the Single European Payments Area (Sepa) immediately, but instead after a year’s delay, in January 2010.
There is an opportunity at least as large on the retail side, as customers can access a wider investment portfolio. “For the retail business, it will be easier to educate clients to buy shares in Vienna, in Frankfurt. As the exchange rate is not a problem any more, it is easier for them to evaluate,” says Ms Ovesny-Straka.
Steady transformation
Of course, this is not an instant transformation that will take place on 1st January 2009. “It will need some years, it is a development issue, but it will also happen as people become richer – wealth creation is what we have been concentrating on in Slovakia and in the group overall, because it is also a concept you have to build up gradually within the bank,” says Ms Ovesny-Straka. In addition, Slovaks are already beginning to invest in real estate over the border in Austria, and competition for their business will be fierce between existing Slovak banks and local Austrian savings banks (sparkassen).
As retail and small and medium-sized enterprise (SME) banking are the activities of scale, they are also the areas that pose the greatest logistical challenges for the switch-over. The NBS began frontloading cash euros to the banks in September 2008, and the commercial banks will begin distribution to clients two months later, offering no-fee euro ‘starter-packs’ equivalent to 500 Slovak korunas ($22) to all retail customers from December.
In theory, companies should have requested the amount and denominations of cash euros that they would need from their banks in March 2008, so that the NBS could order production for delivery three months later. However, many may not have been projecting their business turnover far enough ahead to make that order correctly, if at all, creating extra uncertainty about the demand for euros at the end of 2008. “We think that micro-entrepreneurs will wake up now and realise that they need this, so they will buy the starter-packs instead,” says Ms Ovesny-Straka.
Given the breadth of foreign ownership, most of the country’s banks can call on the experience of their eurozone parent, to avoid missing any important considerations and ultimately to help implement Sepa. But even so, the process is an expensive one, and local banks may be smaller than existing subsidiaries elsewhere in euroland, altering the parameters.
“We have talked a lot to our Austrian colleagues about how much cash they had ready, how they did it, how they administered it, but proof of concept will start now,” says Ms Ovesny-Straka. “We have to store a lot of coins before we distribute them. It’s a huge weight, so you have to check if you have enough room in the branches, if they need a second safe. It’s the small things that you wouldn’t think of,” she adds with a laugh.
