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Czech Republic: Prague's Solution To The Falling Crown

Prague, 27 May 1997 (RFE/RL) -- The financial world is awaiting the announcement in the coming days or weeks of a devaluation of the embattled Czech crown. The man in the street in Prague is already grumbling about how prices will go up and his summer holiday abroad might be ruined.

Everybody is waiting, calculating their loss or gain, as speculative pressure against the crown continues. But the question is, will the announcement ever come?

Some experts say the authorities are already implementing a typically Czech solution to a problem which has embarrassed the government and tarnished the Czech image as a star among emerging economies.

The solution is typically Czech in that it avoids the head-on tackle in favor of a more subtle way of achieving the same end. The strategy is this: the Czech authorities have quietly done away with the former arrangement under which the crown was measured against a "basket" of currencies, occupying a trading band of plus or minus seven percent within this basket. The basket and the trading band have both been dissolved, and although the deutschmark remains as a measuring point, the crown is being largely left to find its own level according to the speculative pressures against it. The Czech Central Bank is not seeking to intervene on the crown's behalf, although it has signaled its continuing intention to cushion any too-steep fall.

The crown has already sunk below the band of the old basket, having lost some ten percent of its value in the last ten days. It may lose another 5 to 10 percent in the coming days, then bottom out, and possibly gain a little.

Czech economic researcher and analyst Martin Kupka says there are several distinct advantages to this approach. Firstly, the official announcement of a devaluation is avoided, with its significant loss of face by a government and a country which have been deeply proud of their achievement of economic stability since the end of the communist era. The crown was devalued in 1990, in the early days of transition, and since then has kept a steady course -- a performance comparing favorably, for instance, with the currencies of the other "wonder" economies of the east, Poland and Hungary.

What is happening to the Czech crown now in labeled a "depreciation", avoiding that nasty term devaluation, which would require the authorities in Prague to select a new parity for the currency against other currencies.

Kupka says the second significant advantage of the floating approach is that it avoids the need for a difficult, and possibly incorrect estimate of the size of the devaluation. If the financial markets do not recognize the announced devaluation as accurate, continued speculative pressure could trigger another devaluation, which would be a bad sign of instability. If on the other hand, the announced devaluation is too small, then the economy loses out because exports do not gain the full benefit of lower prices, imports are not sufficiently discouraged by being higher priced, and inflationary tendencies are emphasized.

Major Czech exports, like cars, medium-level machinery, cement, beer and glass, are already looking more attractive on foreign markets as they offer the same quality as before for a lower price. Imports on the other hand, are going to look less interesting to Czech buyers as their prices rise, and this will have a healthy effect of assisting the balance of payments.

In the shops, prices can be expected to rise moderately. But this is not a wholly negative result since the government is already trying to reduce imports and dampen domestic demand by means of its recent austerity package.

On the wages and incomes front, Kupka notes that depreciation may mean the Czech government and employers will have an increasingly difficult time in their negotiations with labor. This is because depreciation will strengthen the voices of those who can point to a decline in living standards, measured in terms of buying power.

In general, then, the short-term impact of the crown's fall appears to be manageable. But Kupka cautions that the original long term reason for the weakness of the currency remain: namely the slow pace of restructuring. Privatization is going slowly, with more bankruptcies expected, and the capital market needs still to be made more transparent to restore investor confidence. Until core issues like these are tackled, the crown will remain under threat.

And what of the public? Kupa and most other analysts believe Czechs have been looking at the world through rose-tinted spectacles for the last few years, and that now they are seeing an unaccustomed gray. Their sense of disappointment is proportionate to their earlier confidence, and they view the situation perhaps as worse than it is.

Of course, the Czechs are not the only ones to suffer in all this. Neighboring Slovakia, because of its tight trade and historic ties to the Czech lands, can hardly expect the Slovak crown to weather the storm unaffected.