Is the Czech Crown Losing Its Luster?

Long a source of joy for tourists, the Republic's currency has been rampaging recently. The national bank is considering intervention

By S. Adam Cardais

Just a few years ago it was common to hear American university students and tourists scurrying gleefully through the shops, pubs, and cafes of Prague, traveler's pouches thick with inexpensive Czech crowns, obnoxiously raving: "It's so cheap, it's so cheap!"

But these days a more accurate illustration is of the weary foreigner sitting at an Old Town Square café—a considerably thinner traveler's pouch in hand—shaking her head and muttering, "wasn't this place supposed to be cheap?"

The forecast for the U.S. and European currencies against the Czech crown is looking slightly less gloomy. Source: www.kurzy.cz.

You could say the Czech economy has had its revenge. Today, Prague is the 29th most expensive city in the world for émigrés, according to a recent ranking by Mercer Human Resources Consulting, up from 49th place last year.

Though the study focuses on expat life, the findings indicate the overall rising expense of life in the Czech capital; for instance, a Prague metro ticket costs around twice as much today as it did two years ago. And it's not just Prague. The entire country is becoming more expensive, partly as prices harmonize with western European levels following EU accession in 2004.

But an even bigger part of the story, especially for tourists and expats, is the galloping Czech crown. The crown is the world's fastest-appreciating currency, gaining around 50 percent against the U.S. dollar and 25 percent against the euro, respectively, since 2003. This summer it has set record highs against both currencies and cracked the 23 CZK/euro mark on 21 July.

The crown's sustained, rapid ascent has had economists puzzled, the Czech National Bank (CNB) considering intervention, and tourists and Czech exporters, whose goods are becoming dearer abroad, flummoxed. Many people are wondering: What's behind the meteoric rise of the currency? And, even more pressing, when will it end?

"The honest answer is that nobody really knows," says Tomas Sedlacek, chief macroeconomic strategist at the Czech bank CSOB.

Quite true—but, as Sedlacek points out, we've got an idea. Let's start with the fundamentals.

TOO HOT TO HANDLE

The Czech economy is among the healthiest in Central and Eastern Europe. GDP growth tops 5 percent, the trade balance is well in the black, inflation has been low (with the exception of the last few months), foreign investment is robust, and the EU is injecting the economy with billions of euros in development aid.

These factors have for years been a sound foundation for the crown to appreciate, clearly, but the currency has gotten a further push recently from edgy investors looking for a place to put their money during this global economic slowdown. The crown's stability has made it a "safe haven" currency, and currency speculators are rushing in. In the first quarter of this year, crown deposits increased by the equivalent of 4 billion euros, according to CSOB figures.

This inflow of so-called "hot money" has, especially in the past four months, put even more upward pressure on the crown's value. This helps the domestic economy by undercutting inflation as the strong currency offsets high global food and energy prices.

But it's also slicing into the margins of large exporters such as carmaker Skoda Auto. These pistons of the Czech economy have practically begged for intervention and, more specifically, for the government to change course and set an ambitious euro adoption date. (For the record, every Czech government since accession has shown a knack for setting, and then breaking, euro targets, the first being 2010. Regardless of what leaders say, adoption is not a priority and unlikely before 2012 at the earliest.)

CENTRAL BANK MAKES A MOVE

For its part, the CNB has been reluctant to intervene by lowering interest rates because of rising inflation, which reached 6.7 percent in June. But CNB Governor Zdenek Tuma was forced to act after the crown's record-setting day on 21 July, saying that a discussion about cutting rates "may be on the table" if the crown didn't weaken.

The currency immediately fell after Tuma's verbal intervention. Not long after CNB Vice Governor Miroslav Singer punctuated Tuma's message by saying the bank might consider a rate cut at its highly anticipated board meeting on 7 August.

Many analysts doubted a rate cut in the days leading up to the meeting, but the bank board nevertheless unanimously voted to lower the key interest rate from 3.75 percent to 3.5 percent.

The currency subsequently weakened to 24.11 against the euro before closing a few hellers stronger. Many analysts predict further weakening, to around 25 CZK/euro, and another rate cut. The crown is also expected to retreat against the dollar.

For those getting hit hardest by the crown, this would certainly take some of the pressure off. But don't expect to see those traveler's pouches putting on much weight any time soon.

Provided by Transitions Online—Intelligent Eastern Europe