PBZ Analysts: HNB Should Intervene by Selling Foreign Currency to Prevent Escalation

The financial market reacted to the recent implementation of the legal solution for the conversion of loans linked to the Swiss franc (CHF) into euros by weakening the kuna against the euro and increasing interest rates to the highest level in the last 27 months, say analysts from Privredna banka Zagreb (PBZ), who believe that HNB should intervene by selling foreign currency on the foreign exchange market to prevent escalation.

At the end of last week, the exchange rate of the euro on the HNB exchange list was 7.6126 kuna, meaning that the euro strengthened by 0.3 percent on a weekly basis. The market exchange rate, however, at the end of the week was 7.6385 kuna for the euro, PBZ analysts remind in the Monday published “PBZ Weekly Analyses.”

On today’s exchange list of HNB, the kuna weakened an additional 0.28 percent against the euro, so the average exchange rate is 7.633979 kuna.

The rise in interest rates continued, with the overnight Zibor closing last week at 2.30 percent, up from 2.05 percent recorded the previous week, the 1-month Zibor at 2.47 percent, compared to 2.06 percent recorded a week earlier, and the 3-month Zibor at 2.54 percent, compared to 2.04 percent in the previous week.

“Thus, interest rates have reached the highest levels in the last 27 months, while movements in the foreign exchange market remind us of early February when the exchange rate of the franc was fixed at 6.39 kuna,” state PBZ analysts.

Namely, when the Ministry of Finance announced at the end of August the intention to apply a new legal solution that would allow bank clients who are indebted in CHF currency clauses to convert to euro currency clauses, and that at historical exchange rates on the day the loans were realized, the domestic financial market reacted as expected, PBZ notes.

“Since the conversion is done at historical exchange rates, and banks record losses in kunas while simultaneously reducing foreign currency assets, banks must substitute by purchasing foreign currency assets in relation to kuna. Therefore, financial institutions were immediately aware that for projected losses, they would have to buy foreign currency on the foreign exchange market in the same amount, and this from limited kuna liquidity,” PBZ analysts state.

The market, they emphasize, reacted logically, resulting in an increase in the EUR/HRK exchange rate from levels of 7.57 to the current 7.64; interest rates in the money market rose to over 4 percent in trading with deposits, and in trading with SWAP contracts, or the placement of kunas with simultaneous collateral in foreign currencies, to over 5 percent, while Zibor reached the aforementioned levels of 2.5 percent.

According to PBZ analysts, the fundamental problem is that the government has a wrong perception of the so-called large kuna liquidity at the system level of 5-6 billion kuna. This is a fact, they state, but the problem is its uneven distribution among banks, so that some participants must, with considerable effort and costs, meet their regulatory requirements related to liquidity.

“In the current uncertainty and volatility in financial markets, the role of HNB is enormous, as the only way to prevent this situation from escalating is for HNB to intervene by selling foreign currency on the foreign exchange market, along with the release of some forms of mandatory reserves, and to do so in sufficient amounts to cover the foreign currency positions of banks that have arisen from the application of amendments to the Consumer Credit Act,” conclude analysts from Privredna banka Zagreb.