Czech Koruna Rally Halted as Topolanek Loses No-Confidence Vote

By Bo Nielsen, Yon Pulkrabek and Michael Patterson

March 25 (Bloomberg) -- The rally in the Czech koruna, Europe’s best performing currency in the past month, may crumble after Prime Minister Mirek Topolanek lost a vote in Parliament, ousting his government.

The koruna weakened as much as 0.6 percent to 27.300 per euro today, eroding its 5.8 percent gain in the month since Feb. 24, and dropped 3.1 percent against the dollar in the past two days, the biggest decline in emerging-market currencies.

Topolanek, who leads a three-party coalition government, lost a no-confidence vote over his handling of the economy as it heads for a recession. The koruna, which fell to a 3 1/2-year low against the euro on Feb. 17, strengthened after central bank policy makers signaled possible interest-rate increases, world finance chiefs pledged to double International Monetary Fund reserves and the EU agreed to boost a credit line for member countries in financial distress.

“I see a risk of short-term reversal at least until the visibility on the political front clears up,” Benoit Anne, an emerging-market strategist at Banc of America Securities-Merrill Lynch in London, said in an interview late yesterday. “It will create some political uncertainty.”

Analysts had already concluded that the rally was over even before the no-confidence vote. Merrill Lynch forecast an 8.7 percent slide to 29.25 per euro by the end of September. Zurich- based UBS AG, the world’s second-biggest currency dealer, told investors on Feb. 16 to sell the koruna, with a one-year target of 29.5 per euro.

Thanos Papasavvas, head of foreign exchange in London at Investec, said he’s waiting for the koruna to fall a further 11.4 percent to 30 per euro before buying. Poland’s zloty, Europe’s second best performer in the past month, may drop 9.8 percent to about 5 per euro, he said.

Supporting Rally

“I would love to say we’ve seen the bottom in these currencies but I’m not sure we’re there yet,” said Papasavvas, who helps manage more than $4 billion of currency assets. “I certainly don’t want to buy here.”

The koruna’s rally has been supported by a U.S. plan to remove up to $1 trillion of toxic debt from banks, stoking risk appetite and erasing 2009 losses in emerging market equities. The benchmark MSCI Emerging-Markets Index of stocks is headed for a 16 percent gain in March, the best monthly advance since 1989, according to data on Bloomberg.

“You have to take into account the fact that the global backdrop is now supportive and currencies in emerging markets might actually continue to rally,” said Merrill’s Anne. “It’s more a case of the Czech currency will underperform.”

Resignations, Riots

Eastern Europe’s economies have been hurt by a slowdown in the euro region, the main market for their goods. The Czech economy may contract as much as 2 percent this year, Finance Minister Miroslav Kalousek said this month. Gross domestic product will shrink by 3.4 percent in 2009, according to Deutsche Bank AG.

Czech unemployment rose to 7.4 percent in February from 5.2 percent in October.

The economic turmoil caused Hungarian Prime Minister Ferenc Gyurcsany to announce March 22 he would step down in favor of a premier capable of gaining “wider political support” for moves to fight the recession. Latvia’s government resigned last month as the contraction sparked rioting.

Topolanek’s coalition has struggled to govern as it relied on independent or opposition lawmakers for a majority. The government has been “reluctant” to take steps needed to tackle the impact of the global financial crisis, Czech Social Democratic leader Jiri Paroubek told lawmakers.

The opposition Social Democrats and Communists got 101 out of 197 votes in the motion yesterday in the lower house of parliament.

Power Weakened

The government will remain in power until President Vaclav Klaus appoints a new administration or early elections are held. Klaus said in an e-mailed statement yesterday that it was “premature” to talk about the situation.

Topolanek is the current head of the EU’s rotating presidency and the no-confidence vote may weaken the Czech Republic’s negotiating powers within the 27-member bloc, he said.

The past month’s rally pared an 11.2 percent plunge in the koruna against the euro in the previous three months.

Any further selloff in central and eastern European currencies may strain government finances and trigger $300 billion in losses for local banks as rising repayment costs on foreign-denominated loans spark defaults, Deutsche Bank said in a March 13 note. It may also weaken the euro because of concern banks in the 16-member euro zone will be forced to write off some of their $1.3 trillion of loans to the region, according to an ING Groep NV report last month.

Loan Defaults

The euro on Feb. 17 weakened 1.7 percent against the dollar, the most in more than six weeks, after Moody’s Investors Service said that some eastern and central European banks may face credit-rating downgrades as loan default rates rise in the region.

“Eastern and central Europe could be the catalyst for another rout in risky assets,” said Lutz Karpowitz, a Frankfurt-based currency strategist at Commerzbank AG, Germany’s second-biggest lender. “A credit event there could create a horrible snowball effect spreading to the global markets.”

To contact the reporters on this story: Bo Nielsen in Copenhagen at bnielsen4@bloomberg.net; Yon Pulkrabek in Prague on ypulkrabek@bloomberg.net