SLOVAKIA ENTERS ERM2 AT PARITY RATE OF 38.455/EUR

The EU admitted Slovakia to the ERN2 mechanism, effective November 28, at a
parity rate of 38.455/EUR or close to Friday\'s market rate. Slovakia is
targeting EMU entry in 2009 and runs policies consistent with early
Euro-entry. Currently it meets Maastricht criteria on all fronts but
inflation, with the NBS targeting 2% in 2007 vs 4% forecast for end-2005.
The authorites have planned ERM2 entry in 1H 2006.

The early ERM2 entry may come on the back of the EUR/SKK market rate
reaching the NBS\' desired parity level, while the country has been well
prepared for admission on all accounts. We have been arguing that the
fundamentals of the SKK did not justify its 2005 performance vs. the CEE
peer-group (flat YTD), in light of the country\'s rapid productivity and GDP
growth, prudent and EMU compliant fiscal policies, macroeconomic balances.
Given the increase of inflation uncertainty and the rise of the headline
rate above NBS target tp near 4% in Q4 2005, we expected the NBS to raise
interest rates to tighten monetary conditions and safeguard its mid-term
(Maastricht-level) inflation target / early EMU entry goals.

Given the strong economic fundamentals of the EUR/SKK, the exchange rate has
been sensitive to positive interest rate differential to the Eurozone and
forced the NBS to reduce the base rate to 3% to limit speculative capital
inflows. At the same time, the prolonged flat-lining of the EUR/SKK this
year did not provide a sufficient anchor for the mid-term inflation goals.
In the current situation - with the SKK in the ERM2 -, the authorities
committment to 2009 EMU entry has been reinforced. This has a number of
implications: (1) raising interest rates may provoke unwanted exchange rate
appreciation, in light of Slovakia\'s 5-6% mid-term GDP and productivity
growth, macroeconomic balances and sound policies. (2) it also tightens the
constraint on the NBS to meet its 2.5% inflation target in 2006 and 2% in
2007-08, which is demanding when considering the relative lag of nominal
price and wage convergence of Slovakia. (3) It also increases the pressure
on the NBS to limit FX volatility and avert speculative flows of the scale
of early 2005.

INVESTMENT VIEW: We maintain our positive view on the SKK, with an end-2006
target of 37.50/EUR and a continuous gradual, mid-term nominal appreciation.
In the near-term, on a flow-basis the run-up of new automotive export
capacities and ongoing privatisation (EUR 0.8bn, SE) and FDI bode favourably
for the SKK. However, the relative inefficiency of the SKK FX market may not
reflect the fundamentals in a timely manner and the rise in global/ECB rates
may limit the currency\'s upside in the mid-term.

The 2.5% m/m gain of the SKK, however, provides a sufficient monetary
tightening for the NBS - if prevails - to keeps interest rates on hold. Any
potential rate increase, in our view, would follow the ECB and would not
increase its scale. The short-end of the curve is thus oversold, while the
long is anchored by credible EMU entry and local institutional demand.