Analysis - Czechoslovakia: a currency split that worked

PRAGUE Thu Dec 8, 2011 5:53pm GMT

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PRAGUE (Reuters) - Policymakers wondering how a euro zone disintegration would play out could do worse than study one monetary union collapse that went well: the split of the Czech-Slovak currency union. The successful conversion of a federal currency into Czech and Slovak crowns on February 8, 1993, has become a model.

Although there were many differences between the Czechoslovak case and a potential euro zone breakup -- not least the economic importance -- it does bear some scrutiny.

So how did it play out?

The split was announced on February 2. The two countries already had capital controls, but all cross-border money transfers between them were halted to avoid further speculative flows into the Czech Republic. Border controls were tightened.

Komercni Banka, a then state-owned commercial bank, glued stamps, printed by a British firm to ensure secrecy, on 150 million federal banknotes. These were trucked around the country with the help of police and the army.

The exchange for notes stamped by Czech or Slovak stamps, at a 1:1 rate, started on February 8 and was completed in four days. Later in 1993, the stamped notes were replaced by new ones.

People could swap a maximum of 4,000 crowns -- then worth $136 (87 pounds) -- in cash. They had to deposit the rest. The old money ceased to be valid immediately the switch started.

The whole process, which required 40,000 people just on the Czech side, went ahead smoothly. An opinion poll showed 86 percent of Czechs experienced no problems in the operation. Capital controls were essential to stop bank runs. Secrecy in the buildup was paramount.

GOING OWN WAY

The split was a product of the diverging economies of the Czech Republic and Slovakia - another parallel with the euro zone where Germany is powering ahead and Greece is deep in recession. When Czechoslovakia broke in two in 1993, the Czech Republic went from strength to strength and Slovakia went into decline.

Unemployment, a new capitalist concept, had jumped to 10.4 percent in Slovakia by 1992, versus 2.6 percent in the Czech Republic. A sharp downturn in communist-era heavy industry was also hurting Slovakia. And the Bratislava government was painfully slow to implement economic reform, in contrast to the Czech government, led by liberal economist Vaclav Klaus

There was also a strong political element - the election victory of pro-independence leaders in Slovakia in mid-1992.

It was a peaceful separation for the federation of 15 million people, very different from the bloodbath that accompanied the breakup of Yugoslavia. In economic terms, the main consequences were a depletion of foreign reserves and a drop in trade between the neighbours.

"Distrust in the monetary setup, devaluation speculation by importers, exporters and banks led to a quick depletion of foreign reserves in the Czech Republic and Slovakia," wrote Pavel Kysilka, who led the Czech separation team.

This was made worse by money flows from Slovakia into the Czech Republic. Slovakia had a hard time at first but ultimately became a poster child for reform and qualified for the euro before its neighbour.

After contracting 3.7 percent in 1993, Slovakia's economy grew in 1994. Trade between Slovakia and the Czech Republic recovered after a 25 percent drop in 1993 and trade with the European Union grew. The Slovak currency devalued by 10 percent in mid-1993 and remained weaker than the Czech crown until Slovakia's euro entry in 2009.

"The costs of the event were relatively low and order was quickly restored in both new currency markets," Czech central bank chief Miroslav Singer said in a speech earlier this year.

All this said, it would be a mistake to draw too many conclusions from the crown's split. It happened in an environment of a fixed exchange rate regime, capital controls, and much lower trade and financial integration, which made it a much easier job than untangling the euro.

"Seen from today's perspective this was a divorce of two undercapitalised, developing-world economies," said David Marek, chief economist at Patria Finance.

Another important difference was that the Czech and Slovaks wanted to have their own currencies, proud of the new nation states that emerged after the fall of the iron curtain.

(Reporting by Jan Lopatka. Editing by Jeremy Gaunt/Janet McBride)

(This story was corrected in paragraph 9 to show Czechoslovakia split in 1993)

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