15 August 2013

IMF Executive Board concludes 2013 Article IV consultation with the Slovak Republic

Following a sharp downturn in 2009 in the context of the global economic and financial crisis, Slovakia emerged as one of the fastest growing economies in the EU, supported in particular by substantial foreign investment in the auto sector and subsequent exports.

Slovakia has reduced its fiscal deficit substantially since 2009, reaching a deficit of 4.3 per cent of GDP in 2012, and enjoys moderate public and private debt levels. Inflation fell to 1.6 per cent in June 2013, record trade and current account surpluses were recorded in 2012, and the banking system remains sound with healthy levels of capital and liquidity.

Executive Board Assessment

In concluding the 2013 Article IV consultation with the Slovak Republic, Executive Directors endorsed the staff's appraisal, as follows:

After a strong recovery in the wake of the global crisis, the Slovak economy is expected to continue growing, but at a significantly slower pace in 2013. The Slovak Republic has been among Europe's most dynamic economies in recent years, largely due to sizeable foreign investment in the auto sector that led to rapidly rising exports, much faster growth than most others in the region, and limited vulnerabilities. Spillover risks are materialising, however, with weaker demand expected from trading partners, especially in Europe. This, coupled with still anemic domestic demand, has worsened the near-term outlook.

Risks are tilted to the downside. Domestic demand is expected to recover slowly but will remain restrained for some time due to on-going fiscal adjustment as well as high unemployment. If prolonged, high unemployment risks negatively affecting growth, fiscal consolidation, and debt ratios, as well as long-term labour participation and productivity. If weakness in Europe is deeper or more drawn out than expected, this could reduce export demand and contribute to uncertainty holding back investment. Integration into international supply chains has brought great opportunities, but can also amplify risks from trade shocks, underscoring the importance over the medium term of new sources of growth and export diversification.

Addressing very high unemployment - particularly youth and long-term unemployment - should be a top priority. Efforts underway to strengthen education, training, and active labour market policies (ALMPs) including targeting to disadvantaged groups are welcome, but are still at an early stage. Public employment services should be strengthened and funding for ALMPs - which was increased in the 2013 budget - should be a priority even amidst budget consolidation. Effective use of EU Funds will be especially important in these areas. Steps to streamline administrative burdens for businesses are also welcome, and should be complemented by action to achieve a more stable, open, and predictable business climate with respect to labour regulations, the legal environment, procurement practices, and corruption.

Slovakia has demonstrated its strong commitment to sustainable public finances but further progress is needed. The fiscal deficit has come down substantially since 2009 and important structural reforms have been implemented, such as those that strengthen the pension fund's finances, but other sources of revenue or savings have been temporary or have affected valuable projects such as those financed by EU Funds. Slovakia's gross public debt, which includes contributions to support other euro area members and a healthy level of cash balances, remains manageable. However, to avoid economically harmful effects from debt rising above thresholds under the Forward Rate Agreement (FRA) as well as to comply with EU targets, substantial additional adjustment measures will be needed for a number of years.

The 2013 fiscal deficit target is achievable, but automatic stabilisers should be allowed to operate if risks to growth materialise. Provisions in the 2013 budget, additional steps taken so far, and the government's readiness to take further measures that would have little macroeconomic impact suggest the 2013 target can be met. There are risks to this scenario, including the possibility of still weaker growth or difficulties controlling public wages and local government budgets. And should growth further disappoint, automatic stabilisers should be allowed to operate to avoid a further drag on output when growth is weakest.

Efforts should focus on identifying high quality fiscal measures for 2014 and over the medium term. Further fiscal consolidation is needed to ensure medium-term debt sustainability, and in light of EU rules and a domestic debt brake that would mandate an overly sharp move to balance the budget. In addition to maintaining the current VAT rate, adjustment efforts should focus on improving VAT collection efficiency and reducing tax evasion, introducing a property value-based real estate tax, and improving spending efficiency. Moving more quickly to a higher retirement age and potentially raising the overall age target would improve the long-term sustainability of the pension system.

A traditional banking model and prudent supervisory approach have contributed to a sound banking system. Slovakia's banking sector is liquid and well capitalised, with low and well-provisioned nonperforming loans (NPLs), although a weaker economic outlook could have effects on credit quality. Bank taxes have risen at a time when the operating environment is weak and credit to firms is declining, hitting profits. The levy should be lowered to be more in line with other countries in Europe and the proceeds allocated to a more well-defined special resolution fund. The size of the banking system has facilitated close supervision (and risks are low), but the current supervisory framework could be enhanced through a more well-specified intervention and resolution framework, in line with expected European directives and banking union developments.

Full press release

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