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Slovak Republic: Selected Issues and Statistical Appendix

Author(s):
International Monetary Fund
Published Date:
September 2002
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I. Slovakia’s External Current Account Deficit: Why So Large and Is It Sustainable?1

A. Introduction

1. Slovakia’s economic growth has been accompanied by recurring large external current account deficits. Slovakia’s external current account deficit widened through the late 1990s, reaching over 9 percent of GDP in 1996-98. With a strong macroeconomic policy adjustment in 1999, the external deficit was halved in 1999-2000, but widened sharply again in 2001 and—still at over 8 percent of GDP in 2002—remains around the levels reached in the mid-to late 1990s.

2. The large external deficit has raised macroeconomic risks, and may require adjustments in policies to address imbalances. Short-term vulnerability is low, but the external current account deficit remains above sustainable levels. Although the external deficit should start to narrow in the period ahead, as Slovakia starts to reap the export rewards of the industrial restructuring over the past few years, policy adjustments may still be needed to ensure the return of the external deficit to sustainable levels.

3. This chapter investigates the reasons for the large, recurrent external current account deficits in Slovakia, which are unusual by the current standards of other advanced transition economies, and the implications for external sustainability. The chapter focuses on the present episode (2001-02), and is organized as follows. Section B reviews the causes of the widening in the external deficit from 2001. Section C discusses Slovakia’s competitiveness and estimates a range for the external current account deficit that could be sustainable in the medium term, as well as assessing short-term vulnerabilities. Section D concludes.

B. The Reasons Behind the Widening Current Account Deficit

4. The deterioration of the current account balance stems from a combination of factors, some of them exogenous and temporary, and others of a more structural nature, compounded in 2001 by an expansionary fiscal stance (Table 1).

Table 1.Contribution to Widening of the External Current Account Deficit(In percent of GDP)
2001
Exogenous and Temporary Factors1.0
Slowdown in Europe0.5
Other factors0.5
Structural Factors3.0
Investment demand1.5
Consumption shift1.5
Total Analyzed Factors4.0
Of which:
Impact of policy measures0.9
Fiscal expansion0.4
NPF redemption0.5
Source: IMF staff Calculations.
Source: IMF staff Calculations.

Exogenous and temporary factors

5. The downturn in Western Europe, Slovakia’s main export market, adversely affected export performance and contributed about ½ percent of GDP of the widening of the current account deficit in 2001-02.2 The slowdown in exports—real growth decelerated from 13.8 percent in 2000 to 6.5 percent in 2001—can be almost fully explained by the weak external environment. Non-oil exports decelerated less markedly in 2001 than European non-oil imports, indicating that Slovak exporters have continued to gain market share in the European markets (Figures 1-2). Moreover, the buoyant growth of exports in 2000 was partly due to the production pattern of the car manufacturer Volkswagen Slovakia, which accounts for 15 percent of Slovakia’s exports. When car exports are excluded, the gain in market share in 2001 appears even more marked (see Figure 1). This evolution seems to indicate that Slovak exports remain competitive and that the recent slowdown in exports is likely to be temporary.

Figure 1.Market Share of Slovak Exports in EU Markets

(Slovak Exports to EU Imports *)

Citation: 2002, 210; 10.5089/9781451835489.002.A001

* EU Imports exclude Intra-EU trade and Oil Imports

Figure 2.Export Growth Slowdown

6. Other temporary factorssuch as the production pattern of Volkswagen Slovakia and the bad agricultural harvestcontributed to the deterioration of the current account by an additional ½ percent of GDP in 2001-02?.3 Volkswagen Slovakia’s production growth is characterized by a stop-and-go pattern, with periods of slow growth (such as 2001-02) succeeding periods of booms at the launch of new product lines (such as in 2000 and the one expected in mid-2002). This production pattern contributed to weaker Slovak exports in 2001 and early 2002, causing a temporary increase in the external current account deficit of about ¼ percent of GDP.4 The bad harvest in 2000–01 led to higher imports of agricultural and food products resulting in a further deterioration of the external current account deficit of about ¼ percent of GDP.5

7. The exogenous and temporary factors that affected Slovakia’s external position in 2001-02 fell short of explaining the overall deterioration of the current account deficit. After discounting for these factors, the underlying current account deficit remains large at about 7½-8 percent of GDP in 2001-02, compared with about 4 percent of GDP in 2000. This suggests that there are other factors—either structural or policy-induced—that contributed to the external imbalance.

Structural factors

Investment demand

8. The surge in the external current account deficit in 2001 partly reflects import-intensive investment activities. Fixed investment grew by 9.6 percent in real terms and was boosted by enterprise restructuring, increased profitability, and a reduced corporate income tax rate6. More than 10 percent of investment was related to greenfield foreign direct investment which amounted to 3.8 percent of GDP in 2001. This buoyant investment activity was highly import intensive and led to a sharp increase in the import of capital goods (Figure 3).

Figure 3.Growth in Investment and Import of Capital Goods

9. The surge in the investment activity in 2001 contributed about 1½ percent of GDP to the enlarged current account deficit. The contribution of investment demand to the current account deficit was estimated based both on the acceleration in imports of capital goods, and also on the surge in gross capital formation (Table 2).

Table 2.Impact of the Investment Demand on the Current Account Balance
Growth RatesAcceleration 2001/97-2000Impact on CA 2001
1997-20002001
(a)(c)(d)=(c)-(a)
Gross capital formation 1/4.115.211.11.9 percent of GDP (d)*(f)*(g)
Import of capital goods 2/17.327.810.51.5 percent of GDP(d)*(e)
Memorandum Items:in Percent
Imported capital goods to GDP in 2000(e)14.6
Import-content of new investment 1999-2001(f)65.0
Investment to GDP in 2000(g)26.4
Sources: Slovak Statistical Office; and IMF staff estimates.(f) is defined as the ratio between the increase in imported capital over 1999-2001 and the increase in gross investment over 1999-2001.

Growth rates in constant price.

Growth rates in koruna terms.

Sources: Slovak Statistical Office; and IMF staff estimates.(f) is defined as the ratio between the increase in imported capital over 1999-2001 and the increase in gross investment over 1999-2001.

Growth rates in constant price.

Growth rates in koruna terms.

A secular shift in consumption behavior

10. The widening of the current account deficit was also partly caused by a surge in imports of consumer goods. A detailed analysis of the composition of imports indicates that the surge in imports, which started in the second half of 2000, occurred across a wide range of product categories. Capital and intermediate goods increased sharply but so did consumer goods. For the first half of 2001, consumer goods explain one-third of the increase in imports (Box 1 and Table 3).

Table 3.Impact of the Consumption Increase on the Current Account Balance
Growth RatesAccelerationImpact on CA
1997-200020012001/97-20002001
(a)(c)(d)=(c)-(a)
Domestic consumption 1/1.14.23.11.4 percent of GDP (d)*(f)*(g)
Import of consumer goods 2/17.827.810.01.7 percent of GDP(d)*(e)
Memorandum Itemsin Percent
Imported consumer goods to GDP in 2000(e)16.6
Import-content of new consumption 1999-2001(f)60.0
Consumption to GDP in 2000(g)76.0
Sources: Slovak Statistical Office; and IMF staff estimates.(f) is defined as the ratio between the increase in imported consumer goods over 1999-2001 and the increase in consumption over 1999-2001.

Growth rates in constant price.

Growth rates in koruna terms.

Sources: Slovak Statistical Office; and IMF staff estimates.(f) is defined as the ratio between the increase in imported consumer goods over 1999-2001 and the increase in consumption over 1999-2001.

Growth rates in constant price.

Growth rates in koruna terms.

11. The surge in imports of consumer goods contributed about 1½ percentage points of GDP to the deterioration of the current account deficit in 2001. The contribution of the surge in consumer imports was estimated by assessing separately the acceleration in the import of consumer goods and the surge in domestic consumption (Table 3).

Box 1.The Surge in Imports in 20011

For the first half of 2001, consumer and capital goods increased relatively more rapidly than intermediate goods.

  • While imports of intermediate goods increased by 25.2 percent on an annual basis in current prices during the first half of 2001, imports of capital goods increased by 32.6 percent and imports of consumer goods increased by 34.7 percent during the same period.

  • The surge in the imports of capital goods was driven to an important extent by foreign direct investment and joint-venture companies, but reflected also a broader momentum in investment activities.

  • The surge in consumer goods cannot be explained entirely by the temporary increase in food items (33.4 percent) and car imports. There was also a sharp increase in a number of product categories, mainly consumer goods: in the first half of 2001, imports of TV and radio receivers rose by 66.8 percent in current prices, imports of computer equipment by 50.4 percent, imports of textiles by 30.5 percent, and imports of miscellaneous manufactures by 60.8 percent.

  • The relatively lower growth in the import of intermediate goods reflected largely the subdued growth in mineral products: non-oil intermediate goods grew by 29.6 percent.

Comparing growth rates in the first half of 2001 to past growth trends, it appears that imports in consumer goods accelerated from 14.3 percent on average in the period 1998-2000 to 34.7 percent in the first half of 2001, while imports in intermediate goods accelerated from 17.0 percent to 25.2 percent. However, the growth in the import of capital goods accelerated more rapidly than the growth for other commodities (from 9.0 percent to a buoyant 32.6 percent). Nevertheless, capital goods explain no more than one-third of the acceleration in imports in the first half of 2001 (Table).

Share in total importsAnnualized Y0Y Growth Rate in KorunaContribution to GrowthSource of Acceleration
20001998-2000200020011998-20002000200120012001 vs 1998-2000
AverageQ1-Q2AverageQ1-Q2Q1-Q2
(a)(b)(c)(d)(e)=(a*b)(f)=(a*c)(g)=(a*d)(h)=(g)in%(i)=(g-e)(j)=(i)in%
(Based on IMF Staff estimates)
Total import of goods100.014.526.030.014.526.030.0100.015.6100.0
Intermediate goods50.617.039.925.28.620.212.844.34.226.7
of which mineral products18.917.565.717.93.312.43.411.20.10.5
of which non-mineral products31.616.724.529.65.37.89.431.24.126.2
Capital goods21.89.014.632.62.03.27.123.75.233.1
Consumer goods27.614.318.034.73.95.09.631.95.73.63
(Based on Statistical Office estimates)
Total import of goods100.014.526.030.014.526.030.0100.015.6100.0
Intermediate goods57.118.933.426.910.819.115.451.14.529.2
Capital goods17.97.013.238.61.32.46.923.05.736.4
Consumer goods25.013.120.531.33.35.17.826.04.529.1
1 A breakdown of imports into capital, consumer, and intermediate goods is not readily available in the official statistics. To obtain this decomposition, it was necessary to use a disaggregated breakdown of imports and allocate the various items to die three main categories. Ad hoc assumptions were sometimes necessary since many items consisted of a mix of two or three categories. This exercise was performed separately by the IMF staff and the Statistical Office of the Slovak Republic. The composition of imports was analyzed based on both breakdowns. The table shows the results of the two analyzed sets, while the text refers to the results based on the IMF breakdown. Both breakdowns support the findings of the present box.

12. Notwithstanding the temporary exogenous factors, the surge in imports of consumer goods appears to be related to a secular shift in the propensity of households to spend on imported goods. As the transition process proceeds and real convergence takes place, the consumption pattern of households is likely to evolve toward the consumption pattern of higher income countries. Domestic firms would normally adapt their production to the changing demand within the limits of their competitive advantage, but a significant part of this evolving consumption will have to be met by an increase in imported goods, causing a deterioration in the current account deficit. In addition, short-term rigidities, restructuring needs, and possibly structural impediments might prevent domestic producers from adjusting their output in the short run, further increasing the need for imported goods and compounding the deterioration of the current account balance.

13. Countries that entered the EU 15-20 years ago, then having a substantial per capita income differential with EU countries, showed a substantial shift in consumption patterns over time, as their income converged to EU levels (Box 2).

14. Evidence suggests that this shift has already started to occur in Slovakia. First, the surge in the import of consumer goods appears to have outpaced the increase in gross disposable income and domestic consumption, indicating that the propensity to spend on importable goods has increased (Figures 4-5). Second, the analysis of the composition of imports indicates that the growth of some durable consumer goods has been particularly strong since mid-2000—such as the imports of cars, computer equipment (50.4 percent in current prices), TV and radio receivers (66.8 percent)—indicating that a change in consumption behavior driven by real convergence in income is taking place (Box 2). Finally, there is evidence that Slovak firms producing consumer goods are losing market share in the domestic market, as successful foreign retail chains that tend to sell foreign goods are increasingly shaping consumers’ preferences.

Figure 4.Growth in Consumer Import and Domestic Consumption

Figure 5.Growth in Consumer Import and Gross Disposable Income

Box 2.Evidence of Convergence in Consumption Patterns

There is evidence that the evolution of Slovak household consumption patterns toward the patterns of the wealthier European Union countries is already under way. This conjecture is supported by the analysis of the consumption patterns of two large consumer goods, passenger cars and televisions.

Based on data for selected EU countries, Figure A illustrates that, as real income increases, the number of cars per capita increases. Slovakia is following this pattern and currently the propensity to consume passenger cars in Slovakia is as high as it was for Greece and Portugal when household incomes were at similar levels in these countries.

Figure A.Wealth Effect on Cars per Capita, 1978-99

Based on available data, Figure B suggests that the number of televisions per capita also increases with real income. The trend observed for Slovakia appears to show that convergence in consumption in this area is proceeding quickly. Indeed, the number of televisions per capita in Slovakia is higher than in Portugal for similar income levels.

Figure B.Wealth Effect on Televisions per Thousand, 1995–99

15. Structural factors appear to have been more pronounced in Slovakia than in other countries in the region. Indeed, Slovakia started the process of economic transformation later than most neighboring countries, and its initial level of income was lower than the Central European countries’ (CEC5)7 average. Moreover, the country’s specialization in heavy industries prior to 1990 was to the detriment of consumer goods production industries, and required more enterprise restructuring than in some neighboring countries later on. This restructuring is still in process. More broadly, the Slovak pattern of economic growth accompanied by large current account deficits has not been evident in the other CEC5 economies (Box 3).

The role of macroeconomic policies

16. Fiscal expansion—reflecting both above- and below-the-line items—is estimated to have contributed about 1 percent of GDP of the external deficit widening in 2001. As noted earlier, the general government deficit widened in 2001 by ½ percentage point of GDP, to 4.0 percent of GDP. Once the increase in state-guaranteed debt is included in the overall fiscal position, government net savings deteriorated by 0.8 percent of GDP in 2001. Assuming that about half of this deterioration was offset by higher private sector savings, the looser fiscal stance in 2001 would have contributed about 0.4 percent of GDP to the enlarged external current account deficit in 2001.8 Some fiscal measures, such as the removal of the import surcharge and the reduction in corporate and personal income tax rates in 2001, are likely to have particularly fueled the demand for imports. Moreover, a large below-the-line operation—the repayment of National Property Fund (NPF) bonds9—improved the liquidity position of households, resulting in an increase in consumption. This repayment is estimated to have contributed an additional ½ percent of GDP to the current account deficit.10

Box 3.Current Account Deficits in Other Advanced Transition Countries

Slovakia’s economic growth has been accompanied by large external current account deficits—more so than in other countries in the region. In 1996-98, and again in 2001-02, Slovakia was the only country in the region with a large current account deficit. In contrast, the CEC5 countries generally managed to maintain an external current account deficit below 5 percent of GDP (table).

Domestic Demand Growth and Current Account Deficits in the CEC5 Countries
1996-981999-20002001-02
Slovakia
Current account deficit (percent of GDP)-8.8-4.3-8.6
Real GDP growth5.51.83.7
Real domestic demand growth9.6-3.15.3
Consumption7.2-0.54.0
Gross investment15.8-8.79.0
Region (simple average, CEC5, excl. Slovakia)
Current account deficit (percent of GDP)-2.9-4.5-3.2
Real GDP growth3.53.82.8
Real domestic demand growth4.43.73.0
Sources: Slovak Statistical Office; WEO, Winter 2002 Board version; and staff estimates.
Sources: Slovak Statistical Office; WEO, Winter 2002 Board version; and staff estimates.

C. Short-Term Vulnerability and Medium-Term Sustainability

17. Even after netting out the impact of the exogenous and temporary factors, the underlying current account deficit in 2001-02 (of about 7½—8 percent) remains higher than the levels that could safely be financed over the medium term (about 6-7 percent). To assess the resulting increase in macroeconomic risks, staff analyzed the competitiveness of the Slovak economy, financing issues over the medium term, and the near-term risk of balance-of-payment crisis.

Competitiveness

18. A broad range of indicators show no evidence that the external imbalances reflect cost-related competitiveness problems.

  • Although the CPI-based real effective exchange rate (REER) has appreciated by about 8 percent from 1995 through end-2001, this modest appreciation is unlikely to have led to a loss of competitiveness and compares favorably with appreciations in neighboring countries (Figure 6). In fact, the real appreciation appears to be part of the real convergence and is expected to continue in the coming years.11

Figure 6.CPI-based Real Effective Exchange Rate

  • Over the long-run, Slovakia’s ULC-based REER remained in line with trends observed in Poland and the Czech Republic, with structural reform-induced productivity gains and moderate wage increases playing a leading role in preserving competitiveness (Figure 7).

Figure 7.ULC-based Real Effective Exchange Rate

  • The evolution of the euro-denominated wages in the industrial sector shows that wage growth in Slovakia has been in line with trends in neighboring countries and that Slovakia remains a country with relatively cheap labor12 (Figure 8).

Figure 8.Average Gross Monthly Wages in Industry

(in Euro)

19. Moreover, Slovakia’s continued strong export performance points to the sound competitiveness of Slovakia’s export sector. The country’s export performance to the EU was the strongest in the region, with the share of Slovak exports in the total EU imports more than doubling from 1993 to 2001. This rapid penetration of the EU markets reflects not only the end of managed trade and a burst of economic relations with Western Europe, it also points to the sound competitiveness of Slovakia’s export sector (Figures 9 and 10).

Figure 9.Export to EU as share of Total EU Imports*

(in percent)

* excluding intra EU trade and oil imports

Figure 10.Export to EU as share of Total EU Imports*

(index 1993=100)

* excluding intra EU trade and oil imports

20. Slovakia’s business environment, though slightly less attractive than in neighboring countries, has improved substantially over the past years and became conducive to sound investment and effective restructuring. For the period 1996 to 2000, the Economist Intelligence Unit Report on World Investment Prospects ranked Slovakia 37th with respect to the business environment, with other CECs placed between 26 (Hungary) and 32 (Czech Republic)13 (Figure 11). The structural reforms implemented since 1999, including the restructuring of the banking sector, the privatization of some important state-owned companies, the improvement of fiscal transparency and the curtailment of some quasi-fiscal activities, have substantially improved the business climate and created an environment that is more conducive to profitable investment.

Figure 11.EIU Business Environment Scores

(out of 10)

Figure 12.Slovak Scores by Category 1996–2001

(as a percentage of CEECs average scores)

21. As a result, substantial restructuring occurred in the corporate sector, as reflected in strong productivity increases, improved profitability and sustained export growth (Figure 13-14). To increase productivity, firms usually downsized their workforce, reorganized their activities, and upgraded their technology. Gains in productivity, together with higher export sales and lower taxation, resulted in a strong improvement in profitability, in particular in the industrial sector.

Figure 13.Evolution of the Profitability of Enterprises

Figure 14.Productivity Gains

22. However, further restructuring remains necessary to preserve competitiveness, and many companies still need to reassess their strategic positioning in an environment that is increasingly integrated with the global economy. Despite the absence of cost-related competitiveness problems, some firms are losing market share in the domestic market to foreign producers, as they are having difficulties adapting to evolving consumer preferences and changing market structures (Box 4).

23. The unfinished transformation of the enterprise sector has increased the reliance of the economy on imported goods, contributing to the widening current account deficit. As noted, consumer demand has been relying to a large extent on imported goods because domestic producers have had difficulties adapting to the new competitive environment. Also, many large enterprises have had difficulties finding reliable good quality domestic suppliers and needed to rely primarily on imported intermediate goods.

Medium-term sustainability

24. From a financing point of view, the current account is sustainable if the resulting net foreign debt ratio is not increasing. To achieve this end, debt-creating flows—needed to finance the share of the deficit that is not covered by nondebt creating flows—should not increase the net foreign debt faster than GDP. This condition is given by: CA = (g*/(l+g*)) NFD + B where CA denotes the current account as a share of GDP, g* the GDP growth in foreign currency terms, NFD the net foreign debt ratio, and B net nondebt-creating inflows as a share of GDP. However, a stable or declining external debt ratio is a arbitrary condition of sustainability, in the sense that it ignores differences in the initial debt levels.

25. An alternative, and arguably more meaningful approach, is to consider that the current account is sustainable if the resulting gross external debt ratio (GED) converges in the medium-term toward the average debt ratio in countries with similar characteristics (for instance the CEC5 countries), while assuming that foreign assets remain constant in terms of GDP. For Slovakia, this implies a tighter constraint on the current account, as its current level of gross external debt is higher than the CEC5 average.

26. Estimates based on Winter 2002 WEO projections indicate that a current account deficit of up to 5.8 to 6.8 percent of GDP would be sustainable in Slovakia in the medium- term, depending on whether the gross debt ratio is assumed to remain stable or decline to regional averages (Table 4). Similar estimates give rough limits for the current account deficit of 4.6 percent of GDP on average in the region. The relatively high level in the Slovak Republic is a direct reflection of large FDI inflows projected over the coming years including privatization receipts. These estimates, however, implicitly assume a growth path and FDI levels consistent with underlying policies, which in Slovakia, include a determined pursuit of fiscal discipline and implementation of structural reforms.

Table 4.Range of Sustainable Current Account Deficits in the CEC5 Countries
Nondebt-creating Flows (% of GDP)GDP Growth in DollarNet Foreign DebtGross Foreign DebtCA that is consistent with a
stable NFDconverging GED
2002-06 (B)2002-06 (g*)2001 (NFD)2001 (GED)
Slovak Republic6.910.5-0.649.76.85.8
Average C-54.47.23.044.74.64.6
Sources: WEO; IMF staff calculations.
Sources: WEO; IMF staff calculations.

Box 4.Two Cases on the Need for Corporate Restructuring

Company A

Company A is a small-size Slovak enterprise with 140 employees and Sk 220 million in annual sales, producing consumer products.

The company has been losing market share over the past few years, especially since large retail chains have dominated the distribution channels in Slovakia. With the change in the retail market, Company A is faced with (i) increased competition from low-cost foreign producers that, thanks to their larger range of products, are better positioned to negotiate with the retailers, and (ii) higher fixed costs, because the retail chains are requesting retail fees from the producers. In addition, consumers’ preferences are evolving and require increasing marketing efforts.

As a result, the financial position of Company A has become difficult. Despite a substantial downsizing of staff and significant productivity gains, profitability has been hit by stagnating sales and increasing distribution and marketing costs. In addition, the high level of indebtedness, inherited from the privatization process, is weighing on the ability of the company to finance needed investments.

Fundamentally, the fixed costs inherent to the company’s activity (R&D, advertisement, distribution fees, etc.) are too important to be sustained by a small-size enterprise and the current market positioning of Company A is unsustainable.

Company A is considering a number of options to continue growing:

  • Limiting the production under its own brand to a specific segment for which its products enjoy a strong reputation and a leading edge against competition, and developing a complete product line for this segment.

  • Continuing to produce most of its remaining products for other private brands, possibly under a retailers’ brand name.

  • Finding new sources of financing, preferably in the form of equity capital, to undertake the needed capital upgrades.

Company B

Company B is a medium-size Slovak enterprise of 910 employees. The company produces food products for other food producers and directly to the retail market; 30 percent of the output is exported.

The establishment of large retail chains affected the company’s activity by inducing (i) an increased competition from low-cost foreign producers, (ii higher distribution costs because of listing fees and other payments requested by the retail chains, and (iii) additional investment in warehouses to meet the wholesale requirements of the retailers.

The company enjoys a dominant position on the domestic market, and managed to preserve its market shares and margins, thanks to its close relations with agricultural suppliers, a substantial cut in its personnel, and an important investment program to modernize the production facilities and build warehouses. At the same time, the company was able to increase its exports, in particular to Eastern Europe.

However, the cost reduction strategy might soon find its limits, while the competition from multinationals and low-cost regional producers is likely to intensify. The company might then need to reassess its strategic positioning that could require the restructuring of its portfolio of activities and possible alliances with strategic partners.

27. Under appropriate policies, the external deficit should decline on its own accord once the present investment boom starts to pay off in the form of additional exports. In this regard, it is reassuring that an important share of investment has taken place in tradable sectors recently, while investment in nontradable sectors has fallen (Table 5).

Table 5:Sectoral Breakdown of the Gross Fixed Capital Formation
Share in Total GFCF 2000Growth Rate 2001Contribution to 2001 Growth
Agriculture3.315.53.3
Mining0.6-5.7-0.2
Manufacturing24.722.335.3
Electr., gas and water supply10.718.612.7
Construction2.3-21.4-3.2
Wholesale11.727.420.6
Hotels and restaurants1.6-49.3-5.1
Transport, communications8.717.59.8
Financial intermediation10.245.329.6
Real estate, renting15.9-13.6-13.9
Public administration6.825.711.2
Education1.0-22.8-1.4
Healt and social works1.15.20.4
Other community1.59.50.9
Total100.015.6100.0
Sources: Slovak Statistical Office; IMF staff calculations.
Sources: Slovak Statistical Office; IMF staff calculations.

28. According to staff projections, the external position would remain sustainable in the medium term assuming corrective fiscal measures are implemented (Table 6, adjustment scenario). As exports recover with European demand and recent export-oriented investment activities start to pay off,14 the tighter fiscal stance would contribute to moderate import growth. As a result, the current account deficit would decline steadily, while strong FDI inflows would further ease the financing constraints. In fact, the ratio of gross external debt to GDP would decline rapidly as part of the privatization receipts is used to reimburse the outstanding public debt and the shrinking current account deficit would allow a reduction in private sector indebtedness.

Table 6.External Indicators, 2001–06
200120022003200420052006
Adjustment scenario 1/
Current account deficit (in percent of GDP)-8.6-8.5-7.2-6.3-5.4-4.7
Total debt (in percent of GDP)55.853.446.442.538.234.0
of which public sector debt17.416.19.98.57.15.9
of which private sector debt38.437.336.534.031.128.1
Reserves in months of imports3.05.34.13.83.42.9
Reserves/Adjusted short-term debt (percent)92.9136121134132133
Nonadjustment scenario
Current account deficit (in percent of GDP)-8.6-8.8-8.5-7.5-6.5-5.8
Total debt (in percent of GDP)55.856.552.249.846.943.8
of which public sector debt17.416.710.49.07.56.2
of which private sector debt38.439.841.840.839.437.6
Reserves in months of imports3.05.34.13.83.32.9
Reserves/Adjusted short-term debt (percent)92.9130.5105.7107.396.888.2
Source: IMF staff estimates.

The adjustment scenario is based on fiscal measures for over 3/4 percent of GDP in 2002 and over 2 percent of GDP in 2003(see Staff Report for the 2002 Article IV Consultation with the Slovak Republic).

Source: IMF staff estimates.

The adjustment scenario is based on fiscal measures for over 3/4 percent of GDP in 2002 and over 2 percent of GDP in 2003(see Staff Report for the 2002 Article IV Consultation with the Slovak Republic).

29. In the absence of a strong program of external adjustment, the external position would remain vulnerable in the medium term (Table 6, nonadjustment). This scenario would entail higher imports, a more depreciated exchange rate, weaker FDI inflows, and lower foreign reserves. However, the pressures on the external accounts would be somewhat mitigated by the recovery of European demand and the more depreciated exchange rate. As a result, although the ratio of gross public debt to GDP is expected to decline, the private sector debt would remain high and the amount of official reserves would eventually not be sufficient to fully cover the short-term debt. Such an outlook would increase macroeconomic risks. In particular, the export recovery could prove more modest than anticipated, as uncertainties would remain about the true profitability of current investment activities.

Short-term vulnerability

30. Short-term vulnerability is low (Figures 15 to 17), but could increase if a combination of adverse shocks were to materialize. While the Slovak economy seems capable of withstanding an isolated shock,15 a combination of adverse developments could put the private sector in a difficult situation. Such a scenario could result from the political dynamics before and after the September elections. For example, the central bank could increase interest rates further because of inaction on the fiscal front and widening external imbalances, and the exchange rate could continue to depreciate, driven by a deterioration of market sentiment. Under this scenario, the cumulative impact of exchange rate depreciation, interest rate increases, and more difficult market access could put some enterprises in a complicated financial situation, with possible spillovers to the banking sector. However, stress testing exercises suggested that, in the case of interest rate and exchange rate shocks, systemic distress only occurs at relatively large shock levels, while banks can weather significant credit shocks due to their high levels of capitalization. Moreover, as already noted, the high level of international reserves, compared with the amount of debt falling due, should help mitigate the effects of capital movements on the exchange rate.

Figure 15.Total Debt to GDP

Figure 16.Reserves to Adjusted Short Term Debt

Figure 17.Reserves in Months of Import

D. Conclusions

31. The deterioration of the current account balance stems from a combination of factors, some of them exogenous and temporary, and others of a structural nature. Once the temporary factors are netted out, the current account deficit remains large, reflecting structural developments related to the ongoing transition and convergence processes, including buoyant investment demand and a surge in consumer goods imports. Macroeconomic policies also contributed to the widening of the external deficit in 2001.

32. A broad range of indicators show no evidence that Slovakia’s external imbalances reflect cost-competitiveness problems, although further restructuring in the corporate sector is still needed. Despite the substantial restructuring that already occurred in the corporate sector, some domestic firms have difficulties competing with imported goods, indicating the need for these enterprises to adapt their production to the evolving demand and reassess their strategic positioning in an environment that is increasingly integrated to the global economy. It underscores also the need for further restructuring in order to preserve competitiveness. The unfinished transformation of the corporate sector and the difficulties of many enterprises to adjust to the new environment have increased the reliance of the economy on imported goods, contributing to the wider external current account deficit.

33. The present size of the current account deficit is difficult to sustain, although this deficit should start to narrow in the period ahead. The estimates presented here indicate that an external current account deficit of some 6-7 percent of GDP would be sustainable over the coming years—somewhat below its present level. The deficit should start to narrow in the period ahead, led by export growth as demand recovers in Europe. Moreover, the recent investment boom is creating higher export capacity and promoting import substitution, strengthening the supply-side response. Even so, policy adjustments may still be needed to bring the deficit back within the sustainable range.

34. Near-term vulnerability is low, but this will be sustained only if the external deficit starts to narrow. The recent series of large privatizations has allowed for a substantial run-up in international reserves, sharply reducing vulnerability. But although the Slovak economy should be resilient to isolated shocks, a combination of adverse developments could still threaten the private sector. In particular, such a combination—for example, high interest rates and a depreciated exchange rate—would be more likely if the external current account deficit remains high. This underscores the need to address macroeconomic imbalances and for a broad consensus supporting the “adjustment” variant for policies in the period ahead.

Prepared by Patrick Megarbane.

The loss to Slovak exports caused by the slow growth in Western Europe has been estimated by assuming that the ratio of the trend to actual growth in Slovak non-oil real exports is equal to the ratio of the trend to actual growth in European real imports. The import-content of Slovak non-oil exports is assumed equal to 60 percent, in line with trade equations calculated by staff and consistent with the assumption used by the Slovak Statistical Office.

The impact of higher energy prices on the current account balance has not been included because the increase in energy prices occurred in early 2000. Thus, it cannot account for the increase in the deficit in 2001. Moreover, although Slovakia imports a significant amount of fuel products, the impact of fuel prices on the current account is limited, due to substantial refinery and re-export of fuel products. Thus, the (first round) impact on the current account deficit of a $5 per barrel increase in oil prices is estimated at 0.5 percent of GDP.

The impact of Volkswagen Slovakia’s production pattern has been estimated by comparing the actual and projected production over the period 2000-05 by its log-linear regression and using the actual value for the import content of production (78 percent).

The impact of the bad harvest on the current account deficit has been estimated by comparing the actual import growth of agricultural products in 2001 with its historical trend.

The corporate income tax rate was reduced from 40 percent to 29 percent effective January 1, 2001.

The CEC5 countries are the Czech Republic, Hungary, Poland, the Slovak Republic, and Slovenia.

The authorities assume that about 70 percent of any increase in domestic demand would translate in increased imports.

NPF bonds were issued in 1996 in lieu of vouchers when the second wave of voucher privatization was cancelled. These bonds were redeemed in 2001 and 2002.

It is estimated that 40 to 60 percent of the retired NPF bonds has been spent contributing to an increase in domestic demands of about ¾ percent of GDP and implying a deterioration of the external deficit by about ½ percent of GDP (assuming that 60 percent of the spending went to imports; see Table 1).

During the transition process, a number of factors might be expected to contribute to an appreciation of the REER, including the Balassa-Samuelson effect, productivity gains stemming from economic restructuring and improvement in the quality of goods, elimination of price controls, changes in the composition of public spending and persistent capital flows.

Comparing wages across countries can be difficult because of the difficulty in correctly capturing the indirect direct labor costs.

More specifically, the strongest factors explaining Slovakia’s attractiveness as a business location are considered to be the availability of competitively priced and skilled labor as well as open trade and exchange regimes. On the other hand, market opportunities, financing and policies toward foreign investment are seen as the main weaknesses of the Slovak economy relatively to its neighboring countries (Figure 12).

After several months of negative growth, exports increased in April 2002 by 8.6 percent in dollar terms on an annual basis. It is, however, too soon to tell whether this would the beginning of the turnaround in export performance.

For instance, a depreciation of the exchange rate would not by itself trigger a wide-ranging crisis, as the effects on foreign currency-denominated debt, which is largely concentrated in the export sector, would be offset by export proceeds. Moreover, the central bank would likely intervene to limit the extent of the depreciation. Similarly, a moderate increase in interest rates would affect the currently sound profitability of the private sector but is unlikely to cause substantial financial distress. Also, a sudden change in market sentiment, which could lead to a reversal in capital flows, would not substantially affect the external position nor the financing ability of firms, as two-third of the short-term debt is related to trade credits, part of which among affiliated companies.

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