Journal Issue

Slovak Republic

International Monetary Fund
Published Date:
June 2011
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1. Following a deep but relatively short recession, the economy is returning to robust growth. Reflecting the importance of the export-oriented manufacturing sector, Slovakia benefited from the recovery in global demand for manufacturing goods. The surge in exports and expansionary fiscal and monetary policies against the background of a relatively sound financial sector have resulted in robust growth since the second half of 2009.

2. The strong economic rebound in 2010 and an upbeat outlook shift the policy focus from crisis prevention to normalization of policies with medium-term focus. Fiscal consolidation, which started with the 2011 budget, will have to continue with a view to achieving a medium-term sustainable target anchored by an effective fiscal framework. Strengthening medium-term fiscal planning, improving governance, and enhancing the efficiency of tax collections are also priorities. The financial sector should be further developed and deepened, in tandem with steps to reduce risks and limit rapid credit growth. Reducing the high unemployment rate, particularly in less prosperous regions, would be essential to enhancing welfare and maintaining robust medium-term economic growth. Strong productivity growth will be the key for maintaining external competitiveness.


A. A Recovery Led by Export-oriented Manufacturing Sector

3. Real GDP growth swung from a negative 4.7 percent in 2009 to 4 percent in 2010. The recovery, which has been larger than in most of Slovakia’s neighbors, was export led and supported by an expansionary fiscal policy. Consumer confidence is recovering, but the pace is very slow and private consumption remains subdued.

Evolution of Real GDP During the Crisis

(2007Q4=100, seasonally and working-day adjusted)

Sources: Eurostat; and Haver.

4. Slovakia benefited from the surge in global demand for manufacturing goods. The share of manufacturing in GDP is about 35 percent in Slovakia, compared to about 20 percent on average in the EU area. It is composed mainly of transportation equipment, machinery and electrical equipment. As the global demand for these goods expanded in 2010, following their collapse in 2009, Slovakia’s exports surged.

EU27 Industrial Production and GDP

(Percent change)

Sources: Eurostat; and Haver.

5. External competitiveness has remained robust and the exchange rate is broadly in equilibrium. Export of goods has expanded rapidly, reaching pre-crisis level by end-2010, and Slovakia gained market share. The current account deficit narrowed to 2 percent of GDP in 2010 from more than 6 percent of GDP before the crisis. While the trade balance (goods) swung into surplus, the income balance remained negative reflecting the relatively large negative net international investment position (approaching 70 percent of GDP). However, excluding FDI, the negative net investment position is only around 10 percent of GDP. The manufacturing sector’s real effective exchange rate (REER) based on unit labor cost remained stable, and CGER calculations suggest that the exchange rate is broadly aligned with its estimated equilibrium value.

Real Effective Exchange Rate

(Seasonally adjusted, 2000=100)

Sources: Haver Analytics, INS, OECD, and IMF staff calculations.

6. Financial conditions and the situation of the financial sector have improved. Credit growth is recovering gradually, and monetary conditions are supportive with a low interest rate and a modest real effective exchange rate depreciation. At the same time, banks have enhanced their balance sheet and improved capital and liquidity ratios. Profits rebounded in 2010, reflecting cost cutting measures, higher interest rate spreads and lower provisions, notwithstanding a still high level of nonperforming loans.

7. CPI inflation dropped to among the lowest in the euro zone in 2010, but jumped in early 2011. Weak domestic demand against a background of low energy and food inflation reduced inflation to a historically low rate of 1 percent (y-o-y) in November 2010. However, reflecting the global increase in the price of oil and other commodities, and in part because of indirect tax hikes at the beginning of 2011, CPI inflation jumped to 3.2 percent (y-o-y) in January 2011 and further accelerated to 3.8 percent in March. However, the projected tightening of monetary conditions will help reduce the impact of second-round effects.

Headline and Core Inflation

(Percent change)

Sources: Eurostat; and Haver.

8. Notwithstanding the robust GDP growth, the general government deficit remained high in 2010, at 7 ¾ percent of GDP. The deficit had widened to about 8 percent of GDP in 2009, as revenue contracted sharply and spending continued to expand at a fast pre-crisis pace. Although revenue recovered in 2010, the pace fell short of GDP growth, reflecting the export-led recovery and subdued private consumption and employment. With expenditure growth declining only marginally, the deficit was almost unchanged from its 2009 level.

Revenue, Expenditure and Deficit

(Billions of euros)

Sources: WEO; and IMF staff calculations.

9. The economic recovery has had little positive effect on employment. Unemployment, which was already relatively high prior to the recession, spiked to over 14 percent, and is even higher among low-skilled workers and in less prosperous regions. As workers with lower-than-average wages were disproportionally affected by the employment cuts and also reflecting wage indexation mechanisms, nominal wage growth only briefly turned negative in 2009 and bounced back to above 5 percent (year-on-year) in 2010. With the turnaround in economic activity, employment started to recover in late 2010, but the gains, so far, have been small and insufficient to prevent an increase in long-term unemployment.

Real GDP and Employment

(Seasonally and working-day adjusted)

Sources: Eurostat; and Haver.

B. Outlook and Risks

Staff’s Views

10. The outlook is for robust balanced growth, but significant risks remain. Although private consumption and investment have remained subdued so far, the expected modest recovery in employment and economic sentiment would bring some growth in domestic demand. This would help offset the withdrawal of fiscal support and moderation of export growth. Notwithstanding, because Slovakia’s exports to Germany are largely intermediate products for goods with export destinations outside the EU, the impact of the projected slowdown in Germany would be limited. Overall, real GDP is projected to grow by about 3 ¾ percent in 2011 and by about 4 ¼ percent in 2012–15, among the strongest performances in the EU but still significantly below the pre-crisis rate of expansion.

11. The upbeat outlook is supported by positive high frequency indicators. Economic sentiment continues to improve, real estate prices are stabilizing, industrial production is surging, and employment growth is finally starting to pick up.

12. External and domestic risks remain substantial, some improvement since last year notwithstanding. The global economic environment remains clouded, facing risks associated with simultaneous and uncoordinated fiscal consolidation efforts, possible loss of market confidence related to sovereign risk developments, and uncertain oil and other commodity prices developments. Domestically, a renewed decline in real estate prices would hinder consumption, and investment. A loss of fiscal credibility, if the government fails to achieve fiscal consolidation, would increase interest rates and reduce investment and private consumption.

Authorities’ Views

13. While robust growth is projected to continue in 2011 on the back of the export sector, private consumption will remain subdued. Expectations related to the fiscal consolidation increase consumer uncertainty, which, in combination with lower employment growth, translates into a less optimistic projection of households’ consumption in 2011. Overall, real GDP in 2011 is projected to grow by 3.4 percent, driven primarily by foreign demand, investment and stocks.

14. However, from 2012 onwards real GDP growth is projected to accelerate to 4.8 percent. Reflecting the projected recovery in employment, private consumption is expected to rebound and expand by 3.5 percent in 2012. Export growth and investment will continue to be robust reflecting the global outlook.

15. Against the background of the global increase in food and commodity prices, and the increase in VAT and excise taxes, inflation is expected to increase in 2011 onward. Inflation is expected to reach 3.4 percent in 2011, with the higher VAT and excise taxes and other fees contributing near 1 percentage point. Reflecting the global environment, inflation is expected to decline only slightly in 2012 and remain at about 3 ½ percent onward.

Figure 1Slovak Republic—Recent Sector Developments, 2007–10

Figure 2Slovak Republic—Inflation and Monetary Developments, 2004–10


With the stabilization of growth the key fiscal policy challenge is to set a consolidation path toward a medium-term target that ensures sustainability. Following important fiscal adjustment this year, consolidation will need to continue during 2012–13 with a view to bringing the government deficit below 3 percent of GDP in 2013. The authorities’ fiscal policy priorities should guide the composition of the adjustment. Simultaneously achieving these priorities and the consolidation targets will require broad-ranging revenue efforts and expenditure reallocation and cuts.


16. In spite of the recovery, the general government deficit remained high in 2010, at 7 ¾ percent of GDP. The deficit had widened to about 8 percent of GDP in 2009, as revenue contracted sharply and spending continued to expand at a fast pre-crisis pace. Reflecting a subdued revenue performance and continued strong expenditure growth, the deficit was almost unchanged from its 2009 level, and was among the highest in the region.

Overall Fiscal Balance(Percent of GDP)
Czech Republic-3.6-2.6-0.7-2.7-5.8-4.9
Euro Area-2.5-1.3-0.7-2.1-6.3-6.1
Sources: National authorities; and WEO.
Sources: National authorities; and WEO.

17. The 2011 budget contains a front-loaded fiscal adjustment. It includes various revenue and expenditure measures amounting to about 2 ½ percentage points of GDP. Expenditure cuts include a reduction in the public wage bill, intermediate consumption, subsidies, and investment. On the revenue side, the main measures are a temporary rise in the VAT rate by 1 percentage point to 20 percent and higher excise taxes.

18. Although the general government debt rose rapidly during the crisis, it remains relatively low and has a relatively long maturity. The debt reached 41 percent of GDP in 2010. The foreign currency component is negligible following euro adoption, and the maturity profile is spread uniformly over the next 10 years. The domestic financial sector is the main investor in Slovak government bonds, providing additional stability. Nevertheless, contingent liabilities associated with state-owned companies and the National Bank of Slovakia (NBS) could add to the debt. The NBS has a negative equity position,1 which does not have immediate implications for its operations, but will need to be covered within a reasonable period of time according to ECB guidelines to ensure NBS financial independence.

Gross Debt

(Percent of GDP)

Source: WEO.

19. Market confidence, so far, remained intact. The relatively favorable debt position, the rapid rebound in economic growth and the credibility of the government’s commitment to fiscal consolidation have maintained market confidence. Spreads over corresponding euro zone benchmark German bonds, at around 130 basis points, and CDS spreads, at below 100 basis points, are relatively low. Primary market access has remained smooth, as reflected in very successful large bond issuances in mid-February and mid-April.

State Debt of Slovakia: Distribution by Maturity, 2010


Source: Slovakia’s Debt and Liquidity Management Agency, 2011

State Debt of Slovakia: Distribution by Instrument, 2010


Source: Slovakia’s Debt and Liquidity Management Agency, 2011

20. The authorities are considering a significant reform to simplify and harmonize social security contributions. The reform, to be implemented in the beginning of 2012, would reduce incentives to opt for self-employed status, and bring down collection costs. The proposed reform will add the employer’s social security and health contribution (about 35 percent) to the wage base considered for tax purposes. Out of the redefined gross wage employees will pay a combined 48.6 percent social security and health contribution and a 19 percent income tax. Self-employed will face an increase in social security and health contribution and reduced deductions. Overall, the reform, in its current design, will shift collections from social security contribution to income tax, and is projected to reduce revenue collections slightly. The reform maintains the contribution rate to the second pension pillar at 9 percent, which is high by CEE standards (Annex I).

21. A broad fiscal institutional reform is under preparation. The plans include a constitutional debt limit at 55 percent of GDP (below the Maastricht threshold) with increasingly strong sanctions—starting with a letter to Parliament, followed by an expenditure freeze, and ultimately the resignation of the government—when debt exceeds 45 percent of GDP. The debt ceiling will be complemented with rolling medium-term expenditure ceilings at the state level. Enhanced debt and debt service rules and a strict no bail-out clause are envisaged at the municipal level. An independent fiscal council will be tasked with preparing a sustainability report, setting the expenditure ceilings and evaluating compliance with debt and expenditure rules. Broad political support is sought for the reforms to ensure their viability and durability.

22. In addition, restructuring and privatization of state-owned companies is on the agenda. The authorities plan to transfer part of the activities carried out by state-owned companies to the private sector; restructure some companies (railways, Slovak radio and TV); and privatize shares in the Telecom Company, and several city heating companies. Other state-owned companies, including the Bratislava airport, will be slated for long-term leasing. These plans will help eliminate public sector losses, and the associated need for budget support, and repay part of the public sector debt.

Staff’s Views

23. The 2011 deficit is projected to decline to below 5 percent of GDP on the back of a welcome consolidation effort and further economic recovery. The size of the adjustment—around 2 ½ percentage points of GDP—and its composition are broadly appropriate. Implementing the planned expenditure cuts in full, particularly with regard to wages and municipal spending, may prove to be difficult. However, some higher-than-budgeted revenue on account of the improved economic conditions would help offset expenditure slippages.

24. Fiscal consolidation should continue with the aim of reducing the deficit to below 3 percent of GDP by 2013. Adhering to this anchor, in line with EU requirements, will help maintain market confidence and keep Slovakia’s interest premium low. The front-loaded adjustment in 2011 allows for a gradual consolidation path of about 1 percent of GDP a year during 2012–13. Pacing the adjustment will help to minimize the adverse impact on growth and to limit recourse to lower-quality and possibly unsustainable measures.

25. Fiscal adjustment efforts need to continue beyond 2013. A deficit near the 3 percent of GDP Maastricht ceiling provides no room for counter-cyclical fiscal policy in case of a downturn. Moreover, Slovakia has to prepare for a substantial increase in ageing-related expenditure pressures (see Annex I), and efforts to reform the pension and health systems need to continue. A deficit of 1 percent of GDP would be an appropriate medium-term target. It would leave room for considerable counter-cyclical fiscal policy, and reduce the debt-to-GDP ratio to less than 25 percent. A 1 percent of GDP deficit at the same time should allow for substantial capital and other growth enhancing expenditures, especially if the reforms to improve tax collections start to bear fruit.

26. The authorities’ fiscal policy priorities should guide the composition of the 2012–13 consolidation efforts. Priorities could include supporting growth through infrastructure investment and education; reducing the high unemployment and income disparity across regions; and strengthening the efficiency of the tax system. In addition, improving the quality and ensuring the financial soundness of the health care system remain a standing priority. The measures should include incentives to use generic pharmaceutical substitutes; co-payments for doctors’ visits and hospital care; and a stricter basic health care package, allowing some variations in basic insurance premiums (see IMF Working Paper No. 07/226, and recent OECD recommendations).

27. Simultaneously achieving these priorities and the consolidation targets will require fiscal planning, and broad-ranging revenue efforts and expenditure reallocation and cuts. The authorities’ projections are sound and the proposed measures reflect a credible commitment to achieve the 2013 deficit target. However, only raising some minor taxes and concentrating the expenditure efforts on cutting wages and operational costs as envisaged by the authorities may not be sufficient to meet their evolving priorities, and may erode some essential government services to unsustainably low levels. Moreover, it could lead to possible reductions in capital expenditures. Against this backdrop, the emphasis should be on raising revenue and on expenditure reallocation.

28. To enhance the allocation of resources, the medium-term consolidation path should be accompanied by an expenditure growth ceiling. Capping expenditure growth in real terms for 2012–15 would set a consolidation path toward a deficit of 1 percent of GDP. It would also facilitate the transition to the expenditure rules which are envisaged in the fiscal framework reform package, and which would be set by the proposed fiscal council according to the economic conditions.

29. The recently-proposed reform of the social security contributions system is a step in the right direction. The current system is inefficient, complicated, and inequitable. It features eighteen contribution rates; three different assessment bases with various minimums and maximums; and a large number of discretionary allowances and exemptions. In addition, self-employed pay significantly lower contributions. The reform simplifies and harmonizes the system, and to some extent improves equity. However, the built-in revenue loss, albeit estimated to be small at around ¼ percentage point of GDP annually, is a concern in light of the fiscal consolidation needs and the risk of larger losses than projected. It would be preferable for the proposed reform to remain focused on the main objectives of simplification, transparency and reduced incentives to opt for self-employed status and avoid major cuts in the rates, for which there is no room, or non-transparent changes. Maintaining the second-pillar contribution rate at its current level will contribute to the pillar’s sustainability.

30. Steps to harmonize and simplify social security contributions and to unify revenue collection could be complemented with efforts to broaden the tax base and improve the efficiency of VAT collection. Efforts to remove various tax deductions and exemptions should continue. The VAT revenue, as percentage of GDP, is the lowest in the region, despite having comparable rates, indicating an implementation gap and the need for improving VAT administration and harmonizing tax collections. Aligning the collection of income and social contributions could also help enhance the efficiency of tax collection. However, net revenue gains from harmonization, unified collection and improved VAT administration would be slow to materialize and should not be expected to contribute to the 2012–13 consolidation effort.

31. The plans to reform the fiscal framework are welcome. The proposals are guided by standards of best practice and are expected to enhance commitment, discipline and transparency. Efforts to secure broad political support with a view to enshrining the key reforms into the Constitution are particularly important. Broader efforts to increase fiscal transparency, including steps to clearly report and explain the NBS’s negative equity in its financial statements, should be considered and not be delayed until after the fiscal framework reform is agreed.

Authorities’ Views

32. The 2011 consolidation measures, including wage cuts, will be implemented in full and the deficit target will be met. As growth continues to be mostly export-driven, no significant over performance of revenue can be expected. However, the expenditure consolidation, including wage cuts, will be carried out according to plans. Indeed, the development of expenditures in 2011:Q1 is in line with planned executions.

33. The government is committed to bringing the deficit to below 3 percent of GDP by 2013. To reduce the deficit in 2012–13 additional measures will be required and are being discussed. These measures will include both revenue and expenditure efforts with the goal of reducing the deficit to 3.8 percent of GDP in 2012 and to below 3 percent of GDP by 2013. A freeze in public wages, further cuts in operational costs, and a substantial increase in real estate taxes could contribute importantly to the consolidation efforts. Adjustment will continue beyond 2013 with a target of about 1 percent of GDP.

34. Combating tax evasion and unifying tax collection remain high on the authorities’ agenda. Unification of collection of taxes, custom duties, and social security contributions is expected to increase revenue collection. Unification efforts are proceeding according to plan and could be largely completed by end-2012. Net revenue gains are not projected to materialize in the near future, and are not incorporated in next year’s budget projections.

35. The fiscal framework and the pension system are other reform priorities. Discussions are at an advanced stage, and the prospects for achieving a broad agreement on key reforms before end-2011 are good. As to the pension system, reform is essential to help curb expected ageing-related expenditure pressures and ensure sustainability. The proposed automatic alignment of the retirement age with changes in life expectancy and in the old age dependency ratio will help avoid repeated political discussions on adjustments in the parameters of the first pension pillar.

Box 1Public Investment and Absorption of the EU Funds in Slovakia

In contrast to overall investment, which has been relatively high reflecting extensive FDI, public investment has been relatively modest in Slovakia. In 2009, general government investment was among the lowest in the central and eastern European (CEE) region, amounting to about 2.3 percent of GDP. This low level in part reflects the relatively small size of the government, particularly excluding social benefits, subsidies and interest payments (see Annex I).

Government Spending and Public Investment, 2009 1/

(Percent of GDP)

Sources: Eurostat; and staff calculations.

1/ Government spending excludes interest payments, subsidies and social benefits.

Low public investment appears to have implications for the overall level of infrastructure, which appears to be below the level of infrastructure in other CEE countries. According to the 2011 World Economic Forum’s Global Competitiveness report ranking of infrastructure, Slovakia is below most emerging European countries, including regional peers (a higher ranking indicates a less favorable position).

Public Investment in Emerging Europe, 2009

(Percent of total government spending)

Sources: Eurostat; and staff calculations.

Infrastructure Rankings in the Global Competitiveness Index, 2011

Sources: World Economic Forum, 2011.

In part to help narrow the infrastructure gap with high-income EU member countries, Slovakia receives financial support through EU Funds. For the EU multi-year budget implementation period 2007–13, total available EU fund resources for Slovakia amount to close to 3 percent of GDP per year, including co-financing from the state budget at about 10 percent of the total (OECD, Economic Survey of the Slovak Republic, 2010). EU funds also serve other purposes, including in agriculture and education, and in part are disbursed directly to private sector recipients (only about 1/3 of the EU funds is available for government). In 2010, Slovakia received a total of euro 1.9 billion in EU funds, euro 653 million of which was disbursed to government—about euro 454 million for capital expenditure and the rest for current expenditures.

Absorption of EU funds is relatively slow compared with other CEE countries, which in part could reflect a different time profile of the planned disbursements. Oversight of the drawing of EU funds has been strengthened, and Slovakia is expected to absorb near 100 percent of its allocation by the end of the 2007–13 program—as was the case under the previous program.

Allocation of EU-related Spending 1/(Millions of euros)
Current expenditure8584101138199667321745636
Capital expenditure125131115177454464687217175
Source: National authorities.

Only inside the general government.

Source: National authorities.

Only inside the general government.

Box 2The System of Social Security Contributions in Slovakia

Current status:

The current system of social security and health contributions and income taxes in Slovakia is complex and costly to administer. Employers contribute 35.2 percent, and employees contribute 13.4 percent of gross wages and salaries—part of it for social security and part for health insurance. The amounts are capped by maximum assessment bases that depend on the average wages. All together, there are eight types of insurance; eighteen contribution rates; three different assessment bases (for personal income tax, social security contributions, and a special assessment base for economically-inactive people); various minimum and maximum assessment bases; a large number of discretionary allowances; a set of exemptions based on the employment status (employed, self-employed or contractual); different social security contributions for the employed and self-employed; and different deductions from gross income for the employed and self-employed for personal income tax purposes.

The favorable treatment of the self-employed distorts incentives and erodes revenue collection. Self-employed can use standardized deduction of 40 percent of income and then pay social security contribution on only half of the net amount. In 2009, the annual income subject to taxes and social security contributions was euro 5,600 for employees and euro 1,700 for the self-employed. Furthermore, approximately 80 percent of the self-employed who pay social security contributions pay the amount according to the minimum base. As a result on these differences, the number of people claiming such status increased by 34.3 percent between 2004 and 2010.

Proposed changes:

The main goals of the proposed reform (to be implemented from the beginning of 2012) are to simplify the system, make it more transparent and equitable, and create conditions for the unification of collection of taxes, custom duties, and social security contributions. The main change is to focus on overall labor cost (by adding the employers’ total social security contributions to the basic wage) and calculate a “super-gross wage” that would become a universal assessment base for social security contributions and personal income taxes. In addition, the proposed changes entail a standard single health contribution rate (9 percent) and a differentiated social security contribution rate (19 percent for employees, 16 percent for self-employed and 13 percent for contractual). Besides unifying different assessment bases for different types of insurance, the new arrangement will subject all workers to a uniform assessment base regardless of their employment status. The maximum assessment base will be replaced by maximum nominal contributions.

Because the 19 percent flat income tax is calculated from the super gross wage, the reform implies a shift of taxes from social security contribution to income tax. Based on the current proposed rates, the reform is projected to shift over euro 1 billion from social security contribution to income tax. Overall revenue collection is estimated to decline by about euro 70 million a year. The reform is also combined with a scheme to lower social security contribution rates. If fiscal deficit targets are achieved, rates will be cut by 1 percentage point every year with a maximum of 4 percentage points.

Fiscal Impact of Reforming the Social Security Contribution System(Millions of Euros)
Impact on social security contributions-1286-1378-1490
Impact on other revenues-284-304-329
Impact on personal income tax revenue150616111733
Total budgetary impact-64-71-86
Sources: National authorities.
Sources: National authorities.

Figure 3Slovak Republic—Selected Fiscal Indicators


The financial sector has strengthened and banks enhanced their balance sheets. However, similar to other CE4 countries, the financial sector is relatively underdeveloped, and dominated by banks. The key is to enhance safeguards to buttress the banking system, and take measures to encourage further development of the financial sector.


36. The financial sector is dominated by foreign-owned banks (see Annex II). The banking sector accounts for almost three quarters of all assets owned or managed by the financial sector. All banks, except two small ones, are controlled by foreigners through subsidiaries or foreign branches.

Assets, December 2010

Source: NBS.

37. Banks’ soundness and profits have improved with the resurgence of economic activity. A traditional banking model with little reliance on wholesale funding and limited investment in foreign securities helped banks withstand the global financial crisis. Nonetheless, during 2009 nonperforming loans surged and profits declined significantly before recovering in 2010. The rebound in profits, driven by cost cutting measures, higher net interest income and lower provisions, allowed banks to increase capital and liquidity ratios—regulatory capital was about 13 percent, and (core) tier 1 capital 11 percent in 2010. Furthermore, recent stress tests carried out by the central bank suggest that the banks can withstand severe shocks to output and inflation.

38. Nevertheless, risks remain. Nonperforming loans, particularly to the corporate sector, are still high, even though they started to decrease in the last quarter of 2010. Residential property prices have stabilized, but the commercial real estate and construction sectors remain a source of concern. Furthermore, even though banks have limited direct exposure to foreign securities, they could still be affected through the impact on their parent banks in case of renewed sovereign risk pressures in the euro area. Finally, a large share of the banks’ securities portfolio is in Slovak government bonds. While these bonds are low risk assets, a large concentration, in general, is a source of concern.

Nonperforming Loans

(Percent of total loans)

Source: IMF GFSR.

Staff’s Views

39. Strengthening supervision is essential, particularly with respect to cross border risks. As foreign parents banks can still withdraw liquidity, albeit within strict limits, and exchange assets with their domestic subsidiaries, it is important to monitor risks affecting parent banks and to continue to strengthen synergies with the European Banking Authority and home supervisors of parent banks. In addition, it is essential to remain vigilant to prevent excessive risk taking and credit growth, which is particularly costly to unwind as the experience of some earlier euro adopters vividly illustrates.

40. Particular attention should be devoted to the mortgage market. Tougher competition since the second half of 2010 has led to a reduction in lending rates, which are gradually converging towards the average in the euro area. At the same time, the share of new loans with loan-to-value ratios above 80 percent has significantly increased in 2010, from 34 to 43 percent. Furthermore, banks have substituted traditional mortgages with other housing loans that are subject to weaker regulations with regard to loan-to-value ratios and the requirement to issue mortgage bonds. An additional source of concern is the nontransparent pricing of housing loans which allows banks to adjust rates at their full discretion after the fixation period.

LTV Ratios on New Housing Loans, 2010


Source: NBS.

Mortgage Loans and Other Housing Loans

(Billions of euros)

Source: NBS.

41. Harmonizing regulations on all housing loans would ensure that regulation aimed at limiting excessive risk taking remains effective. In addition, steps to increase the transparency of mortgage loans with regard to interest rate adjustments would improve consumer protection.

42. While generally sound, the financial system is still relatively underdeveloped. The equity market is small, a private bond market is non-existent, and the secondary government bond market is thin. While short-term liquidity for government bonds is ensured by the ECB repo refinancing, banks have to rely largely on over-the-counter transactions to adjust their positions. Furthermore, the share of banks’ assets to GDP at the end of 2009 was slightly above 80 percent, compared to averages of 110 percent in the other CE4 countries and 265 percent in the euro area.

43. Investment restrictions on Pillar II pension funds are too tight. In particular, the guarantees of positive returns and low mandated management fees should be adjusted. These restrictions cause Pillar II pension funds to invest exclusively in safe and liquid assets, such as short-term government bonds and bank deposits. This limits investment choices for households that could prefer a portfolio with longer horizon or higher risk and hinders the development of domestic securities markets.

Authorities’ Views

44. The banking sector is sound and well positioned to meet Basel III criteria. The improvement in capitalization and profitability has considerably strengthened the banking sector and stress tests reveal strong resilience even to significant GDP and inflation shocks, including a drop in GDP of 6 percent and a jump in inflation to 8 percent. Basel III capital and liquidity criteria should be met fairly comfortably within the proposed time frame, since the ratios are already around the Basel III 2019 proposed levels. The NBS coordinates supervision at the EU level through the colleges of supervisors. In any case, national supervisors should retain strong supervisory powers, given that the costs to support local financial markets in circumstances of distress fall upon the national authorities.

45. Credit growth and lending conditions are closely monitored and regulatory harmonization of housing loans is being considered. Intensifying competition from small banks against a background of an improving economic environment has reduced borrowing costs. The bank supervisor is paying close attention to the increase in loan-to-value ratios on new loans, the move towards less regulated other housing loans, and early indicators of a possible credit boom more in general. To limit risks, a more homogenous regulation of all housing loans is considered, as well as measures to increase transparency on the pricing of mortgage.

46. Efforts to enhance financial development are being considered. The debt management agency has taken steps to increase the liquidity in the secondary market for government bonds by increasing issuance size and focusing on benchmark instruments. Furthermore, liquidity would benefit from the planned implementation of a primary dealers system. With regard to Pillar II pension funds, proposals to reform the system, including easing investment restrictions, are being discussed with all political parties to seek a broad consensus which would ensure sustainability.

Figure 4Slovak Republic—Financial Indicators, 2005-10

Box 3.Sovereign Bonds Yields

Slovak government bonds performed overall well during the global financial turmoil. In the fall of 2008 reflecting broad concerns about the financial sector in the euro area, the spread on the 10-year German Bund increased considerably. However, the economic recovery in the second half of 2009 and the government commitment to fiscal consolidation led to a gradual reduction in spreads to about 1 percentage point. With reference to CE4 countries, spreads on Slovak government bonds are similar to the Czech Republic, substantially below Hungary and Poland.

Sovereign Spreads Over 10-Year Bund, Euro Area


Sources: Datastream; and Reuters.

Sovereign Spreads Over 10-Year Bund, CE4


Sources: Datastream; and Reuters.

Several factors explain this relatively low spread. Public debt remains relatively low at 41 percent of GDP, even though it has grown considerably since 2008. The government’s commitment to fiscal consolidation has preserved market confidence although the fiscal deficit has increased to almost 8 percent of GDP. The rebound in economic growth improved debt dynamics. Finally, the adoption of the euro in January of 2009 eliminated currency risks and supported the liquidity of Slovak government bonds through the ECB operations.

Nevertheless, conditional on fundamentals the yields on Slovak sovereign bonds are still significantly above other euro countries. A regression analysis based on 11 euro countries (Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, the Netherlands, Portugal, and Spain) reveals that yields are positively correlated with government debt and the fiscal deficit as a percentage of GDP, and negatively correlated with real GDP growth and government bond liquidity (captured by the stock of government debt). The plot below compares the average yields in 2010 with the predicted yields. The average yields on Slovak government bonds have been considerably above the predicted values, similarly to other CE4 countries outside the euro area. This suggests that Slovak yields have benefited from strong fundamentals, but some premium above core euro area still remains.

Actual and Predicted 10-Year Bond Yields in 2010


Sources: Datastream; Reuters; and IMF staff estimates.

Developing domestic financial markets and solidifying credibility would further reduce spreads. Deepening secondary markets for government bonds by introducing market makers and relaxing regulations on Pillar II pension funds would increase liquidity and lower spreads. In addition, establishing a credible medium-term fiscal consolidation path would enhance credibility and bring spreads in line with core euro countries.


The crisis caused the already high unemployment to surge, and long-term unemployment of low-skilled and young workers has risen to among the highest in the EU. Moreover, regional dispersion in employment and income is large. Tackling theses issues is essential and will require a range of policies and long-lasting efforts.


47. An already high pre-crisis unemployment rate has soared to over 14 percent. The unemployment rate, which is among the highest in the EU, is of a particular concern because long-term unemployment among low-skilled workers and youth is exceptionally high. In early 2011, more than one out of three workers under 25 was unemployed, and the long-term unemployment rate, at 9.5 percent, was the worst in the EU. Regretfully, the economic recovery and incipient rebound in overall employment have yet to translate in improved prospects for the long-term unemployed.

48. Furthermore, there is large divergence among regions in terms of economic developments, education and employment. In 2008, GDP per inhabitant in the Bratislava region was almost three times the level in the two poorest regions, which were more than 40 percent below the EU27 average. With regard to unemployment, the regional dispersion is even more pronounced.

49. The authorities plan several steps to bring down unemployment. They propose, among other initiatives, to link part of social benefits for the unemployed to training and job search efforts, and to expand the intermediate labor market.2 More broadly, the authorities intend to amend the Labor Code with a view to reducing administrative burdens, minimizing hiring and firing costs, and enhancing the flexibility of wage negotiations. At the same time they would like to strengthen the protection of the most vulnerable workers.

Staff’s Views

50. The high long-term unemployment and the regional dispersion reflect a range of factors and will require a menu of policy actions. Long-term unemployment was already high before the crisis due to structural problems, including low skills, limited labor mobility, and weak work incentives. Firms sharply cut employment when the crisis hit and used productivity gains to increase output during the recovery, further driving up long-term unemployment. To be successful, the new initiatives announced by the authorities need to be fully implemented and properly funded. In addition, the authorities should make wide-ranging and sustained efforts to enhance existing labor market policies, notably by focusing more on training, and to strengthen implementation and program evaluation capacity. Sharpening the orientation of education and vocational programs towards labor market needs, with a focus on high unemployment regions, should also be on the agenda. Differentiating the minimum wage among regions according to cost of living could help strengthen employment incentives. Improving the transport infrastructure and fostering the development of a private rental market could help ease labor mobility constraints.

51. Productivity gains are the main driver of medium-term growth potential and convergence, and the key to maintaining external competitiveness. Sustained efforts to build and enhance human capital, further improve the business environment and foster competition, notably in network industries, will help boost productivity. To maintain the strong performance of Slovakia’s main export sectors, productivity gains in combination with labor market flexibility and wage growth moderation, particularly in light of the increase in inflation, should help avoid unfavorable unit labor cost developments relative to those abroad.

52. Efforts to improve the business environment should focus on public sector governance and legal enforcement. Business environment surveys continue to show concern about corruption, which is seen as among the most severe impediments to doing business in Slovakia. They also note delays and uncertainties in enforcing legal claims. The authorities have introduced welcome measures to improve the transparency of public procurement, but more may need to be done.

Authorities’ Views

53. There is an urgent need to tackle the high unemployment challenge. The recently announced active labor market policy initiatives, an increase in labor market flexibility, and the resumption of steady and robust growth will all contribute to a significant reduction in long-term unemployment, albeit slowly.

54. The new government sees strengthening public sector governance as one of its key priorities. New measures to improve the transparency of public procurement include the compulsory use of electronic auctions for public procurement and the publication of the terms of the contract and the successful bidder. These measures already are having a positive impact, and will be complemented and expanded with other steps as needed.

Figure 5Slovak Republic—Labor Market Indicators, 2004–10


56. Following a deep but relatively short recession, economic conditions and prospects have turned favorable, with real GDP growth stabilizing at around 4 percent per annum. The financial sector has regained strength, profits in the corporate sector are recovering, real estate prices have stabilized, and the fiscal position is improving. However, long-term unemployment remains very high, and considerable downside risks to the outlook, both domestic and external, are elevated.

57. The favorable outlook shifts the policy focus to enhancing the foundations for long term growth and stability while addressing the crisis-induced deterioration in the fiscal position. Productivity gains will be the key to maintaining robust growth and, in combination with labor market flexibility and wage moderation, safeguarding external competitiveness. Incipient signs of a credit boom that could threaten the hard-won stability should be carefully monitored. And fiscal policy should aim at regaining strong footing while advancing growth-enhancing expenditure and tax priorities.

58. The size and composition of the 2011 consolidation effort are broadly appropriate. The government deficit is projected to drop below 5 percent of GDP this year, as targeted.

59. The authorities’ commitment to further reduce the deficit to below 3 percent of GDP by 2013 is credible and appropriate. Pacing the adjustment evenly in 2012–13 will help minimize the negative impact on growth.

60. Achieving the 2013 deficit target will be challenging and require careful consideration of evolving expenditure and tax priorities and the quality of the adjustment. There is no room for premature tax cuts or for additional spending without re-prioritization. Concentrating the consolidation effort on some minor taxes and on further cutting government wages and operational costs is unlikely to be a viable strategy, and may erode some essential government services to unsustainably low levels.

61. The authorities’ initiatives to pursue important fiscal institutional reforms are welcome. Harmonizing and simplifying social security contributions and unifying revenue collection are important steps toward efficient and transparent revenue collection. The introduction of fiscal rules, a fiscal council and mechanisms to strengthen local public finances are expected to improve commitment, discipline, transparency and planning. The efforts to seek a broad consensus on the key reforms are very laudable.

62. The proposed actions to improve the long-term prospects of the pension system are appropriate. In particular, plans to automatically align the retirement age with changes in life expectancy and the old age dependency ratio and to adjust indexation formulas could help ensure the viability of the first pillar pension system.

63. Financial sector conditions have strengthened further with the improvement in the economic environment. Financial soundness indicators are solid, and recent stress tests carried out by the National Bank of Slovakia reassure that banks can cope with severe shocks to economic growth and inflation.

64. Nevertheless, risks remain and continued vigilance is needed. Indications of an unwarranted easing of lending conditions or acceleration of credit growth will need to be carefully monitored. The authorities should also harmonize the different treatment of housing loans to ensure that regulation aimed at limiting excessive risk taking remains effective.

65. Deepening the secondary government bond market could contribute to broader capital market development. Steps taken by the debt management agency to increase issuance size and focus on benchmark instruments are welcome. Relaxing the restrictions on investment policies of the second pillar pension funds would also benefit the capital market, and would help align the objectives and horizons of savers with their investment.

66. In the wake of the crisis, addressing long-term unemployment and regional disparities is even more pressing. Bringing down long-term unemployment will require a range of measures. In this regard, various new initiatives considered by the authorities are encouraging. They need to be complemented with efforts to enhance existing active labor market policies and require appropriate funding as well as careful program evaluation.

67. It is recommended that the next Article IV consultation take place on the standard 12-month cycle.

Table 1Slovak Republic—Selected Economic Indicators, 2006–15(As percent of World GDP)
(Annual percentage change, constant prices, unless noted otherwise)
Real GDP8.510.55.8-
Domestic demand6.66.45.7-
Public consumption9.
Private consumption5.
Gross capital formation6.19.74.7-
Net exports (contributions to growth)
Exports of goods and services21.014.33.1-15.916.
Imports of goods and services17.89.23.1-18.614.
Inflation (CPI)
Inflation (CPI, end of period)
Employment and wages
Nominal wages6.
Unemployment rate (percent)13.311.09.612.114.413.312.
(Percent of GDP)
Public Finance, General Government
Overall balance-3.2-1.8-2.1-7.9-7.8-4.9-3.7-3.0-2.1-1.4
Primary balance-1.7-0.4-0.8-6.5-6.4-3.2-1.9-1.0-0.10.7
Structural balance (percent of potential GDP)-3.6-2.5-2.6-6.4-7.0-4.5-3.5-2.7-2.8-2.4
General government debt30.529.627.835.441.744.445.445.845.446.0
Monetary and financial indicators
Bank credit to private sector (growth rate) 1/23.922.
Lending rates 2/
Deposit rates 3/
Government 10-year bond yield4.
(Percent of GDP)
Balance of payments
Trade balance (goods)-4.7-1.2-
Current account balance-7.8-5.3-6.6-3.6-3.4-2.8-2.7-2.6-2.7-2.6
Gross external debt51.054.556.371.972.170.467.865.263.160.6
Sources: National Authorities; and IMF staff calculations.

Last data point 30 September 2010

Loans of up to one year, non-housing new loans to households.

Average of interest rates on new overnight deposits from households and nonfinancial corporations.

Sources: National Authorities; and IMF staff calculations.

Last data point 30 September 2010

Loans of up to one year, non-housing new loans to households.

Average of interest rates on new overnight deposits from households and nonfinancial corporations.

Table 2Slovak Republic—Fiscal Operations of the Consolidated General Government, 2006–15(Percent of GDP)
Total revenue33.432.532.933.633.133.132.732.732.732.3
Tax revenue17.217.216.915.815.616.916.816.817.017.0
Indirect taxes, of which11.111.010.510.310.110.910.410.310.310.1
Property tax and other0.
Direct taxes, of which6.
Personal income tax2.
Wage tax2.
Self-employment tax0.
Corporate profit tax2.
Property tax and other0.
Social contributions, of which11.911.812.212.812.512.
Actual social contributions11.811.712.012.712.312.
Employer contributions6.
Employee contributions2.
Voluntary SC Self-employed or nonemployed2.
Imputed social contributions0.
Non-tax revenues2.
Other current revenue1.
Grants and transfers, of which1.
from the European Union0.
Total expenditure36.634.335.041.540.937.936.335.734.833.7
Current expenditure33.731.631.937.
Compensation of employees, of which7.
Employer social security contributions1.
Intermediate consumption5.
Agricultural subsidies0.
Transport subsidies0.
Social benefits16.316.016.118.919.018.317.917.617.216.6
Social benefits other than D.63111.911.611.313.713.713.313.012.812.512.1
Social transfers in kind (Healthcare)
Other current transfers, of which1.
Transfers to the EU budget0.
Transfer of 2% of income tax to the third sector0.
Capital expenditures3.
Capital investments1.
Capital transfers1.
General government balance-3.2-1.8-2.1-7.9-7.8-4.9-3.7-3.0-2.1-1.4
Primary balance-1.7-0.4-0.8-6.5-6.4-3.2-1.9-1.0-0.10.7
Gross public debt30.529.627.835.441.744.445.445.845.446.0
Sources: National Authorities; and IMF staff calculations.
Sources: National Authorities; and IMF staff calculations.
Table 3Slovak Republic—Medium-Term Balance of Payments, 2006–15(In millions of euros, unless otherwise indicated)
Current account balance-4,316-3,240-4,433-2,264-2,271-1,970-2,024-2,002-2,205-2,300
Trade balance (goods)-2,562-725-7581,187509417374431456564
Exports, f.o.b.40,89247,35149,52239,71648,79455,15860,38365,39870,25475,632
Imports, f.o.b.-43,454-48,076-50,280-38,529-48,285-54,741-60,009-64,967-69,798-75,068
Services balance727424-457-1,244-680-637-708-763-821-874
Income balance-2,427-2,571-2,325-1,531-2,400-2,450-2,450-2,450-2,700-2,850
Current transfers-54-368-893-676300700760780860860
Capital and financial account balance1,4506,2455,9463,4222,2711,9702,0242,0022,2052,300
Capital account-40377806464484504524544564584
Direct foreign investment4,1222,4442,236-3471,1751,6572,1362,2132,2912,363
Reinvested earnings933586558499
Portfolio investment1,601-5851,671-928500530560590620650
Other investment-4,0733,9611,3523,967112-721-1,196-1,346-1,270-1,297
Reserve assets 1/2,592-3,186113567
Errors and omissions2,866-3,005-1,436-1,158
Overall balance-2,5923,186-113-567
Gross reserves (negative indicates increase)2,592-3,186113567
Memorandum items:(In percent of GDP, unless otherwise indicated)
Current account balance-7.8-5.3-6.6-3.6-3.4-2.8-2.7-2.6-2.7-2.6
Trade balance (G&NFS)-3.3-0.5-1.8-0.1-0.3-0.3-0.5-0.4-0.4-0.4
Merchandise export volume (percent change)
Value (percent change)23.514.94.6-20.320.515.
Merchandise import volume (percent change)
Terms of trade (percent change from previous year)-5.0-2.7-6.05.5
Income balance-4.4-4.2-3.5-2.4-3.6-3.5-3.3-3.1-3.3-3.2
Current transfers-0.1-0.6-1.3-
Total external debt (billion euros)24.530.137.745.347.549.
Total external debt (in percent of GDP)51.054.556.371.972.170.467.865.263.160.6
GDP (euro millions)55,08161,55567,00763,05065,90669,53273,89878,39182,95488,565
Sources: National Bank of Slovakia; and IMF staff estimates.

Does not include the transfer of reserve assets from the NBS to the ECB which took place in 2009.

Sources: National Bank of Slovakia; and IMF staff estimates.

Does not include the transfer of reserve assets from the NBS to the ECB which took place in 2009.

Table 4Slovak Republic—Financial Soundness Indicators for the Banking Sector, 2008–10(In percent, unless otherwise indicated)
Capital Adequacy
Regulatory capital to risk-weighted assets11.112.612.7
Regulatory Tier 1 capital to risk-weighted assets10.711.411.5
Capital to assets8.29.69.7
Asset Composition and Quality
Nonperforming loans to gross loans2.55.35.8
Nonperforming loans net of provisions to capital6.714.315.7
Customer deposits to total (noninterbank) loans98.9117.3115.4
Earnings and Profitability
Return on assets (after tax)
Return on equity (after tax)15.46.711.5
Interest margin to gross income65.976.873.8
Noninterest expenses to gross income57.362.355.7
Liquid assets to total assets52.143.441.8
Liquid assets to short-term liabilities65.057.357.9
Sectoral distribution of loans to total loans
Central bank22.20.00.0
Other financial corporations4.64.23.5
General government1.92.62.6
Nonfinancial corporations36.144.144.3
Other domestic sectors30.542.543.3
Geographical distribution of loans to total loans
Domestic economy97.495.696.1
Advanced economies, excluding China
Other emerging market and developing countries, including China2.64.43.9
Of which: Sub-Sahara
Central and Eastern Europe2.64.43.9
Commonwealth of Independent States and Mongolia
Developing Asia, including China
Middle East
Western Hemisphere
Other indicators
Gross asset position in financial derivatives to capital17.59.09.6
Gross liability position in financial derivatives to capital17.910.411.4
Trading income to total income12.41.55.5
Personnel expenses to noninterest expenses38.338.539.1
Spread between reference lending and deposit rates (basis points)428.0430.5429.0
Spread between highest and lowest interbank rates (basis points)
Customer deposits to total (noninterbank) loans98.9117.3115.4
Foreign-currency-denominated loans to total loans17.42.02.1
Foreign-currency-denominated liabilities to total liabilities21.72.83.3
Net open position in equities to capital9.610.510.3
Net open position in foreign exchange to capital-
Source: National Bank of Slovakia.
Source: National Bank of Slovakia.
Annex I. Medium- and Long-Term Fiscal Issues in Slovakia

Medium-Term Issues

Excessive Budget Deficit:

The size of the general government in Slovakia is relatively small compared to other European countries. As percentage of GDP, both revenue and expenditure are among the lowest in Europe.

General Government Revenue, 2005–10(In percent of GDP)

Czech Republic41.441.141.840.240.240.8
Euro Area44.745.345.344.944.544.4
Sources: IMF WEO and staff calculations.
Sources: IMF WEO and staff calculations.
General Government Expenditure, 2005–10(In percent of GDP)

Czech Republic45.043.742.542.945.945.7
Euro Area47.246.645.946.950.850.5
Sources: IMF WEO and staff calculations.
Sources: IMF WEO and staff calculations.

Nonetheless, the downturn and the resulting fiscal stimulus have weakened the fiscal position in Slovakia and resulted in one of the highest budget deficits in Europe. Despite the robust GDP growth in 2010, the fiscal deficit remained high due to a permanent revenue loss.

General Government Fiscal Balance, 2005–10(In percent of GDP)

Czech Republic-3.6-2.6-0.7-2.7-5.8-4.9
Euro Area-2.5-1.3-0.7-2.1-6.3-6.1
Sources: IMF WEO and staff calculations.
Sources: IMF WEO and staff calculations.

As such, the European Commission has put Slovakia under the Excessive Deficit Procedure(EDP). Slovakia is not a unique example in this context. Other countries have been put under the EDP along with Slovakia. This proposal was based on the fact that the general government deficits exceeded the reference value of 3 percent of GDP in 2009. It sets 2013 as the deadline by which the excessive deficit should be removed. The authorities expressed a strong commitment to fiscal consolidation and decided to accept the timeline set by the European Commission’s EDP to bring the deficit below 3 percent of GDP in 2013.

Inefficiency of the VAT Collection System:

Slovakia has a fairly high share of consumption taxes in total tax revenues relative to other EU countries. Yet, VAT revenue, as percentage of GDP, is the lowest in the region. The standard VAT rate of 20 percent is around the EU average and exemptions or the application of reduced VAT rates are not widespread.

General Government Taxes on Goods and Services, 2005–10(In percent of GDP)

Czech Republic11.510.911.211.011.411.7
Sources: IMF WEO and staff calculations.
Sources: IMF WEO and staff calculations.

VAT Rate in the EU Countries, 2011


Source: International VAT Services.

However, the VAT gap is very high in Slovakia. The VAT gap measures the actual VAT revenues as a ratio of the “theoretical” revenues that could be gained if all goods were taxed at their respective VAT rates. The smaller the gap, the more efficient a country is in collecting VAT. The VAT gap was estimated to stand at 28 percent in 2006, the second highest figure among EU countries and well above the EU average of 12 percent (Reckon, Study to quantify and analyse the VAT in the EU-25 Member States, 2009). This implies that tax collection within the existing regulatory framework is inefficient (OECD, Economic Survey of the Slovak Republic, 2010).

Estimates of the VAT Gap, 2006

(Percent, as share of theoretical liability)

Source: Reckon, 2009.

Thus, potential gains can be realized from increasing the effectiveness of VAT collection. Decreasing the VAT gap to the EU average would increase revenues by more than 1 percent of GDP. For comparison, the 1 percentage point increase in the standard VAT rate introduced in January 2011, while leaving the VAT gap constant, is estimated to yield an increase in revenues of 0.3 percent of GDP (OECD, 2010). Further efficiency gains could be reaped by moving towards unified revenue collection as planned by the government. The gains are estimated to amount to around 2 ½ percent of GDP (OECD, 2010).

The High Transition Cost of the Pension System:

One challenge facing the current Slovak pension system is the problem of financing considerable transition costs. Out of a total 18 percent of contribution rates, 9 percent is diverted to the Pillar II (privately-managed) system, thus only the remaining 9 percent is retained to cover the expenditure of the Pillar I (pay-as-you-go) system. The magnitude of the contribution diverted to the Pillar II pension funds in Slovakia is larger than that of any other Central or Eastern European country that implemented a similar multi-pillar pension reform. The balance of the pay-as-you-go Pillar I deteriorated due to the misalignment of the number of pensioners and active contributors. While the revenue to the first pillar has decreased due to the diversion of contributions, the current pensioners continue to receive pensions (OECD, 2010).

Contribution Rates for Old-Age Benefits in Selected Central and Eastern European Countries(In percent)
TotalPillar IPillar IIShare of Pillar II

Contribution Rate
Source: ILO, 2008.
Source: ILO, 2008.

Box A1The 2007–08 Amendments to the Pension System

  • For the period from January to June 2008, workers were allowed to move between Pillar I and Pillar II pension systems (the percentage of net number of workers who left Pillar II is about 3 percent).

  • Participation in the second pillar has been changed from mandatory to voluntary for new labor market entrants in 2008.

  • The qualifying period for pensions was extended from 10 years to 15 years for both Pillar I and Pillar II. Since the Pillar II started in 2005, this implies that workers who were older than 47 years of age in 2005 cannot receive a pension under pillar II.

  • The ceiling of the contributory wage has been increased from three times the average wage to four times of that.

  • The indexation of pension is made at the average of price inflation and the wage increase (the so-called Swiss indexation), where the weight of each parameter is 0.5.

  • For disabled contributing workers, the State subsidizes their contributions only if they remain in Pillar I.

  • Women who have children less than six years of age can voluntarily join Pillar II.

  • In 2007, the government approved a Bill to pay Christmas allowance for 1,051,936 pensioners with low level of pensions.

Source: OECD, 2010.

Long-Term Issues: Age-Related Expenditure

In line with other countries in Central Europe, the old-age dependency ratio in Slovakia is projected to increase by one of the fastest rates among OECD countries. While the ratio of the population aged 65 or above to the labor force is currently much lower in Slovakia than in the OECD, this will change over the next five decades. By 2060, the old age dependency ratio will increase by more than four times to 68.5 percent. One main reason for the fast ageing is the sharp and rapid decline in the fertility rates in the 1990s (European Commission, 2009 Ageing Report, 2009).

Old-Age Dependency Ratio

(Above 64 in percent of 15-64 year-olds)

Source: European Commission, 2009.

The effects of ageing will put additional pressure on public finances. Total age-related public spending is projected to increase faster in Slovakia than in the rest of the EU based on current policies. Spending will grow by 5.5 percentage points of GDP over the next 50 years compared with average increases of 5.1 and 4.6 percentage points in the euro area and European Union, respectively. The long-term cost of ageing is mainly driven by an increase in pension expenditure (by 3.6 percentage points in 2060 relative to 2010), while health care also contributes to the long-term cost of ageing (increasing by 2.1 percentage points).

Projected Change in Age-Related Spending, 2010–60(Percent of GDP)
PensionHealth CareTotal
Czech Republic7.
Euro Area11.
Source: European Commission, 2009.
Source: European Commission, 2009.
Annex II. Slovakia’s Financial Sector

Banking Sector

The banking sector is relatively concentrated and almost entirely foreign-owned. Almost 70 percent of all banks’ assets are managed by four banks: Slovenska Sporitelna, VUB Banka, Tatra Banka, and CSOB Slovakia. These are all foreign-owned banks controlled respectively by the Erste Group Bank, Intesa San Paolo, Raiffeisen Zentralbank, and KBC Bank. In addition, foreigners control almost all remaining banks either through subsidiaries or branches. Lending concentration is particularly high for housing loans, where the four largest banks have an 85 percent market share.

Banking Sector Assets, December 2009

Source: Raiffeisen Research.

Individual Banks’ Share of Housing Loans, February 2011

Source: NBS.

Banks’ assets consist mostly of domestic loans and Slovak government securities. Loans account for about 60 percent of banks’ assets, fairly evenly distributed between retail and corporate loans with some shift toward retail credit during the crisis. Banks’ investment in domestic government bond is large and increased during the crisis. Direct exposure to foreign securities remains limited. Banks held large deposits with the National Bank of Slovakia (NBS) in expectation of appreciation of the Slovak Koruna prior to the Euro adoption on January 1, 2009.

Banks’ Assets, December 2010

(Billions of euros)

Source: NBS.

Domestic Securities, December 2010

Source: NBS.

Banks’ funding is primarily based on deposits. The stability of deposits—coupled with little reliance on wholesale funding—has considerably helped the banking system withstand the financial crisis. To solidify confidence during the crisis, deposits have been entirely insured by the government since October 2008, but up to a limit of euro 100,000 since the beginning of 2011. In addition, banks issue mortgage bonds which are required by domestic regulators to cover at least 70 percent of outstanding mortgage loans. In 2009 banks borrowed euro 2 billions from the ECB and at the same time increased their holdings of government bonds.

Banks’ Liabilities, December 2010

(Billions of euros)

Source: NBS.

Government Bonds and Funds from NBS and ECB

(Billions of euros)

Source: NBS.

Nonperforming loans have increased significantly during the crisis. The deterioration in the loan portfolio has been somewhat better than in the region as a whole. Nonperforming loans have started to decline in the last quarter of 2010. However, credit risk, especially from loans to the commercial real estate and construction industries, remains a concern.

Nonperforming Loans

(Percent of total loans)

Source: IMF Financial Soundness Indicators.

Banks’ profits fell considerably during the crisis, but rebounded in 2010. The increase in nonperforming loans and the reduction in foreign exchange transactions after the adoption of the euro led to a significant drop in banks’ profits. However, profits rebounded in 2010, reflecting cost cutting measures and higher net interest income.

Return on Assets


Source: IMF Financial Soundness Indicators.

Return on Equity


Source: IMF Financial Soundness Indicators.

Capital ratios remain at fairly prudent levels. High capital ratios in the early 2000s were progressively reduced by the expansion of loans. The spreading of the international crisis in 2008 has reversed this trend, since banks have reduced riskier loans to enterprises and retained part of the profits to enhance their capital positions.

Regulatory Capital to Risk-Weighted Assets


Source: IMF Financial Soundness Indicators.

Liquidity is high and the funding base is stable. The amount of deposits remains sufficient to cover all loans, thus limiting banks’ exposure to wholesale markets. To ensure adequate short-term liquidity, the NBS introduced in the second half of 2008 the requirement that liquid assets have to be at least as large as volatile liabilities over a one-month horizon. This measure of short-tem liquidity slightly improved in 2010 as banks reduced corporate loans and increased investment in government securities. However, while liquidity of euro-area government bonds, including Slovak instruments, is enhanced by ECB repo operations the absence of a well-developed secondary market impairs otherwise the liquidity of domestic government bonds.

Total Deposits, 2009

(Percent of total loans)

Source: Raiffeisen Research.

Liquid Assets to Volatile Liabilities

Source: NBS.

The adoption of Basel III requirements does not seem to pose major challenges. Basel III introduces stricter capital requirements, especially with respect to Tier 1 capital, and the creation of conservation and countercyclical buffers. It also places constraints on the leverage ratio, and requires minimum liquidity standards through the Liquidity Coverage Ratio (LCR), and the Net Stable Funding Ratio (NSFR). Slovak banks could meet the new capital requirements relatively easily given their traditional banking model and strong deposit base, especially if the economic recovery sustains profitability. For example, the average capital ratio is already around the 13 percent that would be required in 2019 (including a 2.5 percent countercyclical buffer). Meeting the requirement for Tier 1 capital should also not pose particular problems, since it already constitutes a particularly high share of total capital. Furthermore, the relevance of preferred shares and hybrid instruments is quite limited, as own funds accounts for the majority of Tier 1 capital. Banks are also well placed to achieve the LCR target, while satisfying the NSFR criteria could require more significant adjustments.

Financial Development

Security markets remain underdeveloped. The stock market capitalization is considerably lower than in comparator countries. This is the case also for the public bond market, and there are no private bond issuances. While large firms affiliated with foreign companies can rely on foreign financing (especially after the adoption of the euro), fostering development in domestic security markets could further improve financing conditions for smaller firms with good growth potential.

Stock Market Capitalization, 2009

(Percent of GDP)

Source: World Bank FDS.

Public Bond Market Capitalization, 2009

(Percent of GDP)

Source: World Bank FDS.

Restrictive rules on pension funds limit investment opportunities. In particular, funds are obliged to provide positive returns every six months and management fees are capped at 0.3 percent of assets. As a consequence, Pillar II investment funds hold low-return safe assets (32 percent of bank deposits and the rest in short-term government bonds), with negligible differentiation among the offered funds. These tight regulations restrict investment options and limit the development of domestic security markets. Households’ preference for somewhat more aggressive investment strategies is reflected in the composition of Pillar III funds, which are not subject to the same regulatory requirements and include a considerable share (15 percent) in equities.

Negative equity of around euro 4.5 billion is related to unrealized accumulated losses, which are mainly the result of foreign exchange market intervention before euro accession. More recent losses reflect a drop in the market value of the NBS’s portfolio of euro-denominated securities, including instruments from the euro-area periphery.

These include subsidizing temporary employment opportunities that combine paid work with tailored preparation for the open labor market.

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