Slovak Republic
Recent Economic Developments

This paper reviews economic developments in Slovakia during 1995–96. Slovakia registered an impressive macroeconomic performance in 1995, among the best within the transition economies. Growth accelerated to 7.5 percent in 1995 from an already high rate of 5 percent in 1994, and inflation fell to 7 percent from about 12 percent in 1994. In addition, the current account of the balance of payments registered a surplus of about 2 percent of GDP. In 1996, output continued to grow at about 7 percent while inflation declined to 5.4 percent.


This paper reviews economic developments in Slovakia during 1995–96. Slovakia registered an impressive macroeconomic performance in 1995, among the best within the transition economies. Growth accelerated to 7.5 percent in 1995 from an already high rate of 5 percent in 1994, and inflation fell to 7 percent from about 12 percent in 1994. In addition, the current account of the balance of payments registered a surplus of about 2 percent of GDP. In 1996, output continued to grow at about 7 percent while inflation declined to 5.4 percent.


A. Overview

1. This chapter discusses Slovakia’s economic developments in 1995 and 1996.2 Slovakia registered an impressive macroeconomic performance in 1995, among the best within the transition economies. Growth accelerated to 7.5 percent in 1995 from an already high rate of 5 percent in 1994, and inflation fell to 7 percent from about 12 percent in 1994. In addition, the current account of the balance of payments registered a surplus of about 2 percent of GDP, and the fiscal account of the general government showed a small surplus. In 1996 output continued to grow at about 7 percent while inflation declined to 5.4 percent. The main change in Slovakia’s economic performance in 1996 is the large and rapid deterioration of the external current account, reflecting fast growth in domestic demand and rapid credit and monetary expansion. There are also indications that the fiscal performance weakened compared to 1995 (Figure 1).



Citation: IMF Staff Country Reports 1997, 043; 10.5089/9781451835366.002.A001

Sources: World Economic Outlook and International Financial Statistics.1/ Annual data, except for the monthly interbank rate.

2. This chapter is organized as follows. Real sector developments are discussed in Section B. Section C discusses fiscal sector developments, while monetary sector and external sector developments are covered in Sections D and E, respectively.

B. Real Sector Developments

Output and expenditure

3. The recovery of economic activities which began in 1994 accelerated in 1995. Real GDP grew 7.4 percent in 1995, compared with an increase of 4.9 percent in the previous year. Economic expansion continued in 1996; real GDP grew 7.0 percent in the first three quarters of the year.

4. The economic recovery in 1994 was led by a surge in foreign demand. Export grew 14.1 percent in that year, in contrast to domestic demand which contracted by 4.7 percent. The source of output growth shifted from foreign to domestic demand in 1995, the latter increasing by 10.1 percent in 1995 while export growth slowed to only 3.2 percent. Domestic demand growth accelerated to 19.3 percent in the first three quarters of 1996 while export registered a negative growth of 4 percent.

5. Gross fixed investment grew 5.8 percent in 1995,3 following a contraction of 5.1 percent in 1994. Investment in 1996 picked up sharply, increasing by 30.5 percent in the first three quarters of the year. Inventory accumulation was a major source of output growth in 1995, reaching 5.3 percent of GDP for the year from -2.1 percent in 1994. These numbers must however be interpreted with caution because changes in stocks are subject to large measurement errors. The build-up of inventory continued in 1996 with the level of the stock estimated at Sk 16 billion after the first three quarters of the year, compared with Sk 9.2 billion during the same period in 1995.

6. After declining by 3.4 percent in 1994, total consumption grew 2.9 percent in 1995. Government consumption increased by 1.6 percent in 1995 (compared with a contraction of 10.5 percent in 1994) and private consumption increased by 3.4 percent in 1995 (in contrast to a near zero growth in 1994). Official figures indicate that private consumption merely kept pace with output in 1996 with a growth rate of 7.7 percent in the first three quarter of the year.4 Among the driving forces behind the acceleration of private consumption in 1996 are the increase in real wages and the temporary lowering of import duty on small cars which caused the purchase of imported small cars to pick up sharply. Government consumption jumped substantially in 1996, growing by 25 percent in the first three quarters of 1996. This very large increase can be partly accounted for by the acquisition of Russian aircraft and other military equipment as payment for debt from Russia amounting to Sk 6 billion.5

7. The expansion in domestic demand in the second half of 1995 and in 1996 resulted in an increase in the domestic absorption of exportable and in a substantial increase in imports, contributing to the deterioration of the external balance of the economy. Real export grew only 3.2 percent in 1995 while import increased by 6.7 percent. The gap between the growth rates of export and import has grown wider in 1996, with export growth registered a -3.9 percent growth and import growth picking up to 15.4 percent in the first three quarters of the year (Figure 2).




Citation: IMF Staff Country Reports 1997, 043; 10.5089/9781451835366.002.A001

Sources: Slovak authorities; and staff calculations.1/ Total represents GDP plus imports.

Sectoral development

8. The composition of domestic product by sectors changed only slightly after 1993 (Appendix Table 2). After rising from 41.7 to 54.5 percent of GDP between 1992 and 1993,6 the contribution of services to GDP appears to have stabilized. At the end of 1995, services accounted for 53.3 percent of GDP, by far the largest component of GDP. In 1995 the shares of industrial output and construction were 28 and 4.6 percent of GDP respectively. Finally, agricultural production which rose from 6.2 percent to 7.4 percent of GDP between 1992 and 1994, dropped almost 2 percentage points in 1995 to 5.6 percent of GDP. Estimates on the sectoral composition of output in 1996 were not available when this chapter was written.


9. Industrial production registered an increase of 8.3 percent in 1995 but slowed to 2.7 percent in 1996, mainly due to the restructuring of several large enterprises (for instance Slovnaft, the main oil refinery) and a contraction in foreign demand. The expansion in industrial output between 1994 and 1995 was bolstered by a proliferation of small enterprises (Figure 3).7




Citation: IMF Staff Country Reports 1997, 043; 10.5089/9781451835366.002.A001

Sources: Slovak authorities; and staff calculations.

10. Among enterprises with more than 25 employees, those sectors that witnessed the most rapid growth in 1994 and 1995 are the manufacturing of transport equipment (62.4 percent in 1995), machinery (15 percent in 1995), chemical and rubber and plastic products, leather and wood products. Among those sectors that contracted the most were textile (-11.1 percent in 1995) and food products industries (-2.1 percent in 1995).

11. Industry net profits grew 30 percent in nominal terms in 1995, with most of the gains derived from the manufacturing sector whose net profits rose to Sk 8 billion in 1995 from Sk 1.3 billion in 1994 and Sk -0.6 billion in 1993 (Appendix Table 11). Profits of electricity production (Sk 24 billion in 1995) are the largest contributor to the net profits of total industry (72 percent in 1995).8 The net profits of electricity production are likely to be even higher in 1996 following the government’s decision to raise electricity prices. Total industrial labor productivity grew 4 percent during 1995 and 2.5 percent in 1996, as the result of ongoing restructuring and heavy investment.


12. Agricultural production grew 0.4 percent in both 1994 and 1995. Animal production rose 1.5 percent in 1995, with most of the selected categories registering gains in yields (Appendix Table 10). After a 50 percent increase in wheat harvest in 1994, total crop production fell 10 percent in 1995, accompanied by a drop in the yields of grains from 4.3 tons in 1994 to 4.1 tons per hectare in 1995 (Appendix Table 9).


13. Construction represents about half of the investment undertaken in the economy (Appendix Table 12). When investment pace picked up in 1995, so did construction which grew 1.9 percent for the year (in contrast to a contraction of 1.2 percent in the previous year). While industrial and engineering construction as a percentage of total new construction rose from 50.9 to 55.4 percent from 1994 to 1995, dwelling as a percentage of total new construction fell from 39.6 in 1994 to 34.2 percent in 1995 (Appendix Table 7).


14. Annual average inflation declined from 13.4 percent in 1994 to 9.3 percent in 1995 and to 6 percent in 1996. A number of administrative measures helped moderate inflation in 1996, including the lowering of the upper VAT rate from 25 percent to 23 percent on January 1 (together with shifting some items from the higher rate to the lower 6 percent rate), and reductions in some import duties (including those on small cars).

15. The annual average increase in industrial producer prices fell from 10.1 percent in 1995 to 4.1 percent in 1996. While the increase in agricultural produce prices rose from 3.3 percent in 1995 to 4.7 percent in 1996. Construction inflation fell in 1994 but rose slightly in 1995, presumably reflecting the growing demand in that sector. In 1996, construction price increased by 15 percent, twice the increase in construction materials price, reflecting the high wage growth in that sector.

16. The deceleration of the CPI appears to be broad based, as its main components have generally followed its trend. Between 1993 and 1995, inflation rates for food and nonfood goods fell by roughly the same proportion though the increase in the service components of the CPI fell more significantly (Appendix Table 16).9 A recent OECD survey on Slovakia10 reports that relative price changes in Slovakia have been smaller than the neighboring Czech Republic and Poland (Figure 4).



(year-to-year percent change)

Citation: IMF Staff Country Reports 1997, 043; 10.5089/9781451835366.002.A001

Sources: Slovak authorities; and staff calculations.

Real effective exchange rate

17. Real exchange rates in Slovakia have seen some appreciation in the last several years although the magnitude of appreciation differs sharply between different competitiveness measures. While the CPI-based REER grew just 0.2 percent in 1996, compared with 4.1 percent in 1995, the ULC-based REER grew 7.6 percent in 1996, compared with 5.0 percent in 1995 (Figure 5).



(Jan. 1993=100) 1/

Citation: IMF Staff Country Reports 1997, 043; 10.5089/9781451835366.002.A001

Sources: Slovak authorities.1/ An increase denotes real appreciation.

Wages, employment and unemployment

18. After several years of moderate wage growth, real wages have been growing rapidly, due in part to the increase in labor productivity. CPI-based real wages in industry in 1996 rose 8.4 percent, compared with 4.9 percent in 1995 and 3.7 percent in 1994. In a labor intensive sector like trade, real wage growth is even higher (more than 15 percent in 1996), quickly closing its gap with traditionally higher paid sectors. In 1996, the government voted to increase the minimum nominal wage by 10 percent.

19. After a contraction of 1.8 percent in 1994, employment in the economy increased by 2.1 percent in 1995 and by 2.2 percent in 1996. The labor participation ratio rose slightly to 78 percent in 1995 from 77.3 percent in 1994. The fact that employment growth has significantly lagged behind output growth is an indication that labor productivity of the whole economy has risen substantially. Average labor productivity in industry rose 7.7 percent in 1994, 4.0 percent in 1995 and 2.5 percent in 1996. The slowdown in 1996 is due in part to the restructuring in a number of large enterprises. Labor productivity growth in services is likely to be high, as would be implied by the fast growth in real wages and employment in that sector.

20. The unemployment rate continued to fall in 1996, reaching 12.8 percent (329,749 workers) in December, compared with 13.1 percent at the end of 1995 (333,291 workers). The rate of increase in vacancies and labor force slowed down in 1996. At the end of 1996, the labor force stood at 2,576,164 workers, up from 2,542,891 workers from a year earlier. Labor force in 1996 grew only 0.9 percent, compared with 2 percent in 1995. Vacancies in 1996 grew only 11 percent, compared with 40 percent in 1995. These two facts suggest that the pace of job creation is slower than that implied by the decline in unemployment rate.

21. The continued high unemployment is largely structural. More than half of the unemployed have not worked for more than one year, 80 percent of the unemployed have had previous experience and about half of the unemployed lost their jobs because either their former employers have stopped activities or of redundancy. The disintegration of the armament industry shed more than 100,000 workers most of whom were still out of work in 1996. Regional disparities of unemployment indicate that labor mobility is still poor. Unemployment rate in Bratislava is only 4 percent in 1996, compared with rates of more than 20 percent in some regions outside the capital. While the fastest growing sectors (labor-intensive service sectors) are located in the capital, the largest block of the unemployed is located outside the capital. Housing shortage in the capital is partly responsible for low labor mobility (Figure 6).



Citation: IMF Staff Country Reports 1997, 043; 10.5089/9781451835366.002.A001

Sources: Slovak authorities; and staff calculations.1/ For enterprises employing 25 or more workers.

Structural reforms

22. Many large Slovak firms have successfully undertaken restructuring by changing the product mix, entering new markets and seeking strategic partners. By 1995, 56 percent of all firms are already profitable, and another 27 percent have positive cash flows. Only 7 percent of all firms need continued external finance to stay in business. From the point of view of the soundness of its enterprises, these numbers place Slovakia in the same group with Hungary and Slovenia, behind the Czech Republic but ahead of Poland, Bulgaria and Russia.11


23. Following the election at the end of 1994, the new government canceled the second wave of voucher privatization and in 1995 proceeded anew with a bond scheme. Individuals who were registered for the second round instead received a bond with a face value of Sk 10,000, maturing in 5 years and bearing an interest rate equal to the discount rate. The bonds can be used for the repayment of debt to the National Property Fund (NPF) and for the purchase of municipal housing. Formal trading of these bonds began in August 1996, but very few trades have taken place because of the minimum price set by the Ministry of Finance (75 percent of face value). The Slovak Saving Bank has been instructed by the government to acquire these bonds. Recently there has been some interest on the part of enterprises to use the privatization bonds to settle their debts to the NPF.

24. According to data received from the NPF, the book value of enterprises which changed from being majority state owned to majority private owned in 1996 amounted to Sk 48:5 billion (about US$1.6 billion). This can be compared with privatization of Sk 42 billion in 1995, Sk 24 billion in 1994, and Sk 10 billion in 1993. The 1996 privatization was the outcome of the sale of 217 whole state enterprises with a book value of Sk 16.5 billion, and the sale of shares in 118 hitherto state majority-owned joint stock companies with a book value of Sk 32.1 billion. There was a significant acceleration of privatization in the second half of the year. The NPF plans to complete the second wave of privatization by the end of March, 1997. Recent data indicate that 80 percent of Slovak output is produced by private enterprises.

25. Regarding the terms of the privatization in 1996, the purchase price of the shares amounted to about 40 percent of their book value. This does not necessarily mean that the NPF would get the purchase price (Sk 8.4 billion) as the due amount would be reduced by the amount of investment undertaken and which is specified in the contracts. Similarly, the purchase price of state enterprises (non-join-stock companies) was about 39 percent of the book value of these companies, but the NPF will have a claim only on a fraction of the Sk 6.4 billion purchase price if the specified investment is undertaken. Slovak authorities have recently begun considering the privatization of some of its properties which until now have not been marked up for sale. These properties include the telecommunication company, the gas company and institutions in the health and education sectors.

Strategic enterprise

26. In July 1995, the Slovak parliament passed Law No. 175 which specified a list of 29 enterprises in which the state would maintain ownership.12 This measure effectively reduced the book value of enterprises to be privatized under the second wave, from Sk 260 billion to Sk 170 billion. The same law also identified 45 “strategic” enterprises (with a total book value of about Sk 110 billion) in which the state would retain (or regain) veto power over “key” decisions.13 Moreover, the new law returned the responsibility for the exercise of the state’s ownership right from the NPF to the companies’ founding ministries.

27. In May 1996, the Slovak Constitutional Court annulled the articles of the Privatization Law which stipulated the State’s right to “golden shares”. The judgement was based on the constitutional article which guarantees the “equality of the rights of owners”, which was interpreted as precluding the state from having one share with veto power (equal to 34 or 51 percent of shares). In the aftermath of the Constitution Court decision, the government, with varying success, has been trying to pressure companies to amend their charters to allow the state veto power over some corporate decisions. Some companies have already made such amendments which differ among companies. More recently, strategic enterprises have been exempted from bankruptcy, a measure which could have adverse effects on the governance of these enterprises and on financial discipline throughout the economy.

Administered prices

28. Presently government regulations on prices apply to goods and services representing 5 percent of the GDP. Of this 5 percent, 80 percent of price regulations fall into industries with natural monopolies.14 The other 20 percent pertains to goods and services such as education, health care, and housing. There are currently five types of agricultural produce (milk, cattle, pigs, wheat, barleys) under minimum price regulations. The government purchases the surplus production of the produce and either exports it or sells it in times of shortage. Agricultural subsidies will amount to 800 million crowns in 1996. Currently, on the pricing of electricity, there is a price discrimination between enterprises and households whereby enterprises (80 percent of total electricity consumption) pay a higher rate than households. In fact, the prices of electricity are calculated such that enterprises subsidize the household usage of electricity, so that government does not pay out any subsidies. In the Price Act adopted on April 1, 1996 the government expressed the commitment to deregulation and price liberalization.

Housing reform

29. All of the municipal and cooperative houses and apartments have been recently put on sale and the current renters are given, for a period of time, the right to purchase them at a reduced price. Once homes are privately owned, there is no more restriction on the price they can be sold or rented at. However, rent control will still apply to renters who cannot afford to purchase their homes.

C. Public Finance

Fiscal outcome in 1995

30. The authorities continued to pursue a prudent fiscal policy in 1995, consolidating Slovakia’s gains in fiscal adjustment since independence. This was reflected in an improvement in the fiscal balance of the general government from a deficit of 1.4 percent of GDP in 1994 to a small surplus of 0.2 percent of GDP in 1995.15 This corresponds to a state budget deficit of ½ percent of GDP, a surplus of 8/10 percent of GDP for the social security funds and a deficit of 1/10 percent of GDP on account of the other extrabudgetary operations. This favorable outcome was made possible by increased tax collection, in particular indirect taxes, and reduced government expenditures.

31. The deficit of the central government continued to decline in 1995 and amounted to Sk 2.4 billion, or ½ percent of GDP, compared to an official budgetary estimate of a deficit of 2 percent of GDP (Appendix Table 24).16 Fueled by strong economic growth, budget revenue increased by 17 percent and amounted to Sk 158.4 billion. Tax revenues increased by 19 percent to Sk 136.5 billion, overshooting the budget target by about Sk 6 billion. The VAT yield was particularly impressive, its share as a ratio to GDP increasing from 8.4 percent in 1994 to 10.1 percent in 1995, owing essentially to improved collection efficiency and the carry-over effect from the higher rates implemented in August 1994.17 The strong performance of VAT was, however, partially offset by a reduction of excise taxes, partly attributable to exemptions and to evasion. Budget expenditures (excluding amortization of state debt) increased by about 14 percent, less than nominal GDP growth, reflecting the conservative fiscal policy pursued by the authorities, which refrained from spending the additional revenues but kept expenditures largely within budget limits. Wages and transfers to extrabudgetary agencies increased by 13 percent and 14 percent, respectively; subsidies to enterprises increased by only 3 percent and interest expenditures declined by 28 percent. By contrast, social expenditures (state benefits and social assistance) paid from the State Budget and capital expenditures increased markedly, by 37 and 38 percent, respectively.

32. The social security system as a whole registered a surplus of Sk 4.1 billion, 45 percent higher than in 1994.18 This corresponds to a Sk 1.2 billion surplus of the health sector (against a deficit of Sk 1.5 billion in 1994), a surplus of Sk 1.8 billion of the sickness fund (compared to a surplus of Sk 3.3 in 1994), a small surplus of the pension funds (as in 1994) and an increase in the surplus of the Employment Fund from Sk 0.7 billion in 1994 to Sk 1 billion in 1995 (Appendix Table 24). Total revenues of the social security funds amounted to Sk 87.5 billion, which represents an increase of about 20 percent compared to 1994. This strong increase is partly attributable to institutional changes and higher intra governmental transfers.19 Total revenue included Sk 60.1 billion of social security contributions from employers, employees and self-employed, and Sk 25.3 billion of transfers from the State Budget.20 Total expenditure amounted to Sk 83.3 billion or about 19 percent more than in 1994. Health expenditures and sickness benefits both increased by 20 percent,21 pension benefits increased by 17 percent22 and expenditure on active and passive employment policies increased by 39 percent.23

33. Local authorities registered a small deficit of Sk 124 million in 1995, compared to a deficit of Sk 995 million in 1994. This improvement corresponds to a slight increase in revenue by 4 percent while expenditures declined by 1 percent. Direct transfers from the central government increased from Sk 1.080 billion in 1994 to Sk 1.190 billion in 1995.

34. Total revenue of state funds amounted to Sk 9.225 billion in 1995, or 66 percent more than in 1994. State funds’ own revenues almost doubled in 1995 to reach Sk 5.943 billion while transfers from the central government increased by 30 percent, from Sk 2.519 billion in 1994 to Sk 3.282 billion in 1995. Total expenditure of state funds amounted to Sk 9.006 billion, or 36 percent more than in 1994. Current expenditures increased moderately by 9 percent while capital expenditures (investment and capital transfers) almost doubled in 1995, making up slightly less than one half of total expenditures compared to only one third in 1994. In response to these developments, the fiscal balance of state funds improved from a deficit of Sk 1.040 billion in 1994 to a small surplus of Sk 0.124 billion in 1995. In addition, outlays on investment projects financed outside the budget were reduced from Sk 2 billion in 1994 to Sk 0.774 billion in 1995.

Budgetary plans in 1996

35. The State Budget for 1996 implied a deficit of Sk 8.107 billion (1.4 percent of GDP) (excluding financing items from revenues and deducting amortization of state debt from expenditures). Official budgetary estimates planed a reduction in the highest VAT rate from 25 percent to 23 percent, and a shift of certain services from the highest rate to the 6 percent rate. The State Budget also planed a gradual phase down of the import surcharge from 10 to 5 percent and a cancellation of certain exemptions on excise duties. The budgeted wage bill for 1996 did not provide for wage increases.24

36. Official budgetary estimates implied a strong deterioration in the finances of the Social Security Funds, from a surplus of 7/10 percent of GDP in 1995 to a deficit of 3/10 percent of GDP in 1996. This deterioration was entirely attributable to a decline in revenue from 16.9 percent of GDP in 1995 to 15.7 percent of GDP in 1996 while expenditures were maintained unchanged at 16.2 percent of GDP. The budget proposal reduced the contribution of the state to the Pension Fund and the Sickness Fund on behalf of “dependent” persons to 55 percent and 10 percent of the minimum wage, respectively (80 percent and 10 percent in 1995) but increased the contribution to the Health Fund to 70 percent of the minimum wage (50 percent in 1995). The budget proposal maintained the minimum wage unchanged at Sk 2,450 per month. Finally, employers’ contribution rate to the Sickness Fund was lowered by 1 percentage point and their contribution rate to the Pension Fund increased by 1 percentage point.

37. The budget assumed that local government finances would be balanced in 1996, with revenue and expenditure estimated at Sk 15.8 billion. Transfers from the State Budget were assumed to remain unchanged at Sk 1.192 billion as well as the share of local authorities in the wage tax (23 percent), the corporate tax (5 percent) and the road tax (30 percent). The budget proposal projected the revenue and expenditure of state funds at Sk 12.221 billion and Sk 11.626 respectively, leading to a surplus of Sk 594 million (1/10 percent of GDP). In addition, outlays on investment projects, mainly highway construction, financed outside the budget through bank borrowing and bond issuance is estimated at Sk 4.5 billion (8/10 percent of GDP).

Developments during the first three quarters of 1996

38. During the first three quarters of 1996, the general government accounts are estimated to have recorded a small surplus of ½ percent of GDP. Preliminary data on central government finances during the first three quarters of 1996 show a deficit of Sk 0.620 billion. Total revenue reached almost 74 percent of the annual budget. This outcome was obtained against the background of a large shortfall of domestic taxes on goods and services (VAT, excise taxes), partially offset however by the good performance of income taxes and the large increase in taxes on international trade reflecting the boom of imports. Total expenditure has been maintained below budgeted amounts through a strict control of discretionary expenditures. Important measures introduced since the beginning of the year include a 10 percent increase in the minimum wage from Sk 2,450 per month to Sk 2,700 per month as of April 1, a 7 percent increase of wages in budgetary and subsidized organizations as of July 1, a 12 percent increase in pensions as of July 1, and an increase in the parental allowance from Sk 1,470 per month to Sk 2,470 per month as of October 1, 1996.25

Fiscal outlook for 1996

39. Preliminary estimates indicate that the fiscal balance of the general government should deteriorate to a deficit of 1.3 percent of GDP against a target of 2.3 percent of GDP. The central government accounts are projected to be almost in line with the budget assumptions. By contrast, the fiscal accounts of the social security funds are projected to record a large surplus of 1.4 percent of GDP (against a targeted deficit of 3/10 percent of GDP), reflecting higher contributions due to larger than expected increases in wages. Other extrabudgetary operations (local government operations, state fund operations and investment projects financed outside the budget) are projected to record a larger deficit than assumed in the budget, mainly on account of larger outlays on investment projects, mainly highway construction, financed outside the budget.

40. Preliminary estimates also indicate a continuation of the trend of reducing the relative size of government, with total revenue and expenditure projected, respectively, at 44.9 percent and 46.2 percent of GDP, compared to 46.8 percent and 46.7 percent of GDP in 1995. Tax revenue in relation to GDP would decline by slightly more than 1 percentage point, reflecting the sharp decline in the ratio of indirect taxes (VAT and excise taxes) to GDP. Nontax revenues will also decline in relative terms because of less revenue from budgetary and subsidized organizations. On the expenditure side, current expenditures in relation to GDP are foreseen to decline by about 2 percentage points while capital expenditures—both financed by and outside the budget—would increase by 1½ percentage points of GDP. Social expenditures are to decline by about ½ percentage point of GDP due to lower spending on pensions, unemployment benefits and employment programs.26 By contrast, health expenditures are expected to increase partly because of higher prices for health care services.27

Budgetary plans for 1997

41. The 1997 budget aims at a deficit of about 3.5 percent of GDP for the general government, 2 percentage points of GDP higher than in 1996. This is largely explained by a deterioration in the balances of extra budgetary projects, mainly highway construction and social security funds, due to a large increase in benefits. For the first time since independence, public expenditures are targeted to rise as a share of GDP, while the share of tax revenues would remain constant.

D. Monetary Policy and Banking Sector Issues


42. Over the past two years monetary conditions in Slovakia have gradually turned from tight to loose, with the growth in liquidity being driven increasingly by increases in credits to enterprises and households. In July 1996 the NBS declared its intention to tighten monetary conditions and has implemented a number of measures which, however, up to end-1996 showed only marginal effects. Tightening has been difficult to implement due to the commercial banks’ rapid expansion of loans to enterprises, in an effort to capture market share and in an attempt to generate the resources necessary for provisioning for their classified assets. Thus, the banks have shown to be relatively insensitive to rates offered by the NBS on its securities. Finally, the loosening of monetary conditions has been facilitated by the elimination of credit ceilings on large banks on January 1, 1996.

Developments in 1995

43. Average money growth in 1995 reached 22.3 percent, reflecting strong growth in nominal GDP (17.4 percent) and a decrease in velocity (4.1 percent). The growth in M2 was brought about via increases in both Net Foreign Assets (NFA) (which contributed about 76 percent of M2 growth) and Net Domestic Assets (NDA). This was significantly different from 1994 when NDA actually made a negative contribution to broad money growth. The shift between 1994 and 1995 was to some extent intended, as the stabilization of inflation and of expectations concerning the exchange rate permitted a normalization of credit conditions. Nevertheless, the shift was more than programmed. The excess was due to significant growth in credits to enterprises and households, which reached 15 percent by year-end and which the fiscal over performance28 was not enough to counterbalance. The result was that end-of-period M2 growth amounted to 21.2 percent compared to a target of 17.2 percent. While part of the decrease in velocity in 1995 may have been due to a return of confidence in the currency, it is likely that another part may have reflected a buildup of excess liquidity in the hands of the public.

44. In the course of 1995, the NBS engaged in significant sterilization operations, although they fell short of the amounts necessary to avoid excessive M2 and NDA growth. Specifically, in the course of 1995, the average monthly NDA of the NBS decreased by about Sk 40 billion—about 80 percent of the December 1994 average money base—while in the same period the NFA of the banking system increased by about Sk 48 billion. Sterilization was particularly slow in the first quarter of 1995, and as a consequence the rate of growth of credits to enterprises and households accelerated significantly—even abstracting from the effects of a lumpy capitalization of interest in that period. In the context of the very low growth rate of credit to enterprises in 1994, and the seasonal decline in net credit to government, the NBS relaxed its sterilization effort in this period. Sterilization picked up in the second quarter of 1995, as concern arose over both the high credit growth rates and the significantly negative real interest rates in the interbank market. The sterilization effort was assisted by the selling of bonds by the Ministry of Finance to commercial banks to repay government liabilities in the balance sheet of the NBS.

45. By the third quarter of 1995, the Ministry of Finance had completed the issuance of bonds and refused to repay early other liabilities it had with the NBS. This decision forced the NBS to start issuing in August its own paper to absorb liquidity.29 Nevertheless, sterilization weakened in the second half of 1995 as banks showed only limited interest in purchasing NBS bills, and thus credit growth to enterprises and households accelerated. This was due, in part, to the unwillingness of the NBS to accept high enough interest rates on its securities, feeling that such increases would be followed by capital inflows, and decreases in its profits. Thus, in 1995, the NBS effectively operated with an interest rate ceiling which undercut its efforts to absorb liquidity. Until the end of the year, the NBS continued to rely on credit ceilings on five major banks;30 credit ceilings on all other banks had been lifted in October 1994.

46. Regarding its discount rate policy, the NBS continued to use this rate to guide inflationary expectations. It therefore changed the rate infrequently, and accompanied the changes with moral suasion towards the banks to follow the move with changes in their own deposit and lending rates. The discount rate, which was 12 percent in the beginning of 1995, was reduced to 11 percent in April 1995, and then to 9.75 percent in October of that year. In response, the commercial banks changed their average deposit rates by about 4 percentage points, and their average lending rates by a similar amount in the course of 1995. Interbank rates, on the other hand, did not move with the deposit and lending rates; they rose from the lower single digits to about 10 percent in December (Figure 7).



Citation: IMF Staff Country Reports 1997, 043; 10.5089/9781451835366.002.A001

Sources: Slovak authorities; and staff calculations.

Developments in 1996

47. The main characteristic of monetary developments in 1996 was a significant acceleration of the NDA of the banking system, accompanied by a small reduction in the stock of the NFA of the banking system. The 12-month rate of growth of NDA rose from 5 percent at end-1995 to nearly 20 percent at end-1996 as credit growth to enterprises and households rose to 18 percent while the contractionary movement of other items net decelerated strongly.31 Meanwhile, net credit to government increased by about 2 percent of beginning-of-year broad money—in contrast to 1995 when it declined—adding to NDA growth. The contribution of fiscal performance to domestic credit expansion, however, took place at the very end of the year while until November there were fiscal surpluses.

48. As a result of the acceleration in the domestic provision of liquidity, broad money growth (on a 12-month end-of-period basis) initially increased further from the already robust rate at end-1995, reaching a peak of 24.5 percent in April, but then declined continuously to about 16 percent by the end of the year. The deceleration reflected a large turnaround in NFA performance in 1996—from a positive contribution of more than 16 percentage points to M2 growth in 1995 to a small negative contribution in 1996. The increasing provision of liquidity via the NDA of the banking system in 1996 was the result of an effectively accommodative stance of monetary policy. After a small decline in the first quarter, the NDA of the NBS started to rise due to the expansionary effects of refinancing of NBS and government paper.

49. In the first quarter of 1996, the volume of sterilization was not enough to compensate for the shift of NFA from the commercial banks to the NBS. In the second quarter, monetary control deteriorated further, as the NDA of the NBS started to increase after contracting for more than two years. Commercial banks started to refinance their existing holdings of NBS paper, as credit growth to enterprises and households accelerated. Interbank market rates rose by about 2.5 percentage points in this quarter, to about 12 percent. The NBS, however, did not increase its own rates in that period and auctions of NBS paper became increasingly unsuccessful.

50. The third quarter of 1996 saw the adoption of measures by the NBS to tighten monetary policy, as the central bank became concerned with the accelerating credit growth rates and the accompanying high growth in domestic demand and widening external imbalances. These measures included an increase in reserve requirements on term deposits from 3 percent to the 9 percent applicable to sight deposits, an increase in the Lombard rate from 13 percent to IS percent,32 and the announcement of an additional foreign exchange position requirement, effective from January 1, 1997, which excluded from assets foreign currency denominated credits to residents and included in liabilities domestic currency denominated debt to non-residents. A widening of the exchange rate band around the central parity from ±3 percent to ±5 percent was supposed to help discourage capital inflows.33

51. The measures, which were announced in late July, were immediately met by an acceleration of the run down of NBS paper held by commercial banks and by increases in short-term bank borrowing abroad which was used to buy domestic liquidity from the NBS. Thus, the NBS measures appeared to be initially countered by the accommodative movement in the NDA of the central bank and by the capital inflows. Interbank interest rates increased further to about 13–14 percent but interest rates on primary deposits and short-term loans increased by only up to one percentage point in the wake of the NBS measures.

52. In the last quarter of the year, the NBS increased its refinancing rate moderately to about 10 percent. Still, banks reduced their holdings of NBS paper to zero, as there were virtually no successful auctions of such paper. As a result, from July to the end of the year there were no changes in the lending behavior of banks, but there appears to have been a leveling off of the 12-month credit growth rate in the 19–20 percent range and, possibly, some decline in December. The declining of the latter to about 18 percent could, however, only be apparent as banks may have transferred loans to foreign creditors in December in exchange for foreign assets. Such an operation could have helped banks meet the new foreign exchange position requirement imposed by the NBS from January 1, 1997.34 The effort by banks to meet the new foreign exchange position requirement coupled with the large financing needs of the government in December caused interbank interest rates to increase to 16 percent at end-December.

53. The weakness of the sterilization effort in 1996 can be attributed to some extent to the interest rates accepted in auctions of NBS paper. The central bank felt that the rates were highenough given the reduced tax rates on income from such paper,35 while the commercial banks argued that the expected return on NBS paper was low, given the uncertainty of the banks’ tax situation by the end of the year. After keeping its auction rate broadly stable in the first half of 1996—at 7.5-8 percent—the NBS increased the rate to about 9 percent in the third quarter and to 10.6 percent in the last (partially) successful auctions in early October. The NBS did not accept to increase the rate further and after a series of unsuccessful auctions in the fourth quarter the auctions were temporarily stopped. Another important factor behind the weakening of the sterilization effort was the removal of credit ceilings from the major Slovak banks on January 1, 1996, which had supported the demand for government and NBS paper in the past. Finally, a number of other factors contributed to the less effective monetary control in 1996, including the prevailing view among all banks that the way to resolve their classified asset problems was by expanding their portfolios and that increasing market share was necessary to the success in the long-run.36

54. In February of 1996, the NBS, on the occasion of a significant drop in the 12-month rate of inflation, reduced its discount rate to 8.8 percent, where it was kept through end-1996. Short-term deposit and loan rates continued their decline (by 1.5 percentage points and 2 percentage points, respectively) in the first half of 1996, but they increased by about 1 percentage point, following the July measures.

Banking sector structure and reform

55. The Slovak banking system has grown significantly since 1993, and in September 1996 it comprised 10 domestically owned banks, 14 banks with foreign capital participation, 6 branch offices of foreign banks, as well as 12 representative offices of foreign banks. Subscribed equity capital by the domestically owned banks, banks with foreign capital participation and branch offices of foreign banks more than doubled from Sk 13.8 billion in 1993 to Sk 28.3 billion in September 1996. The share of domestically owned banks in total equity capital declined in this period from around 72 percent to 50 percent, despite the fact that domestic bank equity increased in absolute terms by 42 percent. The weighted ratio of foreign capital in the sector reached 37 percent in the third quarter of 1996. The majority of this is accounted for by the Czech Republic with 52 percent, Austria with 21 percent, Germany with 7 percent, and the Netherlands and the United States with about 5 percent. Slovak banks accounted for 70 percent of all assets, 77 percent of all loans, and 74 percent of deposits of the banking system in September 1996, with all shares showing a tendency to decline over time.

56. The three largest banks in the market have continued to be the Savings Bank, VUB, and IRB. The Savings Bank used to have all household deposits, but by 1996 the share had gradually fallen to under 80 percent. VUB is the largest commercial lender with a share of about 36 percent, while IRB with infrastructure and housing projects prominent in its portfolio accounts for about 10 percent of loans. The still strong position of the Savings Bank in the market for deposits has meant that it has continued to be the main supplier of funds in the interbank market, while the lagging deposit base of VUB and its extensive assets have made this bank the most important customer in the interbank market.

57. In 1995, the NBS adopted new regulations concerning loan classification and provisioning in order to help address the bad debt problem. The regulations began to be applied by the banks from August 1995. According to the NBS, by September 1996, about 25 percent of required provisions were not covered by either created provisions or reserves and reserve funds. This represented a significant improvement from September 1995 when 39 percent of required provisions remained uncovered. New provisions and reserves created by banks account for part of this improvement, but a major part is explained by the reduction of the level of required reserves due to the reclassification of loans for the Mochovce nuclear power plant in the portfolio of IRB. The reclassification followed a restructuring of the original credits amounting to Sk 13 billion. Another large reduction in the level of required provisions came about after the government provided an explicit guarantee for the credits of Consolidation Bank—an institution serving as a parking lot and collector of bad loans transferred to it by the government.

58. Regarding new banking legislation, there was an amendment of the Banking Act in March 1996, which strengthened the central bank’s supervisory powers and prepared the ground for the restructuring of the banking sector. The NBS was given clear regulatory power over all commercial banks, savings banks, and foreign branches, while the Ministry of Finance was assigned to the regulation of the insurance and capital markets. Among other changes, the amendment also increased the minimum capital requirement for establishing a bank to Sk 500 million, and decided on the establishment of a central register of loans and guarantees where the banks should report every credit larger than Sk 3 million. Apart from the new Banking Act, a National Deposit Insurance Law was approved in March 1996, establishing a fund to collect and manage the compulsory contributions from banks and the resources from other specified sources. The fund would, in the case of bank default, provide private depositors with full compensation for their deposits up to 30 times the average monthly salary of the preceding year, while for the depositors with building societies the limit would be 60 times the salary.

E. External Sector Developments

Recent developments

59. The rapid pace of export-led growth experienced in 1994 continued into 1995, as exports increased by 28.2 percent (in nominal U.S. dollar terms). Imports continued to expand, at an even higher pace of 32.8 percent. As a result, a trade deficit of US$228 million emerged for the year (versus a surplus of US$59 million in 1994). The services balance remained strong, however, and more than offset the deficit in the trade balance. As a result, the current account registered a surplus in 1995 for the second straight year, of US$391 or 2.2 percent of GDP (versus 5.4 percent in 1994).

60. Underlying the emergence of a trade deficit in 1995 was a deterioration in the trade balance in the fourth quarter of the year. While import growth remained high throughout the year, export growth began to decline in the forth quarter, to 17.1 percent. As a result, the trade deficit during the fourth quarter of the year alone reached US$215 million.

61. Trends in the geographical distribution of trade evident in 1993 and 1994 arising from Slovakia’s integration into the world economy continued into 1995 (Appendix Tables 31 and 32). In particular, imports from, and exports to, the Czech Republic continued to fall as a share of total trade (the share of exports to the Czech Republic declined from 42.4 percent in 1993 to 35.3 percent in 1995, while the share of imports declined from 35.9 percent to 27.8 percent). The share of total trade with the European Union (EU), meanwhile, continued to increase (exports’ share rose from 29.5 percent in 1993 to 37.4 percent in 1995, while imports’ share rose from 27.9 to 34.8 percent). In 1995, Slovakia continued to run large trade surpluses with the Czech Republic (US$590 million) and the EU (US$160 million), and a large trade deficit with Russia (US$1,125 million).

62. Notwithstanding the emergence of a trade deficit in 1995, the overall balance of payments performance was strong, registering a surplus of US$1,677 million. Underlying this performance was a surplus in the current account of US$391 million and a surplus in the capital account of US$1,177 million. The latter arose mainly from large medium- and long-term project loans from abroad. Inflows of foreign direct investment, however, remained low and, at US$134 million in 1995, are estimated to have declined relative to their level in 1994 (US$170 million). The strength of the balance of payments led to a large increase in gross international reserves of US$1,503 million, and by the end of 1995, they stood at over US$3.8 billion or 4.3 months of imports of goods and services (up from 3.1 months at the end of 1994).

63. The trend of slowing export growth and continued high import growth evident during the last quarter of 1995 continued through the first three quarters of 1996. Based on preliminary data, export growth through the first nine months was only 2.6 percent, while import growth was 18.8 percent (both in nominal U.S. dollar terms).37 As a result, the trade deficit widened further, and through the end of September reached US$1,258 million (versus a deficit of US$13 million through the same period of 1995). At the same time, the surplus of the services balance is estimated to have decreased to US$119 million (versus US$541 million during the same period of 1995). This reflected sharply lower services receipts included in a category called “other” of the balance of payments.38 The resulting current account balance is estimated to have reached a large deficit through the first nine months of 1996 of US$1,041 million (or more than 7 percent of projected GDP at an annual rate).39

64. The overall balance of payments is estimated to have recorded a deficit of US$252 million through the first nine months of 1996, as a capital account surplus of US$713 million (stemming mainly from continued large inflows of medium- and long-term loans from abroad) only partly offset the large current account deficit. While gross reserves of the banking system declined, official reserves continued to climb, and stood at about US$4.1 billion at the end of September. This amounted to about 3.9 months of projected imports of goods and services.

65. Underlying the burgeoning trade deficit was a decline in exports to the Czech Republic, of about 7.2 percent (in nominal local currency terms, based on data through August 1996). Exports to Hungary also declined, by almost 3 percent, as did exports to Asian countries (3.5 percent) and to the Americas (almost 25 percent). Offsetting the decline in exports to these countries, however, was growth in exports to the EU (up by 13.2 percent). Exports to Germany, the largest EU recipient of Slovakia’s exports, increased by 11.7 percent. Import growth from nearly all sources remained high. Imports from the Czech Republic were up by 12 percent, from the EU by 30.3 percent, and from Russia by 17 percent (excluding imports of military equipment).

66. On the import side, the largest factor for the widening trade deficit was higher imports of passenger vehicles, associated with the temporary removal of customs duty on small cars in March 1996.40 Imports of automobiles were some 186 percent higher than a year earlier (in local currency terms). Increases in imports of fuels (19.2 percent) and electricity (188 percent) also accounted for a large share of the widening trade deficit. Exports of iron and steel (which accounted for more than 16 percent of total exports in 1995) were the largest factor behind sluggish export growth through August 1996, having declined by 9.4 percent relative to the same period of 1995.

67. There were a few important changes to the policy framework enacted in 1995 and 1996. First, with effect from September 1995, the clearing account arrangement with the Czech Republic was eliminated. This resulted in a 5 percent revaluation of the Slovak currency against the Czech koruna, given the preferential exchange rate which had existed prior to elimination of the clearing account. Elimination of the clearing account facilitated the authorities’ acceptance of the obligations of Article VIII on October 1, 1995. Regarding exchange rate policy more generally, the authorities maintained their practice of pegging the currency to a basket of the U.S. dollar and German mark.41 In July 1996, as part of a package announced to curtail the growth of credit, the authorities announced that their exchange rate band would be widened from ±3 percent to ±5 percent. They stated that widening the band was designed to deter speculative capital inflows. Finally, following discussions with the WTO, the authorities reduced the 10 percent import surcharge on consumer goods (which had been introduced in 1994 in response to balance of payments concerns) to 7.5 percent on July 1, 1996. They stated that the surcharge would be removed entirely by January 1, 1997.

Factors underlying the external current account deterioration

68. Staff projections indicate that the current account deficit in 1996 is likely to widen to 7.9 percent of GDP (including imports of military equipment from Russia). This would represent a turnaround in the current account of more than 10 percentage points of GDP (from a surplus of 2.2 percent of GDP in 1995).

69. The current account deficit is of concern both for its size, and for the speed with which it has developed. The deficit is also of concern to the extent that it was partly caused by a jump in imports of consumption goods, although it was led by imports of investment goods.42 Even if imports of investment goods are behind much of the increase in the current account, the deficit may still be of concern to the extent that investments might be occurring in risky sectors of the economy with uncertain rates of return. Credit market distortions, incomplete privatization, and problems of corporate governance could increase the odds that at least some investments may not yield sufficient returns.

70. Four main factors may be advanced to explain the large swing in the current account deficit:

  • Domestic demand pressures. The largest single factor for the sudden and large increase in the current account deficit seems to be excessive domestic demand pressures. Demand pressures are partly attributable to lax financial policies, including an expansion in domestic credit and a deteriorating fiscal position, at a time when rapid economic growth was already beginning to strain domestic resources. In order to constrain the deterioration of the external current accounts, the NBS introduced in July 1996 a package of restrictive monetary measures.

  • Supply constraints. From a supply-side perspective, the rapid export-led growth experienced over the past few years could be explained by a “catch-up” process. As the Slovak economy in the early 1990s was well within its production possibilities frontier, a reorganization of existing resources could have brought the economy rapidly toward its full productive capacity. At some point (perhaps during the last quarter of 1995), the catch-up process had been completed, meaning that further increases in productive capacity could be achieved only through correspondingly higher investments, and an associated reliance on foreign savings.

  • Adverse terms of trade developments and weak external demand. During 1996, the world prices of several intermediate goods which Slovakia exports intensively had declined on world commodity markets. Prices of iron and steel, and wood pulp in particular (together, these items account for about one-quarter of total exports), had declined.43 At the same time, increases in fuel prices had lifted Slovakia’s import bill in 1996. In addition, foreign demand for some commodities, such as for steel in Western Europe, had been weak.44

  • Decline in external competitiveness. While Slovakia’s level of external competitiveness remains adequate, there is a possibility that an erosion in external competitiveness has contributed, to a lesser extent, to the recent sluggish growth of exports. Indicators of external competitiveness based on unit-labor costs (see Figure 5) revealed that competitiveness had deteriorated over time (by about 10 percent since 1993). This was due to rapid real wage growth (by over 10 percent in the past 12 months). In addition, external competitiveness had diminished vis-à-vis the Czech Republic following the elimination of the clearing account arrangement in September 1995 (which had entailed a revaluation relative to the Czech currency of 5 percent).


A. Introduction

71. Since Poland adopted its big-bang reform program in 1990, transition economies in Central Europe have experienced a substantial decline in inflation. While inflation rates have fallen, sizable discrepancies still remain (as shown in Table 1). Underlying the persistence of the discrepancies are factors whose relative impacts on inflation are generally difficult to distinguish in the data. Disparate progress in price liberalization, different stages of relative price adjustment, dissimilarities in labor market conditions and wage determination and different monetary and exchange rate regimes have probably all contributed to different inflation rates between countries.

Table 1.

Annual Consumer Price Inflation: 1993–95

article image
Source: International Financial Statistics.

72. This paper records the empirical relationships between inflation and some of its supposed underlying factors. We will particularly focus on the Slovak Republic which currently enjoys the lowest level of inflation among transitional economies,46 and one of the fastest rates of output growth. We will examine three factors which we believe to have significantly contributed to the success of Slovak disinflation. First, the relatively high exposure to international competition faced by the Slovak Republic compels its enterprises to maintain their price levels in line with developments among its main trading partners. Second, the effectiveness of a fixed exchange rate as a nominal anchor is correlated with the degree of openness. Third, the links between wages, prices and the exchange rate are examined.

73. There are other channels of inflation which, given the limited scope of the paper, will not be explored here. One of them is relative price adjustment. A recent study by the OECD (OECD, 1996) found the Slovak Republic to have experienced less relative price adjustment than Poland and the Czech Republic. This could imply that the liberalization of prices in Slovakia has been more gradual and that higher inflation could be expected in the future. Another obvious source of inflation is money growth, although its importance in Slovakia is difficult to gauge as excess money appeared to have mostly spilled into the balance of payments without immediately leading to more rapid inflation (see Chapter IV).

74. Section B of the paper describes the recent history of Slovakia’s experience with inflation. Section C discusses and documents the link between inflation and the relative extent of openness. Section D of the paper examines the relationship between exchange rate policy and inflation. In Sections E and F, we will look at the role of openness in the transmission of inflation as the result of exchange rates depreciation. In Section G we will consider the role of the exchange rate in a broader wage-price adjustment model.

B. Overview of Slovak Inflation

75. Figure 8 plots the evolution of year-on-year inflation rates in the Slovak Republic since January 1991.47 The implementation of the stabilization program in 1991 caused output to contract sharply (with the unemployment rate rising from 2.4 percent in January to 11.8 percent in December of the same year) and brought inflation down to single-digit figures in the middle of 1992, the lowest in Central Europe at the time. The introduction of VAT in 1992 and a 10 percent devaluation of the Slovak Koruny in July 1993 contributed to inflationary pressure during 1993, with inflation rates climbing to almost 30 percent in September. The following two years witnessed a continuing decline in inflation, with inflation falling to 7.2 percent at the end of 1995. In January 1996 the upper VAT rate was lowered from 25 to 23 percent, together with the shifting of some goods from the higher rate to the lower 6 percent rate of VAT. These measures helped inflation drop a percentage point in January from the previous month. Inflation fell by another percentage point during the course of 1996, reaching 5.4 percent in December. Figure 9 plots the evolution of the main components of the CPI since 1993. It shows that disinflation has been broad-based, with the main components of the CPI rising by about the same proportion as the CPI itself.



Citation: IMF Staff Country Reports 1997, 043; 10.5089/9781451835366.002.A001

Source: Slovak Statistical Office.


Citation: IMF Staff Country Reports 1997, 043; 10.5089/9781451835366.002.A001

Source: Slovak Statistical Office.

C. Inflation and Openness

76. There are a number of reasons why we should expect inflation to be correlated with openness. Romer48 (1993) suggested that because unanticipated monetary expansion causes real exchange rate depreciation, and since the harms of real depreciation are greater in more open economies, the benefits of surprise inflation are a decreasing function of the degree of openness. Lane49 (1995) pointed out that this reasoning is only true of countries large enough to change relative world prices. He argued that a negative inflation/openness correlation is more likely to result from imperfect competition in the production of nontradable goods. This is because the more open is an economy, the smaller the non-tradable sector, thus less important is the distortion in that sector. It follows that governments’ incentives to stimulate output by pursuing expansionary monetary policies are lower in more open economies and equilibrium inflation under discretionary policy is therefore lower. Romer’s and Lane’s arguments both rest on the speculation that the primary object of a monetary expansion is the stimulation of output. There are actually other considerations entering into the government’s decision to determine the optimal rate of inflation. For example, seignorage is an important consideration in countries where such a tax is a significant part of governments’ revenue.

77. There is a third and a more compelling reason to believe that there should be a negative correlation between inflation and openness among transitional economies. The more open is an economy, the more the pricing decision of its firms is subject to international competition. Considering two monopolistic firms in an economy both facing the same cost pressure (wages, for instance) and identical exchange rate expectations, the one which faces more competition will internalize more of the increase in cost and the one facing less competition will pass on the cost to its customers.50 It is true that if the increase in cost is permanent and continuing, the firm which cannot pass on the cost to customers (without losing all of its customers) will eventually have to raise prices or go bankrupt, but it is also more likely to attempt to lower its cost. This story is relevant for transitional economies because they are primarily exporters of commodities which forces them to compete on the basis of price.

78. The empirical relationship between inflation and openness is well documented. A number of studies found a significantly negative correlation between inflation and openness in large cross-country samples. None of these studies, however, has addressed this issue for transitional economies. In this section we try to document the relationship between inflation and openness for transitional economies.

79. We have chosen to focus on five economies (Slovak Republic, Czech Republic, Poland, Hungary and Slovenia) which are all generally considered to have completed the stabilization process and in which substantial relative price adjustments are assumed to have taken place. We focus on the three years between 1993 and 1996, to avoid attributing disinflation to openness what is generally credited to stabilization policies. Inflation is measured as the end-of-period percentage change in the CPI.51 We will use the sum of exports and imports as a share of GDP as the measure of openness.52 Data are all taken from the International Financial Statistics.

80. Table 2 shows the average annual inflation rate and openness in the five countries between 1993 and 1995. The country with the highest and second highest average annual inflation rates, Poland and Hungary, are also the least open and the second least open of the five countries in the sample. Slovenia, which has the third lowest inflation in the region, however, is the second most open of the five economies, although its degree of openness is not distinguishable from that of the Czech Republic (which has the lowest inflation in the sample). Slovakia is ranked second among the low inflation countries and first among the most open economies. The following analysis is based on a panel for all five countries for 1993–96. Given the small sample size, it is difficult to draw conclusions from the evidence.

Table 2.

Average Annual Inflation and Openness, 1993–95

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Source: International Financial Statistics.

81. Figure 10 is a scatter plot of annual inflation and annual openness for all five countries between 1993 and 1995. The figure shows a negative relationship between inflation and openness. Regressing inflation on openness we have



Citation: IMF Staff Country Reports 1997, 043; 10.5089/9781451835366.002.A001

Source: International Financial Statistics.

The t statistic on the openness coefficient (the number in parentheses below the regression coefficient) indicates that there is a statistically significant negative relationship between openness and inflation. Moreover, the R-square suggests that the degree of openness alone can explain 40 percent of the variation of inflation rates over time and across countries.

D. Inflation and Exchange Rate Regimes

82. It is generally agreed that the choice of exchange rate regimes has an impact on the level of inflation, even though there is no consensus in the literature as to the form the impact will take. In fact, increased nominal exchange rate flexibility has been argued both to increase and decrease inflation. A recent empirical paper by Ghosh, Guide, Ostry and Wolf,53 however, has established that pegged regimes are associated with lower inflation than flexible regimes due to the discipline effect (pegged regimes are found to have lower money supply growth) and the credibility effect (higher money demand growth). The discipline effect refers to the fact that monetary authorities are required to pursue tight monetary policies to prevent a large real appreciation from undermining the exchange rate regime. The credibility effect refers to the fact that pegged regimes demonstrate a certain commitment on the part of the government—their resolve to defend the exchange rate—which strengthens the confidence of households in holding domestic currencies.

83. Several different exchange rate arrangements prevail among the five countries in our sample. The Czech Republic and the Slovak Republic have both maintained a fixed exchange rate regime, although the latter effected a 10 percent devaluation in 1993. Poland and Hungary have both implemented crawling pegs. Slovenia has a floating exchange rate regime.

84. Table 3 presents the type of exchange rate regime of these countries and their respective average inflation between 1993 and 1995. The Czech Republic and Slovak Republic both have lower inflation rates than the other three countries in the sample. Again, the sample is too small to draw any conclusion on the effect of exchange rate regimes on inflation. The fact that Slovenia has a lower inflation rate than Poland and Hungary, however, indicates that a crawling peg regime is not necessarily more inflation proof than a flexible exchange rate regime.

Table 3.

Exchange Rate Regimes and Inflation, 1993–95

article image
Source: International Financial Statistics.

85. Even if we should discover a relationship between the exchange rate regime and inflation, it may well be that it is not the choice of exchange rate regime but rather the magnitude of exchange rate depreciation, that is the ultimate cause of inflation.54 For even in fixed exchange rate regimes, governments can engineer periodic devaluations. The next section looks at the relationship between devaluation and inflation.

E. Inflation and Depreciation

86. It is straightforward that a devaluation leads to higher inflation, at least to the extent that prices of imported goods influence the calculation of the CPI. Table 4 compares average annual inflation with the average annual depreciation of the five countries in our sample. There is almost a perfect correlation between inflation and depreciation. A country with higher inflation also has large depreciation. The magnitude of average depreciation appears to be able to explain cross-country differences in inflation in our small sample. This result probably has to do with the fact that all these countries are relatively open, and thus that the effect of depreciation on inflation is very strong. It must be added that the issue of causality,55 which will not be dealt with here, is important for better understanding of the interdependence between exchange rate movements and inflation.

Table 4.

Average Annual Inflation and Average Annual Depreciation, 1993–95

article image
Source: International Financial Statistics.

F. Depreciation and Openness

87. A devaluation of a currency leads to higher inflation, but it is not clear by how much. Yet the question of the magnitude of the impact of devaluation on inflation is of interest to policy makers, because the answer may determine the effectiveness of a nominal devaluation on boosting competitiveness by engineering a real devaluation. A one-to-one response from devaluation to inflation means that nominal devaluation will not alter the competitive position of an economy.

88. The extent by which a nominal devaluation translates into inflation depends critically on the accompanying financial policies. There are reasons, however, to believe that openness will magnify the impact of devaluation on inflation. One reason is that the more open an economy, the greater is the share of imports in the calculation of its price indices, and a devaluation leading to higher import prices will be immediately translated into higher inflation. Second, if we assume that purchasing power parity holds, inflation will rise so as to cancel the effect of the nominal depredation, leaving the real exchange rate unchanged. The more open is an economy, the more likely it is that purchasing power parity will hold. While the first reason will materialize quickly, the second reason is more long term.

89. To capture the effect of openness on the impact of devaluation on inflation, the following nonlinear regression in which inflation depends on the multiplication of openness and depreciation is postulated:


Taking the derivative of inflation with respect to devaluation, we have


90. Equation (3) implies that, provided that b is positive, the greater is the degree of openness, the greater is the impact of devaluation on inflation and the smaller is the real depreciation that results from nominal depreciation.

91. The above regression is run, using annual data spanning over three years (1993–95) for the five countries. The results are shown below:


92. Openness and depreciation together explain 81 percent of the variation of inflation. It is important, however, to realize that these results are derived from a small sample.

93. Table 5 shows that nominal devaluation for very open economies is going to be a very expensive way of improving competitiveness. For an open economy such as the Slovak Republic, a one percent of nominal depreciation will only lead to less than half a percent real depreciation. Clearly, these results depend on the accompanying financial policies.

Table 5.

Openness and Real Devaluation, Simulation

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Source: International Financial Statistics.

G. Wage and Price Adjustment

94. While many factors have contributed to Slovakia’s impressive disinflation, their relative importance can only be gauged after more detailed empirical analysis. This section presents a simple empirical model of the determinants of Slovak inflation. Though simple, the structure of the model is relatively standard, and has been used in a recent background paper on the determinants of Polish inflation.56 Estimating a similar model permits comparison of the determinants of Slovak inflation with the factors explaining inflation in Poland. The model emphasizes the interactions between wage and price inflation. Given the openness of the Slovak economy, and the use of fixed exchange rates to guide monetary policy, the role of the exchange rate in determining inflation is given special emphasis.

95. The model revolves around three basic economic relations: one each for producer prices, consumer prices and wages. For each economic relation, two equations are estimated, one in log-levels, the other in growth rates. The regression in levels attempts to estimate the long run trend (or cointegrating) relationship. The regression in growth rates captures the short-run dynamic interactions, which can temporarily deviate from the underlying long run trend. Though the short term and long term relations may be quite distinct, the two are linked by including in the short-run equation an “error-correction” term that represents deviations from the long run relationship. The estimated coefficient for this “error-correction” term should be negative, implying that if a series is above its long run trend, ceteris paribus, this will tend to dampen its growth rate.57

96. In the model, producer prices (ppi) are assumed to be determined by foreign producer prices (fppi) expressed in domestic currency, and by domestic unit labor costs (ulc). This assumption has at least two interpretations. First, producer prices can be thought of as a simple mark-up over the cost of imported inputs and domestic labor costs. Alternatively, some producer prices can be thought of as determined by purchasing power parity—and hence by world producer prices—whereas prices of the remaining less tradable items are determined mainly by domestic wages.


97. The estimates indicate that, in the long-run, Slovak producer prices are determined predominantly by foreign producer prices expressed in Slovak koruny and, to a lesser extent, by domestic unit labor costs. The strength of this long-run purchasing power relationship reflects the openness of the Slovak economy. Restricting the sum of the estimated coefficients on foreign prices and unit labor costs to unity—as would be implied by the neutrality of nominal variables—is not rejected by the data, reinforcing the plausibility of the estimated relationship.

98. The short-run equation relates monthly producer price inflation to lagged producer price inflation, together with monthly growth rates of the nominal effective exchange rate (neer) foreign producer prices expressed in dollars (fppi$) and employment (emp) and the “eiror-correction” term representing deviations from the long-run equation (ppires).58


99. As in the long-run equation, monthly producer price inflation is heavily influenced by foreign producer price inflation. The puzzle is that foreign producer price inflation has a far greater impact on domestic inflation than do changes in the exchange rate. Two explanations can be offered: economic and statistical. First, since the Slovak authorities have targeted the nominal effective exchange rate, producers may perceive short-run changes in the exchange rate as transitory, which need not affect their pricing decisions. Conversely, changes in foreign producer prices are more likely to be permanent, and thus are rapidly incorporated into domestic producer prices. Second, the policy of pegging the exchange rate has made exchange rate variability very low. This lack of variation makes it difficult in a statistical sense to obtain precise estimates of the effect of exchange rate changes on inflation. Finally, the estimated equation suggests that producer prices tend to rise with increasing employment. This suggests a pro-cyclical markup, though this effect is somewhat weak.

100. The model’s consumer price equations can be thought of as accounting identities. Consumer prices (cpi) are assumed to be a weighted average of producer prices (ppi) and wages (wage). The wage term can be thought of as representing the greater tabor intensity of consumer goods compared to producer goods, or as capturing the additional retail service component within the consumer price basket.


101. Both the short and long-run equations indicate the considerable influence of producer prices on consumer price inflation. Wages have a relatively weak direct effect on consumer prices, but they also operate indirectly through their impact on producer price inflation. The estimated coefficient on the error-correction term in the short-run equation is relatively large, implying that, on average, almost one-quarter of the disequilibrium in consumer prices is removed in a given month.

102. Finally, long and short-run wage equations were estimated:


where realwage is the nominal wage divided by the CPI, and ur is the unemployment rate.

103. The long-run wage equation shows the close relationship between real wages and labor productivity, with a long-run elasticity close to unity. The short-run wage equation performs less satisfactorily: it is difficult to explain the very volatile movements in Slovak monthly wages. At first, there seems to be little impact from consumer prices to wages—adding consumer price inflation to the right hand side gave a negative sign. However, the large negative coefficient on the error-correction term indicates that any increase in consumer prices is soon offset by a wage increase that preserves the level of real wages. From the estimated equations, unemployment appears to exert little downward pressure on Slovak wages, though there is some evidence that changes in the unemployment rate have an effect on wage growth.

104. The model suggests at least two main differences between the determinants of Slovak and Polish inflation. First, domestic factors, such as wages, labor costs and the unemployment rate have more of an independent influence on inflation in Poland than in Slovakia. In Poland, unit labor costs seem to play an equal role with the exchange rate in determining producer prices, and wages also have a sizeable separate impact on consumer prices. In Slovakia, producer prices are determined almost one-for-one by foreign producer prices and the exchange rate; consumer prices also follow producer prices almost one-for-one.

105. Second, the exchange rate—and foreign producer prices in particular—exert a far greater impact on inflation in Slovakia than on inflation in Poland. This can be seen by simulating the system of wage and price equations. In Slovakia, a 10 percent depreciation of the nominal effective exchange rate raises producer and consumer prices by 5 percent in the first year. By the end of the second year, the pass-through into producer and consumer prices is complete—a powerful demonstration of the effectiveness of the nominal exchange rate as a tool for disinflation. By contrast, in Poland a 10 percent nominal depreciation was estimated to raise consumer prices by 6 percent, and this with a three year delay.

106. It is clear from the estimated equations and model simulations that the exchange rate and foreign producer prices play an important role in determining inflation in Slovakia. This underpins the effectiveness of the exchange rate peg as a means of reducing inflation. However, it also suggests that, at least within the model, devaluation of the nominal exchange rate is not that effective in generating depreciation of the real exchange rate. This suggests that, to be effective, changes in the nominal exchange rate need to be complemented by additional measures, not included in this model, if they are to have a lasting effect on the real exchange rate.


107. The purpose of this note is to estimate the contribution of cyclical factors to the fiscal performance of Slovakia over the period 1993–96, and to calculate the underlying structural budget balances of the general and central governments.60

108. Slovakia’s fiscal performance over the last three years has been impressive. Between 1993 and 1995, the general government deficit was reduced by about 7 percentage points, from a deficit of 7 percent of GDP in 1993 to a small surplus in 1995. This strong performance is partly attributable to strong revenues fueled by a robust and sustained economic recovery.

109. Improvements of budget positions due to a pick-up in economic activity, as experienced by Slovakia, should be viewed as temporary and should therefore be expected to be reversed as activity slows down. For that reason, a more accurate measure of the underlying fiscal position is given by the structural budget balance, which removes the self-correcting cyclical component from the actual budget balance and so allows to gauge the discretionary element in fiscal policy. Movements in the structural budget balance also reflect factors not directly related to discretionary fiscal policy, for example changes in interest rates, changes in the demographic composition of population or changes in natural resource revenues. In particular in Slovakia, changes in interest rates may have affected the structural budget balance.

A. Methodological Issues

110. This section briefly describes the methodology used for calculating the structural budget balances.61

111. The actual budget balance (B), defined as the difference between total government revenue and total government expenditure, can be decomposed into a structural component (BS) and a cyclical component (BC):


112. To isolate the respective contribution of discretionary and cyclical factors, the actual budget balance is disaggregated as follows.


Where T denotes total tax revenue, NT denotes nontax revenue, UN denotes unemployed benefits and G denotes other government expenditure.

113. Nontax revenue and other government expenditure are assumed to be independent of the business cycle, which implies that:


Conversely, tax revenue and unemployment benefits are related to the cyclical output movements, which implies that:


The structural value of tax revenue (TS) is calculated as:


Where GAP is the cyclical output gap and e is the tax elasticity to the current output gap.

114. Under the assumption that cyclical fluctuations in unemployment benefits are proportional to the cyclical fluctuations in the unemployment rate, the structural value of unemployment benefits (UNS) is given by:


Where U and US denote, respectively, the actual and structural rate of unemployment.

Using (3), (4), (7) and (8), the structural budget balance is given by:


115. Finally, the cyclical output gap is defined as:


Where Y and YP denotes, respectively, actual and potential output, both expressed in nominal terms.

B. Data Issues

116. As the above framework makes clear, a key aspect of the cyclical adjustment is the estimate of potential output and structural unemployment. Due to data limitation, the application of standard approaches for calculating potential output proved rather difficult for Slovakia.62 For that reason, a more simple—and rather crude—approach was adopted.

According to that approach, potential output from 1993 to 1996 is obtained as follows: based on the presumption that the Slovak economy was dose to full-employment at end-1995, we selected 1995 as a base year and calculated 1995 potential output as the average of the actual 1995 GDP and the projected 1996 GDP; potential GDP for the rest of the period is then derived from the base-year potential GDP using a constant 5 percent rate of potential real output growth.63 This method yields a negative output gap of 5.7 percent in 1993, 5.4 percent in 1994, 3.3 percent in 1995 and 1.6 percent in 1996. Given structural rigidities on the labor market, the structural rate of unemployment is assumed to be lower than the actual unemployment rate and is set arbitrarily at 9.5 percent of total labor force.

117. The calculation of cyclically adjusted revenue is obtained by applying elasticities that measure the sensitivity of the different categories of revenue to cyclical fluctuations. There are no estimates of tax elasticities for Slovakia. Such estimates are also difficult to obtain, given the limited number of fiscal observations and frequent changes in tax regime during recent years. We therefore decided to adopt the elasticity estimates provided by the OECD (1994) and then calculated, for each category of revenue, the average elasticity for small industrialized countries. The resulting elasticities are: 2.4 for corporate tax, 1.2 for personal income tax, 1.0 for indirect tax, 0.7 for social security contribution and 1.0 for other tax (see Table 6).

Table 6.

Tax Elasticities for Small Industrial Countries

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Source: OECD (1994).

118. Basic data and assumptions are summarized in Table 7.

Table 7.

Slovak Republic: Basic Data and Assumptions

(In billions of Slovak koruny)

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Sources: Ministry of Finance of the Slovak Republic, Slovak Statistical Office, OECD (1994), and staff estimates.

As a percentage of total labor force.

Annual percentage change.

In billions of Slovak crowns.

OECD (1994).

C. Structural Budget Balances

119. The structural budget balance of the general government is presented in Table 8.64 It appears that over the period considered, cyclical factors had a large impact on government deficits. In 1993, the structural budget balance of the general government is estimated at 4.1 percent of potential GDP, compared to an actual deficit of 7 percent of GDP. In 1994, the actual deficit improved to 1.3 percent of GDP. However, when cyclical factors are removed, a structural surplus of 1.4 percent of GDP is obtained. The improvement of the actual and structural general government balances continues in 1995, the improvement of the structural balance being however less pronounced than the improvement of the actual balance. In 1996, the actual budget balance is projected to deteriorate markedly to a deficit of about 1.1 percent of GDP. The effect of removing cyclical factors aggravates the deterioration of the fiscal stance, the structural budget balance being projected to move from a surplus of 2 percent of potential output in 1995 to a small deficit of 0.3 percent of potential output in 1996.

Table 8.

Slovak Republic: Structural Budget Balance

I. General Government

(In billions of Slovak koruny)

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Source: Staff estimates.

120. The structural budget balance of the central government is reported in Table 9. One can observe that the difference between the structural and actual budget balance is smaller than the difference noticed for the general government. One can also observe a slight decline of the central government structural surplus in 1995 while the general government structural surplus increased.

Table 9.

Slovak Republic: Structural Budget Balance

II. Central Government

(In billions of Slovak koruny)

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Source: Staff estimate.

121. Tables 10 and 11 provide a breakdown of structural revenues for the general government and the central government, respectively.65 The difference between actual and structural tax revenues appears to be the largest in 1993 but declines gradually over time, reflecting the narrowing of the output gap. For the general government, structural taxes are estimated to be about 7 percent higher than actual tax revenues in 1993, the difference declining to less than 2 percent in 1996. The difference is the largest for corporate revenues, reflecting the assumed large elasticity of corporate profits to the business cycle; it is estimated at about 14 percent in 1994 but declining to about 4 percent in 1996. By contrast, the difference is the smallest for social security contributions, whose elasticity to the business cycle is set at 0.7.

Table 10.

Slovak Republic: Composition of Structural Revenues

I General Government

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Sources: Ministry of Finance of the Slovak Republic, and staff estimates.
Table 11.

Slovak Republic: Composition of Structural Revenues

II. Central Government

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Sources: Ministry of Finance of the Slovak Republic, and staff estimates.

D. Conclusions

122. Recent staff estimates point out a significant weakening of Slovakia’s fiscal performance in 1996. Given recent signs that Slovakia is operating at almost full capacity, one may suspect that the deterioration of general government’s finance is even more pronounced when corrected for cyclical factors. This chapter has investigated this issue and has estimated that the deterioration of the structural budget balance in 1996 could be about 1 percent of GDP larger than that of the actual budget balance.


A. Introduction

123. The external current account of the Slovak Republic, which registered a surplus of 2.2 percent of GDP in 1995, turned around sharply into a deficit in 1996, projected to be at least 8 percent of GDP for the year. This sudden and sizable deterioration of the external balance of the economy was accompanied by a rapid expansion in broad monetary aggregates. While a number of factors appear to have contributed to the dramatic swing in Slovakia’s external current account (including the recession in western Europe, the one-off importation of military equipment from Russia and the temporary removal of tariffs on imported small cars), this note focuses on the impact of the monetary expansion. The note shows that the Slovak trade balance is strongly correlated with the cumulative lagged change in domestic credit and, particularly, with the cumulative lagged change in domestic credit to the private sector. Moreover, the note argues that the expansion in credit was possible in part because of a relaxation of the monetary policy stance beginning in the second half of 1995.

B. Credit and Trade Balance

124. There are at least three theoretical links between credit expansion and trade balance. First, a loosening of credit allows previously credit constrained households and firms to augment consumption and to undertake new investment, both of which are likely to cause the trade balance to worsen. Second, in an economy under a fixed exchange rate regime, rapid credit expansion, should it lead to an accumulation of excess liquidity in the hands of the public, could result in an erosion of the balance of payments as the public dishoards its excess money holdings. In an economy with limited capital mobility the dishoarding may take place via the current account rather than the capital account. Third, in an economy under a fixed exchange rate regime, rapid credit expansion, should it give rise to inflation, will lead to a deterioration of the real exchange rate and consequently that of the trade balance.

125. In the case of the Slovak Republic, there is circumstantial evidence that can be interpreted as support for each of these theoretical links. First, the fact that the majority of investments undertaken by Slovak firms is financed from retained earnings implies possibly extensive economy-wide credit constraints. Second, the fact that, in face of the rapid credit expansion, money growth and income growth diverged sharply in late 1995 and early 1996 (Figure 11), leading to a substantial decline in velocity, might suggest a build-up of excess liquidity in the economy.67 Finally, although inflation continued to decline in 1996, the CPI based real effective exchange rate appreciated by 0.2 percent in 1996, while the ULC based REER appreciated by 7.6 percent.



Citation: IMF Staff Country Reports 1997, 043; 10.5089/9781451835366.002.A001

Source: International Financial Statistics.

126. Below we provide evidence of a correlation between credit expansion and the trade balance. The available data do not allow us to estimate a model to disentangle the contribution of each of these factors to the deterioration of the trade balance. Instead we estimate a reduced form regression, whose coefficients could be interpreted in several ways. Still, the results provide strong support to link the rapid deterioration of the trade balance to the loosening in credit conditions, but it does not help us understand the channels through which these developments occurred. We estimate the following regression:


where TB represents the trade balance for goods and ADC the change in domestic credit. The reason why the trade balance for goods has been chosen as the dependent variable instead of the current account balance is because non-factor payments and the main service component of the current account balance are not likely to be influenced by credit availability.68 The regression is based on monthly data (from January 1993 to September 1996) from the International Financial Statistics. Both the credit and the trade balance are measured in millions of Koruny. As implied by the lag structure of the regression, we have chosen to study the impact on trade balance of changes in credit within the previous four months.69

127. Table 12 provides the main results of the regression. As expected, all of the signs on the estimated coefficients are negative. Credit changes with a two and a four months lags appear to exercise the highest impact on the trade balance. The sum of all the estimated coefficients is -0.34,70 which implies that changes in domestic credit over a period of four months can have a significant impact on both the direction and magnitude of the trade balance.

Table 12.

Trade Balance and Domestic Credit

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Note: Trade balance of goods. Importations of aircraft and military expenditure are substracted from the trade balance of February 1996 and December 1993. The numbers in the parentheses are t statistics.

128. Credit to the private sector is the largest component of total domestic credit (see Figure 12). To examine the specific effect of the change in private sector credit (ADCP) on the trade balance, we have replicated the regression above, exchanging ADC with ADCP. Table 13 presents the results. The sum of the estimated coefficients is -0.4171 which indicates that the trade balance is very sensitive to changes in private sector credit.72 This is probably because private consumption and investment have a higher tradable content than government consumption and investment.



Citation: IMF Staff Country Reports 1997, 043; 10.5089/9781451835366.002.A001

Source: International Financial Statistics.
Table 13.

Trade Balance and Credit to Private Sector

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Note: Trade balance of goods. Importations of aircraft and military expenditure are subtracted from the trade balance of February 1996 and December 1993. The numbers in the parentheses are t statistics.

C. Money Creation and Sterilization

129. In the previous section of this note we produced evidence consistent with the hypothesis that the deterioration of the Slovak trade balance in late 1995 and in 1996 was the result of the acceleration in the domestic provision of credit and in particular the rapid expansion in credit to the private sector. The question of what had been behind the expansion in credit and money and whether it could have been avoided, however, remains. We argue that the expansion was possible in part because of a relaxation of monetary policy of the NBS, first by weakening its sterilization efforts in face of the current account surplus in the third quarter of 199S, and then by accommodating the effects of the current account deficit in 1996.

130. It is widely accepted that a small open economy is susceptible to large fluctuations in its external balances. For an economy with a fixed exchange rate arrangement, wide swings in the current account and the capital account can lead to sharp changes in the central bank’s holdings of net foreign assets.73 Sharp changes in NFA, unless countered by offsetting changes in NDA, will be translated into a volatile money supply process. Therefore, reduce this volatility and to meet its monetary targets, the monetary authorities have to engage in sterilization operations through manipulation of the NDA of the central bank.

131. The Slovak Republic is a small open economy74 with a very volatile current account and consequently, volatile holdings of NFA by the NBS (Figure 13). The figure also shows that the NBS, until the second quarter of 1995, sterilized increases in its holdings of net foreign assets by reducing its holdings of net domestic assets. By doing so, the NBS avoided the unpredictable and potentially undesirable outcome of having excess money work its own way through the current account.



Citation: IMF Staff Country Reports 1997, 043; 10.5089/9781451835366.002.A001

Source: International Financial Statistics.

132. To assess the commitment of the NBS to its sterilization policies, we regress the change in its holdings of net foreign assets (ΔNFA) on the change in its holdings of net domestic assets (ΔNDA)


133. Table 14 shows that the absolute value of the estimated coefficient of ΔNFA is lower for the whole sample period than for the period leading up to the second quarter of 1995. Despite the obvious small sample problem inherent in the above regression, the results appear to imply that the NBS relaxed its sterilization practice after the first half of 1995. Figure 13 perhaps illustrates this point more clearly.

Table 14.

Measure of Central Bank Sterilization

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Source: International Financial Statistics.

134. Figure 13 shows that the money base was relatively stable up to the middle of 1995 (changes in reserve money were small compared with the changes of its two components). In the third quarter of 1995 both NDA and NFA experienced increases, causing reserve money to rise sharply. Despite the sterilization measures undertaken by the NBS with the issuing of its own bills, the expansion of the reserve base was halted but not reversed in the following two quarters. In the second quarter of 1996, in face of a small increase in NFA, NDA grew again (with a small increase in credit to both government and commercial banks) resulting in a further increase in reserve money.


135. This chapter looks at the evolution of Slovakia’s external trade. Section A examines its geographic distribution and the composition of imports and exports. Since its independence, Slovakia has steadily redirected its trade towards the EU and away from the Former Centrally Planned Economies (FCPE), especially from the Czech Republic. On the other hand, the product composition of exports and imports has remained relatively unchanged. Section B estimates that a significant part of the external deficit in 1996 was linked to the still ongoing investment boom and to the large surge in the import of cars.

A. Geographic Reorientation and Composition of Trade

136. Since the beginning of the transition and especially since its independence in 1993, Slovakia’s trade has been gradually shifting towards the western industrial economies. Figure 14 compares the geographic trade pattern of the former Czechoslovakia in 198576 with those of the Czech and Slovak Republics in 1995. While in 1985 about 32 percent of Czechoslovakia’s total exports were destined to industrial countries, in 1995 almost 50 percent of Slovakia’s exports went to industrial countries. On the other hand, in 1985, Czechoslovakia’s imports from industrial countries amounted to 34 percent of its total imports, yet this share was 47 percent for the Slovak Republic in 1995. These figures may actually underestimate the success in redirecting trade since there are indications that in 1985 the share of exports to the West from the Slovak territories was substantially lower than the average for all of Czechoslovakia.


SLOVAK REPUBLIC: Geographic Evolution of Trade

(In percent total)

Citation: IMF Staff Country Reports 1997, 043; 10.5089/9781451835366.002.A001

Sources: IMF Direction of Trade Statistics.

137. Table 15 presents the evolution of imports, exports and the trade balance with major trading groups since independence. It shows that the trend of reorienting trade away from FCPEs is most pronounced towards the Czech Republic. Exports to Russia also continued to decline in importance, but imports of energy and other raw materials continued to rise fast and led to a bilateral deficit of over US$1.5 billion in 1996. It is clear from Table 15 that the EU is fast becoming Slovakia’s main trading partner, already accounting for about 40 percent of all trade.

Table 15.

Slovak Republic: Direction of Trade (1993–96)

(In billions of US$)

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Source: Slovak authorities.

138. Table 16 examines the commodity structure of Slovakia’s trade with the FCPE and the EU, in 1995. Manufactured intermediate goods are the main exports to both regions, at about 40 percent of total exports in each case. Actually, Table 17 shows that Slovakia’s exports are concentrated in a relatively narrow range of products, with nearly 70 percent accounted for by about 15 product groups (mainly iron and steel products). The composition of imports, on the other hand, is very different across regions. Slovakia relays on the FCPEs mainly for raw materials and mineral fuels, and on the EU countries for capital goods and technology.77

Table 16.

Slovak Republic: Regional Product Composition of Trade

(In millions of US$)

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Source: Slovak authorities. Based on 1-digit SITC codes.

Transition economies, including CEFTA, and the former Soviet Union

Table 17.

Slovak Republic: Trade Shares

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Source: Slovak authorities and staff calculations. Based on Harmonized Commodity Description and Coding System (97 sectors).

B. The Composition of Imports

139. This section examines the composition of imports in 1996 to ascertain the relative shares of imports of consumption, intermediate and investment goods, and assesses their respective roles in the large deterioration of the trade balance. This is done by assigning each of the Harmonized Commodity Description System data (2 Digits, 97 sectors) to one of these uses. Table 18 shows that imports grew by over 30 percent to about Sk 340 billion (or about US$11 billion). The largest contributors to the import bill in 1996 were fuels (Sk 57 billion), nuclear power plant equipments totaling (Sk 52 billion), electrical machines and equipments (Sk 25 billion). Imports of vehicles, encouraged by a temporary reduction in tariffs, more than doubled (to Sk 35 billion) and represented a substantial portion of the overall increase. Also, about sk. 6 billion (or about US$190 million) in military equipment, mainly aircraft, were imported from Russia in payment for existing Russian debts. These categories account for about 50 percent of Slovakia’s total imports in 1996.

Table 18.

Slovak Republic: Sectoral Classifications of Imports

(In billions of Sk)

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Source: Slovak authorities.

Includes: food, animals, beverages, tobaco, clothing, jewel, opticals, clocks, music instrmnts. furniture, toys, art, antiques.

Includes: mineral fuels, oils, minerals, chemicals, plastics, leather, wood, fabrics, base metals.

Includes: nuclear reactors, boilers, electrc. machines, parts, railway locomotive, aircraft, ships, boats, arms, parts. Excludes total value of aircraft impors from Russia in 1996.

140. The structure of imports in terms of consumption, investment and intermediate inputs was calculated using the Harmonized Commodity Description System data. While goods in these sectors have diverse usages and applications, Table 18 aggregated the 97 sectors into 4 categories, according to their main application. Categories A through D respectively represent imports of consumption goods, intermediary inputs, investment goods, and finally cars and vehicles.78 Imports of vehicles (Category D) displays the highest growth rate of 147 percent, followed by investment (Category C) 45 percent, consumption (Category A) 22 percent, and finally intermediary inputs (Category B) 16 percent.

141. Table 18 also shows the implications of allocating different proportions of the imports of vehicles among consumption and investment. Assuming, as in official Slovak estimates, that 1/3 of the imported vehicles were for personal use and 2/3 were allocated for investment would imply that the import of consumption goods in 1996, in nominal terms, increased by 33 percent, whereas the imports of investment goods rose by 50 percent. Also, in 1996 the share of consumption goods in total imports grew by about 0.7 percentage points, while the share of investment goods increased by 4.6 percentage points.

142. An alternative case could be based on the assumption that all the imports of cars and vehicles were for consumption purposes. This, in 1996, renders a growth rate of imports of consumer goods of 50 percent, and of 35 percent for investment goods.

143. Imports of intermediate inputs increased by only 16 percent in 1996, thus reducing its share in total imports by 5 percentage points to 47. Mineral fuels make up 17 percent of total imports, as Slovakia imports about 90 percent of its primary energy requirements. Of this, coal and oil account for about 20 percent and 75 percent of total fuel imports. This leaves Slovakia highly exposed to changes in energy prices. In particular, in 1996 the prices of coal and oil rose by about 7.5 and 13.5 percent respectively contributing to the widening of the trade deficit.


Appendix Table 1.

Slovak Republic: Selected Indicators of Real Sector Developments, 1992–96

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Sources: Data provided by the Slovak authorities; and staff estimates.

In comparable 1993 prices.

In constant prices as of January 1, 1989, in methodology and organization of current year, includes mining and quarrying, manufacturing industry and production and supply of electricity, water and gas.

Final consumption of households and final consumption of government; in constant 1993 prices.

Real wages of industrial enterprises with more than 25 employees.

In constant January 1989 prices.

Appendix Table 2.

Slovak Republic: Gross Domestic Product—Current Prices, 1992–96

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Source: Data provided by the Slovak authorities.