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).

SLOVAK REPUBLIC: SOURCES AND USES OF ECONOMIC RESOURCES

(IN PERCENT OF TOTAL) ^1/

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

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

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SLOVAK REPUBLIC: SOURCES AND USES OF ECONOMIC RESOURCES

(IN PERCENT OF TOTAL) ^1/

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

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

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SLOVAK REPUBLIC: SOURCES AND USES OF ECONOMIC RESOURCES

(IN PERCENT OF TOTAL) ^1/

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

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

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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.

Industry

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

SLOVAK REPUBLIC: INDUSTRIAL PRODUCTION

(1993=100)

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

Sources: Slovak authorities; and staff calculations.

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SLOVAK REPUBLIC: INDUSTRIAL PRODUCTION

(1993=100)

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

Sources: Slovak authorities; and staff calculations.

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SLOVAK REPUBLIC: INDUSTRIAL PRODUCTION

(1993=100)

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

Sources: Slovak authorities; and staff calculations.

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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.

Agriculture

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).

Construction

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).

Prices

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).

SLOVAK REPUBLIC: PRICE INDICES

(year-to-year percent change)

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

Sources: Slovak authorities; and staff calculations.

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SLOVAK REPUBLIC: PRICE INDICES

(year-to-year percent change)

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

Sources: Slovak authorities; and staff calculations.

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SLOVAK REPUBLIC: PRICE INDICES

(year-to-year percent change)

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

Sources: Slovak authorities; and staff calculations.

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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).

SLOVAK REPUBLIC: EXCHANGE RATE INDICATORS

(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.

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SLOVAK REPUBLIC: EXCHANGE RATE INDICATORS

(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.

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SLOVAK REPUBLIC: EXCHANGE RATE INDICATORS

(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.

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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).

SLOVAK REPUBLIC: WAGES AND UNEMPLOYMENT RATE

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.

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SLOVAK REPUBLIC: WAGES AND UNEMPLOYMENT RATE

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.

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SLOVAK REPUBLIC: WAGES AND UNEMPLOYMENT RATE

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.

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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

Privatization

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.

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.

Overview

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).

SLOVAK REPUBLIC: SELECTED INTEREST RATES

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

Sources: Slovak authorities; and staff calculations.

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SLOVAK REPUBLIC: SELECTED INTEREST RATES

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

Sources: Slovak authorities; and staff calculations.

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SLOVAK REPUBLIC: SELECTED INTEREST RATES

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

Sources: Slovak authorities; and staff calculations.

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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.

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).