This Selected Issues paper and Statistical Appendix examines external competitiveness and the exchange rate for the Slovak Republic. The paper describes two simple types of competitiveness indicators: (i) real effective exchange rate measures, which examine underlying fundamentals thought to influence external performance; and (ii) indicators of actual export performance. The results suggest that the unfavorable outcomes in the merchandise trade balance and the current account from 1996 to 1998 reflected, at least in part, competitiveness problems. The paper also presents an assessment of banking conditions and the supervision system in the Slovak Republic.

Abstract

This Selected Issues paper and Statistical Appendix examines external competitiveness and the exchange rate for the Slovak Republic. The paper describes two simple types of competitiveness indicators: (i) real effective exchange rate measures, which examine underlying fundamentals thought to influence external performance; and (ii) indicators of actual export performance. The results suggest that the unfavorable outcomes in the merchandise trade balance and the current account from 1996 to 1998 reflected, at least in part, competitiveness problems. The paper also presents an assessment of banking conditions and the supervision system in the Slovak Republic.

I. A Note on External Competitiveness and the Exchange Rate1

A. Introduction

1. The persistence of Slovakia’s large current account deficits combined with recent volatility in the koruna exchange rate has focused attention on the external value of the koruna and the external competitiveness of Slovak enterprises. Concern over this issue arose with the rapid deterioration of the Slovak trade balance in 1996 to 12 percent of GDP, from 1 percent in 1995. The trade deficit continued at some 11-12 percent of GDP through 1998.

2. This chapter presents and discusses two simple types of competitiveness indicators: (i) real effective exchange rate measures, which examine underlying fundamentals thought to influence external performance; and (ii) indicators of actual export performance. None of the individual indicators presented is comprehensive or completely reliable on its own, particularly in the context of a transition economy, where rapid structural change and the reorientation of trade complicate the analysis. However, taken together the indicators often can provide useful guidance.

3. The results, while somewhat mixed, suggest that the unfavorable outcomes in the merchandise trade balance and the current account from 1996-98 reflected, at least in part, competitiveness problems. These problems stemmed from the rapid appreciation of the real effective exchange rate of the koruna on a unit labor cost basis. The reversal of this appreciation through a depreciation of the nominal exchange rate, particularly since September 1998, appears sufficient to offset this loss of competitiveness.2 Indeed, Slovak exporters have again begun to increase market shares in their most important market, the European Union (EU) countries. At this stage it seems that no further depreciation is needed on competitiveness grounds.

4. While the focus of this section is external competitiveness and the exchange rate, other considerations also help determine the appropriate level of the exchange rate. Adjustment to unbalanced domestic policies, cyclical factors, response to external shocks, and the need for eventual surpluses to offset persistent trade deficits are examples of factors that may require exchange rates to deviate from their long-term equilibrium. If such factors were to cause downward pressures to develop on the exchange rate, and unless these pressures were clearly ephemeral, a continued policy of non-intervention would be appropriate in order to avoid a decline in the international reserves of the National Bank of Slovakia (NBS) from existing uncomfortably low levels.3

B. Real Effective Exchange Rates

5. Measures of the real effective exchange rate (REER) include those based on consumer prices (CPI), producer prices (PPI), and unit labor costs (ULC). The CPI-based measure is widely available, allowing comparisons to other countries; however, it has the disadvantages of including non-traded goods, and the representative basket used will vary across countries (although CPI-based series can, under certain assumptions, be taken as a measure of the relative price of tradables to non-tradables at home and abroad). The PPI-based measure retains the disadvantage that the basket varies across countries; however, the items in each country’s basket are slanted more toward traded goods. The ULC-based measure may be the most appropriate for use as a competitiveness measure;4 however, this nevertheless misses important components of actual costs, such as capital, and the measurement of productivity, which underlies the ULC-based measure, is difficult in practice.

6. The CPI, PPI and ULC-based real effective exchange rate measures are shown for Slovakia in Figure I-1 (the nominal effective exchange rate, NEER, is also shown for comparison purposes). The CPI- and PPI- based measures indicate that the real value of the koruna did not deviate from its January 1993 level by more than 10 percent until May 1997, well after the deterioration in Slovakia’s external trade balance had begun. The real appreciation, according to these measures,5 peaked in January 1998 with the koruna some 15 percent above its level of January 1993 (when the Slovak Republic became independent). The koruna, according to these measures, fell by some 5 percent over the next eight months, then dropped 10 percent further in September and October 1998, to levels 1 to 2 percent above January 1993. From October through January 1999, the CPI- and PPI- based measures indicate a real appreciation of some 4 percent, although the nominal rate has since depreciated some 15 percent further.

7. The unit labor cost-based real effective exchange rate measure provides a different view; it indicates a steady appreciation beginning in early 1995. The period average ULC-based REER (not shown in the chart) appreciated 6 percent in 1995, 9 percent in 1996 and 12 percent in 1997. On a ULC basis, the koruna appreciated 54 percent from its inception in January 1993 to January 1998.

Figure I-1.
Figure I-1.

SLOVAK REPUBLIC: EXCHANGE RATE INDICATORS 1/

(Jan. 1993=100)

Citation: IMF Staff Country Reports 1999, 112; 10.5089/9781451835380.002.A001

Sources: Slovak, authorities.1/ An increase denotes appreciation. The ULC measure is based on gross output in the industrial sector. Using value added in Slovak manufacturing, the ULC measure would show stronger external competitiveness in 1999.

8. The considerable gap between the ULC-based measure of the REER and the CPI- and PPI-based measures reflects the extent to which wage growth has out paced measured productivity increases. It suggests that to the extent a competitiveness problem existed before September 1998 it may have stemmed from either slow productivity growth (perhaps related to unambitious structural reform) or from fast wage growth (perhaps related to loose incomes policies).6

9. Table I-1 provides some related indicators of competitiveness and a comparison to other European transition economies for the period 1994-98. With respect to unit labor costs (shown here converted to a DM basis), this shows a wide range of developments across countries. The Baltic countries (which have also had sizeable trade deficits) and Russia experienced unit labor cost increases through 1996 (in Lithuania, through 1997) much larger than those of Slovakia, as did Russia. Focusing on Slovakia’s closest comparators and on the period beginning 1995, just preceding the deterioration of Slovakia’s external balances, suggests a relatively rapid increase in Slovak unit labor costs. From 1995-97, Slovak unit labor costs rose some 35 percent, compared to some 15 percent for the Czech Republic and Poland, and a decline of 20 percent for Hungary. The divergence with respect to the Czech Republic and Poland was largely reversed in 1998.

Table I-1.

Slovak Republic: indicators of Competitiveness

(In percent change)

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Source: EBRD Transition Report

C. Performance-based indicators of Slovak competitiveness

10. To examine the performance of Slovak exports, this section focuses on merchandise trade with the EU, which now accounts for some 55 percent of Slovak exports. This assessment is complicated, however, because the rapid increase of Slovakia’s trade with the EU in the early 1990s (like that of other European transition economies) largely reflected the ending of managed trade and a burst of economic relations with western Europe. It is difficult to disentangle such effects from those related to competitiveness. Nevertheless, the data can provide some guidance.

11. Table I-2 shows EU total imports, imports from Slovakia, and Slovakia’s share of EU imports (including intra-EU trade).7 This share grew from 0.11 percent of EU imports in 1993 to 0.21 percent in 1995, but this growth virtually halted in 1996 and 1997, perhaps reflecting the increased unit labor costs noted above. The stagnation in EU import share is consistent with the rapid increase in the ULC-based real effective exchange rate of the koruna during that period, but would also be consistent with a “catch-up” story, according to which Slovakia’s share of EU imports was repressed during the socialist period but by 1995 reached its natural level. Slovakia’s import share rose to 0.29 percent in 1998, providing support for the former explanation, and exceeded 0.3 percent in the second half of 1998.

Table I-2.

Slovak Republic: Share of EU Imports, 1993-98

(In millions of U.S. dollars)

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Source: IMF, Direction of Trade StatisticsNote: EU imports include intra-EU trade.

12. Figure I-2 presents the EU’s imports from Slovakia as a share of EU imports from five central European countries (including Slovakia). While exports from each of these countries to the EU have risen markedly since 1993, Slovakia’s share of this group’s exports has risen from under 5 percent in early 1993 to nearly 10 percent in 1998. Still, this share was stagnant from late 1994 until early 1998, during the period in which Slovakia’s ULC-based REER was rising.

Figure I-2.
Figure I-2.

Selected Central European Countries: Share of EU Imports, 1993-98

(Percent of five-country total)

Citation: IMF Staff Country Reports 1999, 112; 10.5089/9781451835380.002.A001

Source: IMF, Direction of Trade Statistics.

13. Measures of aggregate bilateral trade can be influenced by several factors that are not related to competitiveness. Changes in prices or import demand of those particular products exported by Slovakia could, for example, account for changes in the Slovak share of EU imports.8 Table I-3 provides information about the export performance of detailed Slovak products in the EU market. The product groupings were selected based on their overall share of total Slovak exports to the EU.9 The selected products accounted for 60 percent of Slovak exports to the EU in 1997. Shares are reported relative to extra-EU imports.

Table I-3.

Slovak Republic: Share of EU Imports in Selected Product Categories, 1993-98

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Source: Eurostat COMEXT.

14. The performance of Slovak exports in particular industries remains consistent with the pattern described above for the overall market share of Slovak exports. In most product categories, Slovakia’s share of EU imports rose sharply from 1993 until 1995, then stagnated in 1996 and 1997 (exceptions are insulated wire and cables; and vehicles). The more detailed analysis does, however, provide some insight into the renewed growth in the market share in 1998. In particular, much of this growth stems from exports of vehicles, the market share of which rose from 2.1 percent in 1997 to 3.1 percent in the first half of 1998 and over 4.3 percent for all of 1998. Other than for vehicles, which accounted for 16 percent of Slovak exports to the EU in 1997, the market share of the selected products rose only modestly.10 The increase in vehicle exports is associated with a large-scale foreign direct investment project.

D. Concluding Remarks

15. Slovakia’s share of EU imports rose to some 0.83 percent in the second half of 1998, after stagnating at 0.59 percent in 1996 and 1997. Moreover, the lagged effects of the depreciation in late 1998, combined with the further substantial depreciation witnessed in early 1999, are likely to support further increases in competitiveness. While the recent depreciation has been helpful in restoring competitiveness, it thus appears that at this stage no further depreciation is warranted on competitiveness grounds.

1

Prepared by Brad McDonald.

2

As of mid-June 1999, the koruna had depreciated some 20 percent against the U.S. dollar and 12 percent against the Deutsche mark/Euro since end-September 1998.

3

At end-1998, NBS gross official reserves were equivalent to 2.3 months of imports of goods and non-factor services, or 49 percent of short-term external debt.

4

Marsh and Tokarick (1994) suggest that export volume equations using competitiveness indicators based on ULC can explain trade flows for exports of goods overall, and for many goods alone, somewhat better than indicators based on consumer price indices.

5

As seen in the graph, the CPI- and PPI- based measures track very closely in the case of Slovakia.

6

An earlier study based on data through 1997 concluded that no loss of competitiveness was yet evident in the deterioration of the trade balance (see “Competitiveness and the Trade Deficit in Slovakia,” SM/98/33, Revision 1, June 2, 1998). This study estimated equilibrium exchange rates for Slovakia using a vector of fundamental variables (share of investment in GDP, share of public consumption in GDP, the ratio of exports and imports to GDP, and real wages as a proxy for productivity increases), a measure of excess money growth, and a dummy variable for episodes of major nominal devaluations. Regression results were, however, handicapped by the relatively brief time series available.

7

The EU accounted for 56 percent of Slovak merchandise exports in 1998. The Czech Republic is the only non-EU country accounting for more than 5 percent of Slovak exports. However, extending the analysis to trade with the Czech Republic did not seem fruitful given that the decline of the Slovak share of Czech imports from 17 percent in 1993 to 9 percent in 1998 largely reflects factors unrelated to Slovak competitiveness, such as the dissolution of the Czech and Slovak Federal Republic.

8

In these circumstances, a constant market share analysis would normally be preferred (see, for example, Feldman, 1995). However, in this case the brief duration of the available time series and other data limitations are not amenable to more detailed statistical analysis.

9

The homogeneity of products within a grouping was also considered. This led, for example, to the decomposition of HS Chapter 85 (“electrical machinery and equipment, and parts thereof) and the use instead of certain four-digit components of the chapter, such as HS 8501 (“electric motors and generators”).

10

Vehicles accounted for 0.35 points of the total 0.38 point increase from 1997 to 1998. Exported vehicles have a large component of imported parts, estimated at around 40 percent of the export price.

Slovak Republic: Selected Issues and Statistical Appendix
Author: International Monetary Fund
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    SLOVAK REPUBLIC: EXCHANGE RATE INDICATORS 1/

    (Jan. 1993=100)

  • View in gallery

    Selected Central European Countries: Share of EU Imports, 1993-98

    (Percent of five-country total)