Statement by Johann Prader, Executive Director for the Slovak Republic

This 2002 Article IV Consultation highlights that after two years of subdued domestic activity, strong private domestic demand and expansionary fiscal policy in the Slovak Republic buoyed economic growth, which recovered to over 3 percent in 2001. Increased profitability, enterprise restructuring, and reduced corporate income tax boosted fixed investment. Rising real wages and employment, personal income tax reduction, and the redemption of National Property Fund bonds underpinned vigorous growth in private consumption. The general government deficit widened by a half percentage point of GDP to 4 percent of GDP in 2001.

Abstract

This 2002 Article IV Consultation highlights that after two years of subdued domestic activity, strong private domestic demand and expansionary fiscal policy in the Slovak Republic buoyed economic growth, which recovered to over 3 percent in 2001. Increased profitability, enterprise restructuring, and reduced corporate income tax boosted fixed investment. Rising real wages and employment, personal income tax reduction, and the redemption of National Property Fund bonds underpinned vigorous growth in private consumption. The general government deficit widened by a half percentage point of GDP to 4 percent of GDP in 2001.

Introduction

The Slovak authorities are continuing their program of macroeconomic stabilization and comprehensive restructuring and privatization. They wish to express their special appreciation to the staff and to Mission Chief Fernandez-Ansola for their advice and constructive discussion during the preparation of Slovakia’s staff-monitored program (SMP).

The aim of this voluntary program was the implementation of a comprehensive economic agenda with monitoring and advice from Fund staff. No financing by the Fund was involved, but a good performance under the program was a precondition for the World Bank’s Enterprise and Financial Sector Adjustment Loan (EFSAL) to Slovakia.

Since the last Article IV consultation, Slovakia’s economy has been affected by the world slowdown, mostly by reducing exports to its main trading partners. Increasing imports also played a key role in the deterioration of the trade balance. The outgoing authorities agree with the staff that the external deficit can be reduced by corrective measures on the fiscal side. Both the government and the opposition parties recognize the need for measures to reduce the fiscal deficit and create conditions leading to current account sustainability, although they will not be implemented until after the elections in September 2002.

Slovakia has made significant progress towards EU accession. In November 2001 the government approved a list of “Priority Tasks for the Government” drawn from the regular report of the European Commission on the Slovak Republic’s Progress Towards EU Accession issued last November. These tasks include speeding up the process of EU accession negotiations. Their implementation has enabled the Slovak Republic to catch up with the other candidate countries, having so far concluded 27 chapters out of 31.

Real Sector Development

Stabilization policy and progress with structural reforms are creating favorable conditions for economic recovery. Growth accelerated to 3.3 percent in 2001, largely impelled by a significant increase in fixed investments attracted by the improved profitability, as well as by foreign direct investments. A rebound of real wages brought a turnaround of private consumption. However, increasing domestic demand and the global slowdown reduced exports and helped widen the current account deficit. The authorities expect that economic growth in 2002 and in 2003 will be 4 percent of GDP.

Current Account Deficit

Reduced export growth, increased import-intensive investments, and higher private consumption, are the main factors responsible for the widening of the current account deficit last year and early this year. The authorities note that import-intensive investments are a positive sign of restructuring and should lead to increased export capacity in the years ahead.

The authorities regard the present increase in the current account deficit as largely temporary. It is expected to recede as Slovakia’s western European trading partners recover and its household-driven domestic demand returns to trend. But the authorities agree that the current level of the current account deficit is unsustainable. The Selected Issues paper provides an excellent analysis of the sustainability of the current account deficit, which generally agrees with the views of the Slovak authorities.

Already there are signs that the deficit is starting to narrow. The latest data on the trade balance clearly shows an improvement in the export performance. Exports in June 2002 were 6.7 percent higher than in June 2001, while imports over the same period increased by 2.7 percent. At the same time, the current account deficit has been more than fully financed by capital inflows.

Monetary Policy

The National Bank of Slovakia (NBS), which bases its monetary policy on inflation benchmarks, has achieved continuous disinflation. On April 26, 2002, the Banking Board of the NBS raised its policy interest rate by 50 basis points. The change was mostly a response to the worsening external imbalances due mainly to the increased foreign trade deficit.

Currency fluctuations, and the tendency of the Slovak koruna to depreciate vis-à-vis the euro, led the central bank to intervene in the foreign exchange market in June, after which the koruna/euro exchange rate stabilized. The tendency toward depreciation mainly reflects political uncertainty created by the upcoming elections.

With regard to EMU strategy, the NBS expects to work with the new government on a memorandum for establishing inflation benchmarks once the process of price deregulation has been completed.

Fiscal Policy

In 2001 substantial reductions in personal and corporate income tax rates, and the phasing out of the import surcharge, were not matched by comparable declines in public spending. Expenditure arrears have spread to the health sector. The general government deficit reached almost 4 percent of GDP.

The present government is committed to holding down the fiscal deficit to 4.5 percent of GDP in 2002. In revising Slovakia’s Pre-Accession Economic Program (PEP), the government envisages a fiscal deficit of 3.5 percent of GDP for 2003. There is a broad political consensus that these targets are appropriate, and the incoming government can be expected to take the necessary measures to ensure that the targets are met.

These measures will focus mainly on expenditures. On the revenue side, the focus will be on improving tax collection, particularly the VAT. This will be accomplished by an amendment to the VAT law which will become effective in January 2003. In addition, the authorities will strengthen tax administration along the lines recommended by IMF technical assistance missions.

Pension Reform

The authorities’ efforts to improve the pension system have focused mainly on establishing a legal framework. Parliament passed a Social Insurance Act in May 2002, which will become effective in July 2003. This act puts in place reforms of the first pillar, including individual accounts and a gradual increase in the retirement age for women. The act is a first step toward a full reform of the pension system, and prepares the ground for introducing a second pillar.

In order to speed up the reform of the administration of social benefits, in February 2002 the authorities agreed to accept technical assistance from the World Bank. This technical assistance will assist the administrative reforms, including increasing administrative capacity and designing the second pillar.

Restructuring of the Banking Sector

To create conditions for a well-functioning financial system and ensure efficient resource allocation, the authorities have continued their restructuring of the banking sector. And as noted earlier, the authorities have signed an agreement for an EFSAL, which was approved in September last year.

Based on the World Bank’s recommendations, the authorities have prepared and begun to implement a plan for improving prudential regulation. They are enforcing the new Banking Act that came into force in 2002, and the 2001 amendment to the National Bank of Slovakia Act, which brings Slovakia’s legal framework closer to EU standards and the Basel Core principles. Also, based on a diagnostic evaluation, the NBS approved a multi-year “Supervisory Development Plan” in December 2001. This plan is focused on risk-oriented banking supervision and integrated off- and on-site supervision. To put this into practice, the NBS has hired new staff, created a training program, and will upgrade its supervisory information system.

The Slovak authorities have greatly appreciated the opportunity to have Slovakia’s financial sector assessed by the Fund and the Bank. The Financial Sector Assessment Program has usefully reviewed the strengths, vulnerabilities, and opportunities for key improvements in Slovakia’s financial system. The authorities concur with most of the views presented by the mission, and they will carry out the main recommendations.

Privatization of Banking Sector and Public Utilities Companies

Slovakia’s privatization process gained significant momentum in 2001 and 2002 and is entering its final stage. The major state-owned banks have all been privatized by foreign companies. The present share of the private banks amounts to over 90 percent, and the authorities are continuing to privatize the other state-owned banks. The rest of the banking sector-consisting of small and medium-sized banks-has also been restructured and will be completely privatized.

The most important parts of the privatization process were privatizing the banking sector and privatizing the public utilities. In November, a 94.5 percent stake in Všeobecná úverová banka (VUB), Slovakia’s second largest bank, was sold to Italy’s IntesaBCI. And in April, a 66.8 percent stake in Slovenská Poistovňa (SP), the largest Slovak insurer, was sold to Allianz AG of Germany. And the Hungarian saving bank OTP Bank has become the owner of a 92.6 percent stake of Investičná a Rozvojová banka (IRB).

Most of the public utility companies have been sold to foreign strategic investors. The authorities sold the natural monopoly Slovenský Plynárenský Priemysel (SPP) to a consortium of Ruhrgas of Germany, Gaz de France, and Gazprom. SPP was the largest privatization in the Slovak Republic. At the end of last year a 49 percent stake in Transpetrol, the oil pipeline, was sold to a Russian company.

In May 2002, the authorities approved the sale of 49 percent shares in each of the three electricity distributors. Západoslovenská Energetika (ZE) was sold to EON of Germany, Stredoslovenská Energetika (SSE) to Electricité de France, and Východoslovenská Energetika (VSE) to RWE Plus Germany. In addition, the authorities agreed to sell to private investors 49 percent stakes in four companies of Slovenská Automobilová Doprava (SADs).

The authorities have scheduled further privatizations for the second half of this year. These will concentrate on the remaining public utilities, mostly heating companies and leftover SADs. Many of these will likewise be sold to foreign strategic investors.

Regulatory Authorities

To promote efficiency and harmonize legislation with the EU, an independent regulatory authority for the setting of administered prices has been established and a new Regulatory Council was appointed in October 2001. This regulatory body has been preparing to set energy prices based on economic criteria, beginning on January 1, 2003.

Unemployment

Though the latest data on unemployment reflect a slight improvement, the present level of unemployment is still worrisome. The excessive unemployment is structural in nature. It includes large numbers of prime-age and older workers displaced by industrial restructuring and the closure of agriculture co-operatives. The very low level of labor mobility is caused both by problems in the housing market, and by social assistance benefits that are uniform nation-wide despite large regional differences in living costs.

Partly in order to address the unemployment problem, a new Labor Code was approved last year, and became effective in April 2002. Based on broad discussions among entrepreneurs, trade unions, and officials, the authorities agreed with the staff that the Code should establish a more general framework for labor relations which would give employers and employees substantial flexibility in reaching agreement on specific work arrangements. The authorities noted an emerging consensus for amendments to this effect, and the next government is likely to act quickly to introduce such amendments.

Conclusion

The Slovak Republic’s present government, which took office in the fall of 1998, has established a macroeconomic framework for medium-term development, and has restructured, and nearly completed the privatization, of the banking sector and public utility companies. Despite these accomplishments, the next government will face serious challenges, especially if the current account balance does not improve. These include the need for further fiscal consolidation, completing enterprise reforms, creating favorable conditions for small- and medium-size enterprises, improving labor market mobility, and introducing the second pillar of the pension system. Such undertakings will create the conditions for a smooth accession to the EU and prepare Slovakia for the highly competitive EU marketplace.