Slovak Republic: Selected Issues
Author:
International Monetary Fund. European Dept.
Search for other papers by International Monetary Fund. European Dept. in
Current site
Google ScholarClose
Publication Date:
02 Sep 2014
eISBN:
9781498333801
Language:
English
Keywords:
ISCR; CR; Slovakia; net; FDI; EU accession; export; FDI shock; FDI multiplier; FDI inflow; macro variable; trade pattern; Real exports; Exports; Foreign direct investment; Trade balance
Download PDF (1.8 MB)

In recent years, the IMF has released a growing number of reports and other documents covering economic and financial developments and trends in member countries. Each report, prepared by a staff team after discussions with government officials, is published at the option of the member country.

Abstract

In recent years, the IMF has released a growing number of reports and other documents covering economic and financial developments and trends in member countries. Each report, prepared by a staff team after discussions with government officials, is published at the option of the member country.

Evolution of Drivers of the Business Cycle in Slovakia1

A. Introduction

1. EU accession further deepened Slovakia’s integration into the world economy. Participation in the German-Central European supply chain, mainly in the automotive sector, as well as in export-oriented electronic industries, has strengthened the trade and financial linkages of the Slovak economy with the rest of the world. As vertical integration has increased, trade flows with upstream and downstream partners have expanded and FDI inflows have intensified. However, this process of integration has also made the Slovak economy more vulnerable to global shocks, whether affecting the production chain or the markets that are the final destination of exports.

2. The aim of this note is to quantify the impact of the changing economic structure on the business cycle in Slovakia. The business cycle of the Slovakian economy is found to have become more synchronized with the German one in first half of the 2000s compared to the second half of the 1990s (IMF 2013, p.8). The increase in German value added in Slovak exports has also spurred the production of domestic value added (IMF 2013, p.10). As a result, the main drivers of the domestic business cycle may have changed over time.

3. To this end, a Vector Autoregressive Model (VAR) incorporating domestic and external factors has been estimated (Appendix, Section A). The set of variables considered includes Slovakia’s industrial production, the stock of real FDI, real final consumption, real exports and imports, the euro-area business cycle driver (proxied by either the euro area GDP, Germany’s industrial production, or Germany’s real exports), and the rest-of-the world output (proxied by the real GDP of the euro area’s 16 key trading partners). The VAR is estimated by using monthly observations over the period 1998–2004 and 2005–2013, with the analyses based on the impulse responses of onetime shocks to variables in the VAR model, with a focus on the statistically significant maximum impacts. Structural shocks are identified using a Cholesky decomposition; therefore, in the model, shocks are orthogonal to other structural shocks. Shocks thus represent unexpected events for a specific variable not related to other variables. The Slovak economy has experienced a number of important events (e.g., EU accession, euro adoption, and the recent global and regional crises) that could lead to structural breaks in the data. The analysis uses two different estimation periods to help reflect some of these changes, especially EU accession in 2004.2

4. The main findings are the following:

  • Foreign direct investment and demand from Europe have become key drivers of the business cycle since EU accession (Figure 1). Starting in 2005, shocks to FDI, which had been important to exports and imports in 1998–2004, became more so, and also show sizeable impact on industrial production and consumption cycles where none were seen in the earlier period. Shocks to euro area growth began to show a strong impact on the dynamics of industrial production and imports, while the effect on exports was still significant although smaller. Moreover, the co-movement of industrial production, exports and imports following shocks to FDI and euro area growth likely reflects the growing integration of the Slovak economy into global supply chains, though the degree of co-movement varies across shocks. Such integration could increase the exposure of Slovakia to developments in final export destinations through global supply chains and in source countries for FDI.

  • Trade flows have become more affected by external variables than domestic ones. Domestic industrial production played a role in driving the cycle of real exports before 2005. However, this relationship is not statistically significant in the recent period and exports started to be driven more by FDI. Import cycles began to follow shocks to euro area growth since 2005. This change probably reflects the fact that the export-oriented sectors engaged in global supply chains are FDI-intensive and mainly serve foreign consumers.

  • Supply chain activities have spurred overall consumption. Consumption has been mostly driven by trade and FDI since 2005. A structural shock to industrial production, such as an expansion of domestically-financed manufacturing targeting the domestic market, has a positive but insignificant impact on consumption, which is in contrast to the period before joining the EU.

  • This probably shows that income and employment are heavily influenced by FDI-intensive export sectors or links to the global supply chain.

Figure 1.
Figure 1.

Maximum Significant Impact of Shocks on Domestic Economy

Citation: IMF Staff Country Reports 2014, 255; 10.5089/9781498333801.002.A002

Sources: Eurostat, Haver and IMF staff calculations.1/ Each chart shows the statistically significant maximum impact of seven shocks (real GDP of the rest of the world vis-a-vis the euro area, real GDP of the euro area and domestic variables for Slovakia: industrial production, real exports, real imports, real consumption, and stock of real FDI) on a domestic variable within two years after the shocks materialize. Shocks are one standard error (GDP_EA trading partners: 0.06%, GDP_EA: 0.14%, GDP of IP: 3.24%, real export: 2.53%, real import: 0.73%, real consumption: 0.42%, stock of real FDI: 0.86%) of the residual of the corresponding equation in a Vector Autoregressive Model. Results are robust to different ordering in shock identification schemes, nominal and real variables, and different types of error bands.

B. Macroeconomic Dynamics and Inward Spillovers

5. Spillovers to Slovakia from external shocks are substantial, although the magnitude and persistence vary across shocks. Greater trade and financial openness increased the interconnectedness of the Slovak economy with regional and global trading partners. Analysis focuses on the later period (2005–2013) since it is likely to be more relevant given evolution of the economy. The VAR model described above estimated using data for this period shows that shocks to external factors have non-negligible spillovers to the domestic economy. In particular, shocks to FDI tend to have the most persistent and widespread spillovers to the Slovak economy, while shocks to euro area demand have the most sizeable impact.

6. FDI shocks have persistent impact on Slovakia’s business cycle. The model shows that the impact of a onetime shock to FDI (equivalent to an increase of 0.86 percent) on industrial production, exports and imports lasts for about 1½ to 2 years (Figure 2). The maximum increase in industrial production reaches 1 percent, in about one year, indicating that the FDI multiplier is larger than one. Exports and imports both increase, with the effect on exports more sizable and persistent. Consumption rises by 0.2 percent in half a year before the effect dies out in 1½ years.

Figure 2.
Figure 2.

Responses to a Shock to FDI Stock

(Response to Cholesky One S.D. Innovations ±2 S.E.)

Citation: IMF Staff Country Reports 2014, 255; 10.5089/9781498333801.002.A002

Sources: Eurostat, Haver and IMF staff calculations.

7. Slovak industrial production and trade are very sensitive to euro area demand. Under the model, changes in real GDP in the euro area trigger higher, but less persistent effects on industrial production and trade than FDI shocks (Figure 3). A 0.14 percent increase in euro area real GDP leads to a more than 1 percent increase in industrial production, exports, and imports. However, the effects fade out within a year.

Figure 3.
Figure 3.

Responses to a Shock to Euro Area GDP

(Response to Cholesky One S.D. Innovations ±2 S.E.)

Citation: IMF Staff Country Reports 2014, 255; 10.5089/9781498333801.002.A002

Sources: Eurostat, Haver and IMF staff calculations.

8. Shocks to German production also drive Slovakia’s industrial production and trade flows. Domestic industrial production and external trade respond to higher industrial production in Germany almost one-to-one; that is, a 1.5 percent increase in Germany’s industrial production pushes up Slovakia’s industrial production, exports, and imports by roughly the same amount within a year.

9. Germany affects Slovakia’s supply side through its production chain. Slovakia’s industrial production, consumption, and external trade respond to shocks to indicators related to German production and exports significantly, including German IP, export of goods, and manufacturing orders. However, German GDP, domestic demand and exports including services have much more limited impact on Slovakia and do not seem to affect domestic IP (Figure 4). These findings suggest that Slovakia’s economy has become more synchronized with the German economy on the production side, while Germany’s domestic demand per se does not seem to influence the Slovak economy. As expected, given Slovakia’s trade patterns, it is indeed euro area demand, as a whole, that plays a more prominent role.

Figure 4.
Figure 4.

Responses to a Shock to German Industrial Production

(Response to Cholesky One S.D. Innovations ±2 S.E.)

Citation: IMF Staff Country Reports 2014, 255; 10.5089/9781498333801.002.A002

Sources: Eurostat, Haver and IMF staff calculations.

10. Shocks to the real economy of the rest of the world (i.e., outside the euro area) do not have a statistically significant impact. The impulse response suggests that a positive shock to real GDP of the euro area’s trading partners increases Slovakia’s industrial production and FDI but the responses are statistically insignificant, though they are more sizeable in the model that includes Germany’s industrial production as the euro area factor (Figure 5). This suggests that the link to the rest of the world is indirect. In other words, global shocks are transmitted to the Slovak economy insofar as they affect euro area demand and/or German production.

Figure 5.
Figure 5.

Responses to a Shock to GDP of Euro Area Trading Partners

(Response to Cholesky One S.D. Innovations ±2 S.E.)

Citation: IMF Staff Country Reports 2014, 255; 10.5089/9781498333801.002.A002

Sources: Eurostat, Haver and IMF staff calculations.

11. Inward spillovers may vary over time. Model results are based on data from 2005 to 2013. This is a period when Slovakia adopted the euro and was affected by the global crisis, and these factors imply that potential time-varying features of the economic relationships are not captured. For example, Slovakia’s macro variables such as industrial production and consumption became less volatile after the country joined the euro area in 2009. Thus, the magnitude of inward spillovers in the more recent period and in the future may be different from those implied by the model.

C. Trade Developments and the Sustainability of External Surpluses

12. Since 2012, Slovakia’s current account balance has shifted into surplus, reflecting large positive trade balances. Slovakia’s current account was in deficit from 1996 to 2011. Since 2009, the trade balance has been in surplus, and widened significantly starting in 2012, shifting the current account balance into positive territory.

A02ufig01

Current Account in Slovakia

(In percent of GDP)

Citation: IMF Staff Country Reports 2014, 255; 10.5089/9781498333801.002.A002

13. Recent current account surpluses are higher than the long-term value implied by fundamentals. Cross-country analysis suggests that the Slovak economy’s fundamentals would imply a small current account deficit over the long term. Hence, most of the improvement in the current account balance in 2012–2013 would be attributed to cyclical factors. However, the importance of the cyclical component varies depending on the methodology used. Results show that the trend of the current account has been improving, but at a slower pace than the actual current account. The current account surplus is likely to be lower when the cyclical factors fade out.

A02ufig02

Slovak Republic: Current Account, 2001-13

(In percent of GDP)

Citation: IMF Staff Country Reports 2014, 255; 10.5089/9781498333801.002.A002

Sources: Eurostat, Haver and IMF staff calculations.

14. As indicated, the current account improvement has been driven by growing trade surpluses. While until mid-2011, exports and imports of goods (in real terms) have grown side-by-side, since then exports have started growing at a faster pace, thus opening a wedge between the two series.3

A02ufig03

Slovak Republic: External Trade, 2005-13

(In logarithms)

Citation: IMF Staff Country Reports 2014, 255; 10.5089/9781498333801.002.A002

Sources: Eurostat, Haver and IMF staff calculations.

15. Evidence shows that both structural and cyclical components play a role. The results of the Hodrick-Prescott filter suggest that both trend and cyclical components contribute to the trade surplus.4 However, the HP-trend of the growth of exports relative to imports is lower than the actual level in the first 10 months of 2012 and the middle of 2013, indicating the cyclical component represents a non-negligible share of the recent trade surplus.

A02ufig04

Decomposition of the Gap Between Growth of Real Export and Real Import

Citation: IMF Staff Country Reports 2014, 255; 10.5089/9781498333801.002.A002

Sources: Eurostat, Haver and IMF calculations.
A02ufig05

Decomposition of the Gap between Real Export and Real Import

Citation: IMF Staff Country Reports 2014, 255; 10.5089/9781498333801.002.A002

16. The application of a Vector Error Correction Model (VECM) confirms these findings. The structural and cyclical components of real exports and imports have been determined by applying a VECM over the period 2005–2013 in order to better capture the changes in long-term equilibrium values of these variables due to the supply chain structure (Appendix).5 Results show that export growth is partially driven by long-term factors, especially in the period between mid-2012 and early 2013, whereas short-term dynamics and surprise elements play a more important role in the rest of the sample period (Figure 6). This result suggests that a structural shift may have occurred between 2012 and 2013, which could suggest a lower import intensity of exports due to more domestic production of inputs. On the contrary, import growth is mainly driven by cyclical factors, including weak domestic demand, for the whole sample period. These two pieces of evidence tend to confirm that part of the current account surplus is structural.

Figure 6.
Figure 6.

Slovak Republic’s External Trade: Cyclical and Structural Breakdown1/

Citation: IMF Staff Country Reports 2014, 255; 10.5089/9781498333801.002.A002

Sources: Eurostat, Haver, and IMF staff calculations.1/ The charts show the breakdown of the gap between export and import growth in three components: the adjustment to its long-term equilibrium path, the short-term dynamics driven by relevant macroeconomic variables and the unexpected component. The breakdown is based on a VECM estimated on monthly data over 2005-13 for seven variables: exports, imports, industrial production, FDI, consumption, euro-area GDP and GDP of euro-area trading partners.

References

  • Chen, Qianying, Andrew Filardo, Dong He, Feng Zhu (2014) “Global impact of US monetary policy at the zero lower bound,” The HKMA-FRBNY Joint Conference on “Domestic and International Dimensions of Unconventional Monetary Policy, March 20-21, conference draft.

    • Search Google Scholar
    • Export Citation

  • International Monetary Fund (2013) German-Central European Supply Chain—Cluster Report, IMF multi-Country report No.13/263.

  • Luetkepohl, Helmut (2007) New Introduction to Multiple Time Series Analysis, Springer.

Appendix. Methodology and Data

Structure of the Vector Autoregressive Model (VAR)

y t = a 0 + Φ y t − 1 + u t

with ut~iid(0,Σ) where ut is independent and identically distributed (iid) across time. Moreover, yt is a vector containing the six variables as the following:

y t = ( IP t FDI t C t EX t IM t EXT t ROW t ) ′

where IP is the industrial production; FDI is the stock of real FDI, which cumulates from the first observation of the data and deflated by the producer price index; C is real consumption, which is deflated by HICP; and EX and IM are real exports and imports respectively, deflated by the export and import prices. EXT denotes one of the euro area factors, which include GDPRQ_EA (euro area GDP), IP_GER (German IP), EXP_GER/ EXPDEF_GER (German real exports). ROW is the real GDP of the euro area’s 16 key trading partners (Chen et al 2014).

Monthly data from January 1998 to December 2004 and January 2005 to December 2013 are used, with interpolation from quarterly to monthly data applied to some of the time series. All data are obtained from Haver Analytics, the IMF’s International Financial Statistics, and the IMF’s Direction of Trade Statistics. See Table 1 for detailed information about data sources and transformations as well as descriptive statistics.

Table 1.

Data Source and Transformation

article image
article image

Impulse responses are calculated based on a Cholesky decomposition scheme of shock identification. The Wold order used is (ROW, EXT, IP, EXP, IMP, C, FDI), with the assumption that Slovakia is a small open economy so that domestic variables do not have contemporaneous impact on external factors. Error bands are constructed using 10,000 repetition of Monte Carlo simulation.

Structure of the Vector Error Correction Model (VECM)

The structure of the VECM can be presented as the following:

Δ y t = a 0 + α β ′ y t − 1 ︸ A ︸ B + ∑ j − 1 p − 1 Γ s ⋅ Δ y t − s ︸ C + u t

with ut~iid(0,Σ) where εt is iid across time.

y t = ( IP t FDI t C t EX t IM t EXT t GDPRQ_EA t ) ′

Therefore, the change of each variable in the vector yt can be explained by the deterministic term a0, long-run dynamics B, short term dynamics C and the residual ut. The error correction term A characterizes the long-term equilibrium relationship between the levels of the variables, which are cointegrated. Therefore, the term B reflects the adjustment needed for the corresponding variable on the left-hand side to catch up with the trend, with α representing the speed of adjustment. The short-term dynamics can be characterized by the term C and the residual. Monthly data from January 2005 to December 2013 are used for estimation.
1

Prepared by Qianying Chen.

2

Model requirements and the length of time series limit the discrete periods that can be considered to capture potential structural breaks including those occurring during 2005–2013 (e.g., euro adoption and external crises).

3

Based on data from Eurostat and IFS. Data from Direction of Trade Statistics show a limited increase in exports relative to imports in recent years.

4

The HP filter is applied to the growth rate of the wedge, using data from 1998-2013.

5

Results are based on the overall impact estimated over 2005-2013; potential time varying relationships due to factors such as euro adoption and recent financial crisis are not captured.

Same Series

Other IMF Content

Other Publishers

  • Collapse
  • Expand
Cover IMF Staff Country Reports
Slovak Republic: Selected Issues
Author:
International Monetary Fund. European Dept.
Volume/Issue:
Volume 2014: Issue 255
Publisher:
International Monetary Fund
ISBN:
9781498333801
ISSN:
1934-7685
Pages:
47
DOI:
https://doi.org/10.5089/9781498333801.002
  • Figure 1.
    View in gallery
    Figure 1.

    Maximum Significant Impact of Shocks on Domestic Economy

  • Figure 2.
    View in gallery
    Figure 2.

    Responses to a Shock to FDI Stock

    (Response to Cholesky One S.D. Innovations ±2 S.E.)

  • Figure 3.
    View in gallery
    Figure 3.

    Responses to a Shock to Euro Area GDP

    (Response to Cholesky One S.D. Innovations ±2 S.E.)

  • Figure 4.
    View in gallery
    Figure 4.

    Responses to a Shock to German Industrial Production

    (Response to Cholesky One S.D. Innovations ±2 S.E.)

  • Figure 5.
    View in gallery
    Figure 5.

    Responses to a Shock to GDP of Euro Area Trading Partners

    (Response to Cholesky One S.D. Innovations ±2 S.E.)

  • View in gallery

    Current Account in Slovakia

    (In percent of GDP)

  • View in gallery

    Slovak Republic: Current Account, 2001-13

    (In percent of GDP)

  • View in gallery

    Slovak Republic: External Trade, 2005-13

    (In logarithms)

  • View in gallery

    Decomposition of the Gap Between Growth of Real Export and Real Import

  • View in gallery

    Decomposition of the Gap between Real Export and Real Import

  • Figure 6.
    View in gallery
    Figure 6.

    Slovak Republic’s External Trade: Cyclical and Structural Breakdown1/

Figure 1.

Maximum Significant Impact of Shocks on Domestic Economy
Figure 2.

Responses to a Shock to FDI Stock

(Response to Cholesky One S.D. Innovations ±2 S.E.)
Figure 3.

Responses to a Shock to Euro Area GDP

(Response to Cholesky One S.D. Innovations ±2 S.E.)
Figure 4.

Responses to a Shock to German Industrial Production

(Response to Cholesky One S.D. Innovations ±2 S.E.)
Figure 5.

Responses to a Shock to GDP of Euro Area Trading Partners

(Response to Cholesky One S.D. Innovations ±2 S.E.)

Current Account in Slovakia

(In percent of GDP)

Slovak Republic: Current Account, 2001-13

(In percent of GDP)

Slovak Republic: External Trade, 2005-13

(In logarithms)

Decomposition of the Gap Between Growth of Real Export and Real Import

Decomposition of the Gap between Real Export and Real Import
Figure 6.

Slovak Republic’s External Trade: Cyclical and Structural Breakdown1/