IMF Executive Board Concludes 2019 Article IV Consultation with the Slovak Republic

2019 Article IV Consultation-Press Release; Staff Report

Abstract

2019 Article IV Consultation-Press Release; Staff Report

On July 11, 2019, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation1 with the Slovak Republic and considered and endorsed the staff appraisal without a meeting.2

Following consecutive years of favorable performance, the Slovak economy is facing deceleration. Strong domestic demand fueled by double-digit household credit growth, robust job creation, and rising wages as well as capacity expansions in the automotive industry has lifted growth to 4.1 percent in 2018. With a positive output gap and unemployment at record lows, rapid wage growth has been outpacing productivity. Strong growth, together with past reforms in health and social spending, has helped lower the fiscal deficit to below 1 percent of GDP in 2018 and public debt below the lowest limit prescribed by the national Fiscal Responsibility Act. Meanwhile, the banking system remains stable and well-capitalized, although profitability is under pressure.

Signs of deceleration in growth are becoming apparent owing to softer external demand and weaker sentiment. As one-off effects of investment in the automotive industry taper off, real GDP growth is projected to slow to 3.5 percent this year and 3.1 percent in 2020 before converging to its potential over the medium term. Private consumption is expected to remain the main propeller of economic activity supported by continued credit and wage growth. Higher exports on the back of capacity expansions in the automotive sector are expected to contribute to growth and narrow the current account deficit toward a balanced position in the medium term.

The softer economic outlook faces significant uncertainties. A turning economic cycle is unmasking several structural vulnerabilities. Slovakia’s heavy dependence on exports and a concentrated export structure makes the economy highly sensitive to ongoing global trade tensions and risks of a no-deal Brexit. Meanwhile, the country’s comparative advantages arising from the availability of low-cost skilled workers are being tested by rising automation of assembly jobs. Structural challenges are compounded by lingering weakness in public institutions and gaps in the quality of education and infrastructure relative to EU peers. In addition, a decade of strong credit growth has significantly raised household indebtedness and made banks vulnerable to economic downturns.

Executive Board Assessment

In concluding the 2019 Article IV Consultation with the Slovak Republic, Executive Directors endorsed staff’s appraisal as follows:

With one-off effects of investment in the automotive industry tapering off, growth is projected to decelerate and gradually converge to its potential. Domestic demand, supported by robust wage and credit growth, is expected to propel economic activities, while contributions from net exports are also expected to improve on the back of recent capacity expansion in the automotive sector. Continued international trade tensions and a hard Brexit pose major downside risks to Slovakia’s export-led economy. With still-high credit growth, households and banks are vulnerable to possible labor and property market downturns.

Slovakia’s continued success in export-led growth strategy hinges on capturing higher-value activities. Recent policy efforts to ensure an adequate supply of qualified teachers and strengthen dual-track vocational training should be complemented by improving the quality of tertiary education and aligning higher education with technical skills needs. Improving the coordination of public research system, strengthening linkages between businesses and universities, and ensuring full use of EU funds for R&D would help enhance innovative capacity, which are important to move beyond assembly activities in exports. To increase the role of domestic firms, reforms should target a more predictable and enabling business environment, competitive and transparent public procurement system, independent judiciary, and well-developed infrastructure and logistics networks.

With the population set to experience fast ageing, efforts to ensure optimal use of the domestic labor force are appropriate. An insufficiently inclusive education system combined with a lack of affordable early childcare facilities is contributing to the still-high gender gap and regional disparities in labor market participation. Legislative proposal to make schooling mandatory starting at age 5, efforts to reintegrate the long-term unemployed into the labor market and increasing availability of affordable childcare are welcome. This should be complemented by active labor market policies to invest in skills and increase employability of the marginalized groups, including through better absorption of EU funds.

With above-potential growth, a balanced budget target for 2019 and 2020 is appropriate but will require additional efforts. Recent fiscal consolidation, driven by strong growth and policy efforts, has created some fiscal space under the SGP. However, the public debt trajectory is vulnerable to sizable economic downturns given strict escape clauses and debt brakes prescribed under the national FRA. Sustained fiscal consolidation will require fending off pressures to increase discretionary stimulus, which has absorbed a good part of the revenue windfall in recent years. The proposal to introduce multi-year expenditure ceilings to anchor budget planning and execution, while being consistent with the FRA and the SGP, would serve as an important step to instill durable fiscal discipline. Overly strict escape clauses may need to be revisited to avoid pro-cyclical fiscal tightening.

Higher revenue and spending efficiency are needed to create resources for growth-enhancing social and infrastructure investment. Planned measures to improve tax compliance through online electronic cashiers and electronic taxpayer services should be sustained through further strengthening of audit capacity in all core tax areas. Strong political will and better inter-ministerial coordination are needed to push through reforms outlined in the spending reviews. Strengthening the mandate of the implementation unit and incorporating actionable measures in the medium-term budget would help actualize savings. Additionally, a more robust public investment framework can improve the efficiency of public investment and absorption of EU funds, including through better project selection and prioritization at a national level.

The banking sector is stable and well-capitalized, but profitability is under pressure and segments of vulnerability exist. A prolonged period of low interest rates, a too benign credit risk assessments by banks, the regulatory cap on mortgage refinancing fees, and the strong market intermediation role of mortgage brokers result in the compression of the lending margin. A sustained period of high credit expansion by banks, especially to low income segments, has nearly doubled household debt relative to disposable income. Moreover, rapidly rising flat prices in urban areas and appreciating house price-to-income ratio indicate growing vulnerabilities of households and banks, in particular, smaller banks with less capital buffers.

Proactive macro-prudential measures have moderated credit growth and reduced credit risks of new loans. The incremental use of CCyB and supervisory capital requirements have been appropriate in ensuring adequate capital buffers for banks. Strong vigilance of smaller banks, including through reduction of NPLs, is important and further increase in capital buffers may be needed given their higher vulnerability. Allowing the bank levy to expire as scheduled in 2021 should help the smaller banks build more capital buffers. Given historically low default rates, considerations should be given to impose add-on risk weight on mortgages loans to ensure better internalization of credit risks. To complement macro- and micro-prudential policies, consideration should be given to reducing preferential tax treatments for housing investment and removing obstacles to develop the rental housing market.

Slovak Republic: Summary of Economic Indicators, 2016–24

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Sources: National Authorities; and IMF staff calculations.

Average of interest rates on new housing loans to households and loans of less than EUR 1 million to nonfinancial corporations (all maturities).

Average of interest rates on new deposits with agreed maturity (up to 1 year) from households and nonfinancial corporations.

1

Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.

2

The Executive Board takes decisions under its lapse-of-time procedure when the Board agrees that a proposal can be considered without convening formal discussions.

Slovak Republic: 2019 Article IV Consultation-Press Release; Staff Report
Author: International Monetary Fund. European Dept.