Slovak Republic-2013 Article IV Consultation: Concluding Statement of the IMF Mission

June 4, 2013

Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.

Bratislava, June 4, 2013

The strong growth the Slovak Republic has enjoyed in recent years is slowing as the external environment weakens and domestic demand remains subdued. Policies should focus on identifying high quality measures to achieve remaining fiscal adjustment needs, stepping up efforts to tackle high unemployment, ensuring continued strength in the financial sector, and enhancing the business climate.

1. Growth is expected to slow significantly in 2013. The Slovak Republic—among Europe's most dynamic economies in recent years, largely due to sizeable foreign investment in the auto sector that led to rising exports—registered 2 percent growth in 2012. External risks are materializing, however, with weaker demand expected from trading partners, especially in Europe. This, coupled with still anemic domestic demand, leads to a growth forecast of 0.6 percent for 2013.

2. Risks are tilted to the downside. The baseline scenario assumes a pick-up in activity in key export markets including Germany later in 2013 and into 2014. If weakness in Europe is deeper or more prolonged than expected, this could reduce export demand and contribute to uncertainty holding back investment. Domestic demand is expected to recover in 2014, but will remain restrained for some time due to ongoing fiscal adjustment as well as very high unemployment. Growth is expected to recover to about 2 percent in 2014 and 3–3½ percent over the medium-term. Slovakia’s integration into international supply chains has brought great opportunities, but can also amplify risks from trade shocks, underscoring the importance of promoting new sources of growth and export diversification over the medium term.

Charting a high-quality fiscal adjustment path

3. Further progress on fiscal adjustment is needed. Slovakia has demonstrated its strong commitment to sustainable public finances by reducing its fiscal deficit substantially since 2009, reaching 4.3 percent of GDP in 2012. This commitment was recently reaffirmed in the country’s Stability Program. Important structural reforms have been implemented, such as those that strengthen the pension fund’s finances, but other sources of revenue or savings have been temporary or had undesirable side-effects (e.g., lower use of EU funds reduces co-financing costs but delays potentially valuable projects). Slovakia’s public debt is manageable (52 percent of GDP in 2012 on a gross basis, including contributions to support other euro area members and a healthy level of cash balances) and favorable financing conditions have allowed it to borrow at historically low rates while extending the average maturity of its obligations. To prevent debt from continuing to rise, however, substantial additional adjustment measures will be needed for a number of years. Action is also necessary if Slovakia is to avoid economically harmful effects from crossing a debt threshold (currently defined in terms of gross debt under its fiscal responsibility act) and to comply with targets agreed at the European Union level.

4. The 2013 fiscal deficit target is achievable, but automatic stabilizers should be allowed to operate if risks to growth materialize. The 2013 budget and some additional steps taken so far should deliver a fiscal deficit a little over 3 percent of GDP, factoring in the lower growth now forecast. There are risks to this scenario, including the possibility of still weaker growth or difficulties in achieving public sector wage reductions or savings from local governments, on which the state’s influence is limited. But the government’s strong commitment and readiness to take additional measures that would have little macroeconomic impact suggest the target can be met. Should growth disappoint such that additional action would be needed to meet the target, the mission recommends instead letting automatic stabilizers operate (e.g., lower tax revenue and higher benefits outlays) to avoid a further drag on output when growth is weakest.

5. Given still sizeable fiscal adjustment needs, efforts should focus now on identifying high-quality fiscal measures. A little over 2 percent of GDP in additional permanent fiscal adjustment measures will be required over 2014–16 with about 1 percent thereafter to help ensure medium-term debt sustainability, and in light of EU rules and domestic debt brakes that would mandate a sharp move to balance the budget. Some of the fiscal adjustment needs stem from past budgets relying on temporary or one-off policy changes. Efforts to identify high-quality and durable revenue and savings measures should be accelerated and deepened. In particular, the staff team encourages: (i) improved efficiency in VAT collections to narrow the gap compared to other European countries, and stands ready to provide analysis in this regard; (ii) a real estate tax based on market-based property values; and (iii) more efficient spending, particularly related to health outlays, procurement, public administration (where efforts are underway), and social benefits (where targeting could be improved). Early action in these areas is important to allow time to design and implement specific measures. Swift implementation of the authorities’ plan to fight tax evasion would provide further support. The 20 percent VAT rate now in place should be maintained (current law would reduce it after the deficit falls below 3 percent of GDP) to avoid adding to fiscal adjustment burdens.

6. Pension reforms have strengthened long-term finances. Changes, including a gradual increase in retirement ages and adjustments to indexation, have improved the long-term sustainability of the pension system substantially, especially in light of demographic challenges in coming decades. Some future gaps remain, however, and consideration could be given to further steps such as moving to a higher retirement age somewhat more quickly.

7. Creation of the Council for Budget Responsibility is welcome. The council’s good analysis and emphasis on the government’s overall financial position can help underpin sound policies and the development of high-quality fiscal measures.

Ensuring continued financial stability

8. Slovakia’s prudent approach has contributed to a sound banking system, and could be reinforced as European banking union efforts proceed. Due to a largely deposit-funded system and high capital requirements, Slovakia’s banking system is strong, although subdued lending and a bank levy have led to lower profitability. While non-performing loans are relatively low and well-provisioned, tax policies could be modified to reduce delays in loan write-offs and potentially support additional lending. The size of the banking system has facilitated close supervision (and risks are low), but this approach could usefully be enhanced with a more developed framework for early intervention and if needed, resolution, in line with expected changes as part of a European banking union. The resources of the Deposit Protection Fund also might be strengthened. Implementation of a banking union would reinforce the importance of good cooperation among supervisory authorities.

9. Bank taxes have risen at a time when the operating environment is weak and credit to firms is declining. The staff team encouraged a lowering of the bank levy, which will decrease over time but is nonetheless high compared with others in Europe, and noted that the planned financial transactions tax could impose additional burdens on financial intermediation. In principle and keeping in mind potential changes at the European level, revenues from the bank levy could be allocated to a more well-defined special resolution fund, perhaps under the umbrella of the Deposit Protection Fund. Consideration of how EU and other funds could be used to enhance the availability of credit to small businesses and innovative firms is welcome.

Addressing high unemployment and bolstering competitiveness

10. More effective education, training, and support for those out-of-work are essential to lower very high joblessness. With unemployment above 14 percent, and much higher for youth, the long-term unemployed, and those in the eastern part of the country, boosting employment should be a top priority. Government initiatives to link curriculums more closely to employer needs, pilot a “dual-system” approach so that students also gain hands-on experience, and improve education for marginalized groups are welcome, but implementation and funding will be key. Similarly, efforts to strengthen active labor market policies (ALMPs) and target support to youth and the long-term unemployed move in the right direction, and should be pursued vigorously and tailored based on outcomes. Funding for ALMPs, which has been low compared to peers, should be a priority even amidst budget consolidation, and the increase in the 2013 budget is welcome. Effective use of EU Funds will be especially important in these areas. While keeping in mind fiscal constraints, steps to address the high tax wedge on labor, which hits low-wage workers especially hard, could also help, as would steps to promote labor mobility such as easing access to rental housing and better transportation infrastructure.

11. Enhancing worker skills and infrastructure stand out as priority areas for sustaining the competitiveness that has supported strong export growth. In addition to the education and training priorities outlined above, improved infrastructure and especially highway links to the eastern part of the country will help keep Slovakia attractive to investors and could facilitate hiring of those now unemployed in the east. While acknowledging efforts underway to streamline administrative burdens for businesses, the staff team also encouraged steps to achieve a more stable, open, and predictable business climate with respect to labor regulations, the legal environment, and procurement practices.

The staff team would like to thank the authorities and other counterparts for their warm hospitality, candor and close cooperation.


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