Press Release No.

IMF Executive Board Concludes Article IV Consultation with Slovak Republic

March 23, 2017

On March 17, 2017, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Slovak Republic, and considered and endorsed the staff appraisal without a meeting.

Slovakia is an economic success story. Sustained convergence since 1995 has lifted real per capita GDP to over 70 percent of the European Union average and the post-crisis recovery has been one of the most robust in Europe. After picking up in 2015, thanks to the exceptionally high absorption of EU funds at the end of the 2007–2013 programming period, real GDP growth is projected to moderate in 2016 but remain robust at 3.3 percent. Growth continues to benefit from an improving labor market, low inflation and strong household credit growth. The output gap is now closed. Fiscal consolidation resumed in 2016, and the fiscal deficit is estimated to have narrowed to 2 percent of GDP. Although public debt remains low and sustainable, it is not far below domestic debt brake thresholds. The banking sector remains stable and profitable, whereas private sector credit growth remains among the highest in the EU.

The outlook is favorable with growth expected to peak at 3.9 percent in 2019, and settle around 3.5 percent thereafter, reflecting the expansion of export capacity from investments in the automotive industry. The current account surplus is also expected to rise, with developments in Europe and key export markets constituting the main external risks.

However, significant challenges lie ahead. Slovakia faces some of the most acute regional disparities and worst aging pressures in Europe. Although all regions have seen declining unemployment and some increase in per capita income over the last decade, gains have not been evenly shared but rather heavily concentrated in the Bratislava region – where unemployment is lower and per capita income is much higher. Much of these disparities can be explained by lower levels of education and underdeveloped infrastructure outside Bratislava. In addition, Slovakia has experienced a drastic slowdown in productivity growth since the global financial crisis, due in part to its aging workforce.

Executive Board Assessment

In concluding the 2017 Article IV consultation with Slovak Republic, Executive Directors endorsed staff’s appraisal as follows:

Slovakia continues to enjoy strong economic growth.  Real incomes are now more than 70 percent of the EU average. Rising employment and real wages supported estimated GDP growth of 3.3 percent in 2016. Similar growth is forecast for 2017 due, in part, to a rebound in EU funds absorption.  Planned investment in the automotive sector is projected to drive growth in the medium term.

Risks to the optimistic outlook are primarily external. The United Kingdom’s planned exit from the European Union and elections in Europe’s larger economies create some uncertainty about growth prospects in Slovakia’s key trading partners. Continued rapid growth in credit to households, following several years of double-digit increases, is a potential domestic risk.

An aging population and sharp regional disparities are key long-term challenges. Productivity growth has nearly halved since 2008. With its population aging the fastest in Europe, a further slowdown in productivity is likely unless countered by structural reforms. At the same time, the Bratislava region has captured the lion’s share of Slovakia’s past economic success. Underdeveloped infrastructure, lower educational attainment, and limited labor mobility have held back the Eastern and Central regions.

The authorities’ planned fiscal consolidation is appropriate and can create space for addressing regional inequities and future aging-related spending. It is important to identify clear measures to meet the balanced budget objective by 2019. On current policies, the fiscal deficit is likely to be 0.7 percent of GDP in 2019.  To close the gap, the authorities should save in whole or in part expenditure reductions identified in current spending reviews, and increase VAT and corporate tax efficiency by implementing a compliance strategy that targets tax evaders. In addition, further fiscal space should be created by raising property and environmental tax collections to preserve public investment.

To safeguard the stability generated by the FRA, Slovakia’s fiscal anchor, debt rules and brakes should not be modified to provide more favorable treatment of any specific type of investment. To strengthen cash management, modifications to allow for government cash balances to be netted out from gross debt can be considered when assessing performance relative to the debt ceiling: the current ceiling on gross debt discourages pre-financing efforts during periods of low interest rates even when these have no impact on net debt. However, the introduction of any escape clause for investment spending should be avoided to allow the budget process to remain a forum for assessing the relative merits of competing demands for government spending. Staff also recommends keeping the debt limits and brakes at their current levels.

Unwavering implementation of approved pension reforms is imperative to help contain age-related spending. The politically-costly and significant pension reforms undertaken in 2012, including indexing benefits to inflation, will pay off only if implemented in full.  In addition, re-opening Pillar II should be avoided. Other measures such as indexing accrued pension benefits to inflation or broadening the social contribution base would yield further savings. In the health sector, current efforts to centralize procurement and restructure the hospital network should be advanced.

Continued regulatory and supervisory vigilance would help preserve the stability and health of Slovakia’s banking system. Slovakia’s banks are profitable, well-capitalized, and possess healthy balance sheets. Looking ahead, profit pressures stem from tight interest margins and the burden of the special levy on bank profits.  In addition, bank exposure to Slovakia’s households, which are among the most indebted in central and eastern Europe, has grown rapidly. The authorities have made good pre-emptive use of micro- and macro-prudential measures such as introduction of tighter loan-to-value (LTV) ratios and introduction of a systemic risk buffer in 2017. However, further steps may be necessary to maintain credit quality in the current environment of high credit growth. Specifically, the authorities should consider imposing higher risk weights on riskier mortgage loans, lowering the maximum LTV ratio, and reducing the bank tax as originally planned.

To support productivity growth and sustain convergence, measures to improve labor market efficiency and the business environment are needed. The shift in active labor market policies (ALMP) toward activities that move the long-term unemployed into the labor market are welcome.  Successful implementation of recommendations from the ongoing expenditure review of ALMP will be important to maximize benefits. In the near term, a review and possible relaxation of the process for granting work permits to foreign workers could help ease the growing skills mismatch.  In the long run, revamping education policies to strengthen vocational training will be needed to ensure a better match of labor supply and demand. Beyond the labor market, tackling the widespread perception of corruption in Slovakia will require steps to improve judicial transparency and independence and the assiduous implementation of recent measures to curb unethical behavior in government.

Implementing a comprehensive strategy to improve economic outcomes in underdeveloped regions is also essential to boost growth and equity.  Effective and timely absorption of EU funds can help address shortcomings. The focus needs to be on identifying priority infrastructure projects that facilitate further investment and labor mobility in under—developed regions, establishing clear selection criteria and following a competitive procurement process. The authorities’ recent initiatives to create jobs in the lagging regions through an integrated approach of working with local businesses, communities and government is welcome.