Public Information Notice: IMF Concludes Article IV Consultation with Slovak Republic
July 28, 2000
|Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.|
On July 21, 2000, the Executive Board concluded the Article IV consultation with Slovak Republic.1
Although the Slovak economy grew at high rates averaging over 6 percent during 1995-98, it was also characterized by large macroeconomic imbalances and the absence of key structural reforms, thus making it vulnerable to crisis. While rapid growth in investment helped fuel rapid real GDP growth, much of this investment was financed either from abroad using government guarantees, or from the unreformed state-owned banks. This resulted in an exceptionally rapid increase in overall external indebtedness and a worsening bad loan problem domestically. The deficit of the general government reached about 5 percent of GDP in 1997-98, compared with a small surplus in 1995. And the external current account deficit was 10 percent of GDP or more in each of the three years to 1998.
A strong policy response was essential to reduce macroeconomic imbalances and re-invigorate structural reform. In this regard, the deficit of the general government has been reduced, the external current account deficit has narrowed, and, though yet to be completed, important steps have been made toward restructuring and privatizing state-owned banks and enterprises, including by strengthening the bankruptcy framework. The decision by the EU to invite the Slovak Republic to start negotiations on EU accession has added to market confidence.
Determined fiscal tightening—with the package of May 1999—was a key component to reducing macroeconomic imbalances. The general government deficit (excluding privatization receipts) was reduced to 3.6 percent of GDP in 1999, representing a contraction of about 1½ percentage points of GDP from the previous year. Key elements of the package included an increase in the lower value added tax rate, higher excises, an import surcharge, measures to rationalize social assistance programs, as well as significant increases in important administered prices. Although tax collection was relatively weak, and social transfers were higher than budgeted, the authorities were able to hold the line on their target for the state budget by achieving savings in other areas. The 3 percent of GDP target for the general government was exceeded mainly because of overruns in the extrabudgetary funds.
The authorities recognize that there are structural weaknesses in the fiscal area. For example, as noted above, tax collection has been weak: tax arrears increased in 1999, and the ratio of tax revenue to GDP fell from 37.1 percent in 1998 to 35.3 percent in 1999, notwithstanding higher statutory taxes. Primary expenditure, and spending on social benefits in particular, has stayed high; and the targeting and administration of the latter could be improved. High taxes on labor discourage formal sector employment. Reforms in the pension and health funds would help ease fiscal pressures.
In addition to fiscal tightening, developments in the non-government sector contributed to a sharp fall in domestic demand in 1999, which was more than offset by a significant increase in exports. Non-government investment (including that of state-owned enterprises) declined sharply, while private consumption recorded only a very modest increase, as a decline in real personal income was offset by a decrease in household saving. Although GDP growth slowed in 1999, its deceleration to 1.9 percent was limited by strong export performance: in real terms, exports grew by 7 percent. At the same time, import volume fell significantly, in the face of the sharp decline in domestic demand. Data for the first months of 2000 indicate that the combination of weak domestic demand (particularly consumption) and strong export growth has carried over into this year. In these circumstances, balance of payments difficulties have eased considerably. The external current account deficit fell to 5.7 percent of GDP in 1999. The trade deficit has narrowed further so far in 2000 and, by March 2000, official reserves increased to the equivalent of 3 months of imports of goods and non-factor services.
Increases in indirect taxes and administered prices pushed up headline inflation to 14 percent at end-1999 and 16 percent in May 2000. However, with the unemployment rate reaching almost 20 percent, wage pressures have been in check. Moreover, core inflation (which excludes the impact of changes in administered prices and indirect tax changes) has remained moderate: it was 6½ percent in May 2000.
The authorities have been gearing monetary policy toward meeting their target for core inflation. With wage costs and underlying inflation seemingly at bay, and heartened by reductions in the fiscal and external current account deficits, the National Bank of Slovakia (NBS) allowed domestic interest rates to decline, in circumstances of upward pressure on the koruna. The NBS initially welcomed the strengthening of the currency when it began in mid-1999, but, owing to concerns about losing external competitiveness, the central bank eventually began to resist further appreciation, first by sterilized intervention in early 2000 and then—in the context of an expected decline in core inflation—by moving short-term interest rates lower.
Some important steps were taken toward restructuring and privatizing state-owned banks, and improving the legal framework. The authorities have decided to sell a significant majority of the state's stake in the Slovak Savings Bank (SLSP), and the entire state's stake in the General Credit Bank (VUB) and the Investment and Development Bank (IRB). They also transferred non-performing loans from these three banks to the Consolidation Agency and the Consolidation Bank, and injected capital into the banks. The effectiveness of the Bank Privatization Unit has been improved through external technical assistance and the recruitment of additional staff. In addition, the government amended the banking act in order to strengthen the supervisory power of the NBS; and a number of amendments to strengthen the bankruptcy law have recently been approved by Parliament. Timely implementation of the extended powers of banking supervisors would help ensure a sound banking system in the future.
Enterprise profitability has improved and the privatization process has gathered steam. However, the increase of profits in the non-financial sector by 2 percentage points of GDP in 1999 was from a low base and inter-enterprise arrears have remained high, suggesting that governance has been weak. On the privatization front, the authorities have recently sold a majority share in the telecommunications company to a strategic foreign investor, in addition to privatizing two financial institutions. Under current plans, the privatization of other utilities (e.g., the Gas and Electricity companies, and Transpetrol) is to be kept to a minority share.
Executive Board Assessment
Executive Directors noted that, after having experienced previously large macroeconomic imbalances and strains in the banking and enterprise sectors, the Slovak Republic has made significant progress in stabilizing the economy and accelerating structural reform. In particular, decisive fiscal action has contributed to a reduction in fiscal and external current account deficits. Important steps have also been taken toward restructuring and privatizing state-owned banks and enterprises, strengthening banking regulation and supervision, and initiating legal reform. Continuation of measures to stabilize the economy and accelerated structural reforms should help pave the way for sustained economic improvement and accession to the European Union.
Looking at the period ahead, Directors stressed that it was important to build on recent successes. They emphasized that, on the heels of huge external account deficits in the past and the associated buildup of external debt, a key priority was to ensure continued external adjustment, reduce external vulnerabilities, and protect and consolidate macroeconomic stability generally. Directors therefore urged the authorities to keep close to their initial target of a general government deficit of 3 percent of GDP in 2000, followed by further fiscal adjustment in subsequent years. They encouraged the authorities to avoid additional spending financed by privatization proceeds. They also urged them to use privatization proceeds to retire foreign debt. In addition, Directors observed that, while improving tax administration could raise fiscal revenues significantly, the bulk of fiscal adjustment would need to come from lowering primary spending from its high level in relation to GDP. In that regard, Directors urged the authorities to reduce spending on social benefits by improving their targeting and administration, and to reduce other discretionary spending, with a view to leaving room for tax cuts, especially focused on high social security payroll contributions.
Directors observed that designing fiscal policy in a medium-term framework would provide more opportunity to manage fiscal policy strategically. In addition, they urged the authorities to improve fiscal transparency and to strengthen their control over the operations of the general government outside the state budget, including by reducing the number of extrabudgetary funds, and by improving the timeliness and quality of data on the overall operations of the general government. Directors suggested that the authorities undertake a self-assessment of fiscal transparency, using the Fund's questionnaire developed for that purpose.
Directors generally supported the current flexible exchange rate regime, and agreed that monetary policy should be geared to bringing inflation down further, noting that capital inflows may well lead to increasing policy challenges ahead. To prepare for this challenge, the authorities should endeavor to strengthen the modalities of their informal inflation-targeting framework. With the exchange rate at a broadly competitive level, Directors also stressed that an appropriate policy mix, focused on a tight fiscal stance, would help avoid a sustained and significant currency appreciation, which would be undesirable at this juncture. Therefore, Directors noted that, if future pressures from capital inflows were to emerge, there would be room for domestic interest rates to decline, as long as inflation objectives were not threatened. But if capital inflows were still to pose challenges to macroeconomic management because of their impact on inflation, or the current account in the face of upward exchange rate pressure, Directors observed that additional fiscal tightening would need to be considered.
Directors emphasized the importance of bringing unemployment down by improving incentives for seeking work and job creation. Since growth alone seemed unlikely to make a sufficient dent in the problem, they considered that structural factors—including the high rate of payroll taxes and the weak targeting and administration of social benefits—needed to be addressed.
Directors considered that the authorities should make every effort to increase foreign direct investment, given that such investments could help to reduce external vulnerabilities and reduce unemployment. They welcomed recent privatization efforts, but were of the view that improving the business environment—including by enhancing the rule of law and strengthening governance more generally—would go a long way to attracting further foreign direct investment.
Directors welcomed recent progress in improving the banking system, including efforts to privatize state-owned banks. However, they emphasized the importance of completing this process and of taking further steps to strengthen the supervision and regulation of the banking system. In this context, they encouraged the authorities to avoid a culture of regulatory forbearance and to ensure a prompt resolution to problems in small and medium-sized banks.
Directors expressed concern about financial performance and governance in the enterprise sector. They welcomed recent efforts to accelerate enterprise privatization, including the sale of a majority share in the telecommunications company, and to strengthen the bankruptcy framework, which, along with stronger banks, would help promote restructuring and financial discipline in the enterprise sector. They urged the authorities to complete enterprise privatization, to strengthen state enterprise financial performance in the meantime, and to improve accounting standards and the disclosure of company results.
Directors noted that the provision of data by the Slovak authorities was generally adequate for Fund surveillance and welcomed the subscription of the Slovak Republic to the Special Data Dissemination Standard. They also encouraged the authorities to continue their efforts to improve the statistical base to enhance the conduct and monitoring of economic policies and developments.
|Slovak Republic: Main Economic and Financial Indicators|
|(Percent change, period average, unless otherwise indicated)|
|12 months to end of period||7.2||5.4||6.4||5.6||14.2|
|Gross industrial output (constant prices)||9.8||2.8||2.2||3.6||4.1|
|Real wages in industry|
|Employment in industry||4.1||0.0||-2.0||-4.1||-3.0|
|Unemployment rate, period average||13.7||12.6||12.9||14.0||17.5|
|(Percent change, period average)|
|Real effective exchange rate 1/|
|(Percent of GDP)|
|General government finances|
|State budget balance||-0.5||-1.9||-2.6||-2.3||-1.8|
|(Percent change, 12 months to end-period, unless otherwise indicated)|
|Money and credit|
|Net domestic assets||5.8||20.5||8.7||10.9||9.4|
|Credit to enterprises and households||14.9||17.9||2.2||5.5||4.3|
|Interest rates (in percent, end-of-period)|
|Lending rate (short-term)||13.7||13.5||21.6||18.9||17.0|
|Deposit rate (one-week)||6.3||9.5||17.1||16.2||12.1|
|(In billions of U.S. dollars, unless otherwise indicated)|
|Balance of payments|
|(percent of GDP)||(2.2)||(-11.2)||(-10.1)||(-10.4)||(-5.7)|
|Official reserves, end-period||3.4||3.5||3.3||2.9||3.4|
|(in months of imports of G & NFS)||(3.7)||(3.2)||(2.9)||(2.3)||(3.1)|
|(in percent of broad money)||(28.6)||(26.8)||(25.2)||(23.8)||(27.5)|
|Gross reserves of banking system||5.5||5.7||6.5||6.0||4.6 4/|
|Gross external debt, end-period 5/||5.7||7.7||9.9||11.9||10.5|
|Short-term debt (end-of-period) 6/ 7/||...||1.9||2.3||2.6||2.7|
|Official reserves to short-term debt (in percent) 6/ 7/||...||179.8||143.4||112.2||127.2|
|GDP, current prices (Sk billions)||516.8||575.7||653.9||717.4||779.3|
|Exchange rate (Sk/U.S. dollar)|
|End of period||29.6||31.9||34.8||36.9||42.3|
Sources: Slovak Statistical Office; and IMF staff calculations.
1/ Calculated for trade partners of Germany, France, Austria, Italy, Czech Republic, Poland, and Hungary.
2/ Includes Sk 23.5 billion in exceptional NBS profits used for the equity injection into banks.
3/ Overall balance, excluding privatization receipts.
4/ As of January 5 of the subsequent year, to avoid atypical variations.
5/ Excludes domestic currency denominated debt.
6/ Debt and gross reserves are reduced by US$2 billion in 1997 and 1998 (and US$1 billion in 1996) to take into account offsetting claims and liabilities of two Slovak subsidiaries of foreign banks with their parents.
7/ Short-term debt is defined so as to exclude MLT debt due in the subsequent year.
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. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. In this PIN, the main features of the Board's discussion are described.