IMF Executive Board Concludes 2005 Article IV Consultation with the Slovak Republic

Public Information Notice (PIN) No. 06/32
March 22, 2006

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. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2005 Article IV consultation with the Slovak Republic is also available.

On March 20, 2006, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Slovak Republic.1


Economic performance in 2005 continued to be strong. Real GDP growth accelerated to 6 percent, as domestic demand growth maintained momentum and the contribution of net foreign demand improved. Private consumption strengthened appreciably, fueled by large increases in real wages and employment, and rapid credit growth. Fixed investment also picked up markedly though inventory accumulation was smaller. Exports continued to grow in the double-digits. However, because of a deterioration of the terms-of-trade due to rising oil prices and higher reinvested earnings on foreign investment, the external current account deficit doubled to 7¼ percent. Competitiveness remained adequate. Much of the external deficit was covered by inflows of foreign direct investment. However, external liabilities increased, as banks resorted to external finance to fund their lending.

The strength of the economy was visible in labor market conditions. Real wage growth is estimated to have accelerated to about 6½ percent in 2005, from 2½ percent in 2004 and large increases were recorded in both self-employment and wage-employment. Thus, the economy-wide unemployment rate declined by 2 percentage points to about 15½ percent in September 2005, with considerable regional variation in the level and trend.

Inflation declined further in 2005. Headline consumer price inflation (HICP basis) fell by 1.9 percentage points to 3.9 percent at end-December—at the upper end of the NBS's target range of 3-4 percent. Koruna appreciation, increased competition at the retail level subsequent to EU membership, and lower increases in regulated utility prices moderated inflationary pressures. Higher gasoline prices (which are not regulated) restrained the progress with disinflation.

The general government deficit in 2005, estimated at 3.1 percent of GDP, was better than envisaged in the budget and implied a substantial withdrawal of stimulus. Collections in most tax categories and non-tax revenues surpassed expectations. In addition, interest payments came in lower than expected, and, with receipts from the EU budget at 60 percent of the envisaged level, co-financing of projects was below budgeted amounts. These gains were partly offset by forgiveness of certain foreign debt claims not envisaged in the budget.

In January 2005, the NBS adopted a hybrid monetary framework of "inflation targeting under ERM2 conditions." It announced explicit end-year inflation targets for 2005-08. At the same time, it intervened in the foreign exchange market in both directions on several occasions to influence the exchange rate. Slovakia entered ERM2 on November 28, 2005. The central parity was set at Sk 38.455 per euro, equal to the then-prevailing market rate. The koruna appreciated in the immediate aftermath and strengthened further in January 2006, in step with other currencies in the region, to nearly 3 percent above the central parity. Following a cut in February 2005, NBS kept its policy interest rate unchanged at 3 percent until February 2006, when the rate was increased by 50 basis points to 3½ percent.

Economic growth is projected by the staff to strengthen further and reach 6¾ percent in 2007, with the commencement of production at two new automobile plants in 2006-07 and the associated pick up in exports. The current account deficit is projected to narrow progressively to about 5 percent of GDP over the medium-term. Fundamental improvements in the economy and continued positive sentiment of investors toward Slovakia are likely to result in some appreciation of the koruna. The NBS expects inflation to fall to 2¾ at end-2006, and has announced a target of below 2 percent for end-2007. The 2006-08 budget framework envisages the general government deficit declining progressively to about 1¼ percent of GDP.

Executive Board Assessment

Executive Directors congratulated the authorities for Slovakia's recent early entry into ERM2. Sound macroeconomic management and a wide range of important structural reforms over the past few years have positioned Slovakia well for euro adoption, but challenges lie ahead, in particular, to reduce the still-high rate of, and wide regional disparities in, unemployment, and to bring down inflation in a manner that does not undermine exchange rate stability and competitiveness. Directors considered that, while agreeing on the benefits of meeting early the Maastricht criteria and adopting the euro, it is equally important to secure continued strong economic performance in the monetary union through a strengthening of fiscal policy and enhanced structural flexibility.

Directors observed that the authorities' inflation targets for 2006-08 are ambitious, especially viewed against the structural influences stemming from the process of catching up economically with other Euro area states. Some Directors expressed concern that the tight fiscal policy that might be needed to defend the inflation target would have negative effects on the real sector, and saw no obvious gain in targeting an inflation rate lower than that needed for euro adoption. Directors cautioned that higher energy prices, strong economic growth, and rising unit labor costs in the nontradable sector are risks for inflationary pressures. They welcomed the National Bank of Slovakia's (NBS) readiness to increase its key policy interest rate to counter second-round effects from these factors, as demonstrated by their recent step in this direction. Directors urged the authorities to improve policy communication on adjustments of regulated prices to reinforce the role of the NBS's inflation targets in anchoring inflation expectations.

Directors noted that, consistent with the favorable growth and external outlook and continued inflows of foreign direct investment, some exchange rate appreciation could occur in the period ahead, and that this would help with disinflation. However, they stressed the importance of safeguarding competitiveness, noting that while Slovakia's prevailing level of competitiveness is adequate, its initial cushion has diminished. Directors cautioned that significant appreciation under ERM2 would erode competitiveness and risk producing an excessively strong conversion rate, with potentially serious long-term consequences. They observed that Slovakia needs to be sufficiently competitive within the monetary union to facilitate a significant reduction in unemployment over time.

Directors recommended orienting fiscal policy not only toward meeting the Maastricht deficit criterion, but also toward supporting the inflation goal while containing koruna appreciation. Most Directors encouraged the authorities to attain a tighter fiscal stance than envisaged in the 2006-08 budget framework. This could be achieved by saving any revenues collected above the targeted amount, as appears likely, and by durably restraining expenditure beyond that anticipated in the budget framework. At the same time, some Directors cautioned against seeking budgetary savings by not implementing EU-funded public investment projects, as these are designed to produce long-term gains through increased convergence with the Euro area. Directors observed that maintaining a tight fiscal stance will require continued steadfast political commitment to further fiscal consolidation and the support of all levels of government. With regard to the latter, more binding expenditure ceilings and a stronger fiscal framework for local governments, consistent with the national fiscal consolidation strategy, would be advisable.

Directors highlighted that wage moderation would be important to bring inflation down and maintain competitiveness. They welcomed the authorities' efforts to encourage the social partners to adopt forward-looking adjustment of wages to inflation. They encouraged the authorities to signal the need for wage moderation by restraining wage increases in the public sector. A slower pace of minimum wage increases and greater enterprise-level wage bargaining will also help moderate overall wage growth and enhance wage flexibility.

Directors noted that Slovakia's banking system is generally sound, but that rapid household credit growth calls for vigilance. Directors commended the NBS's initiatives to improve data collection, monitor risk management practices of banks more closely, and regularly interact with home supervisors of foreign-owned banks. They welcomed the NBS's intention to extend the risk-based supervision approach to non-bank financial institutions. They encouraged the authorities to enhance the supervision of rapidly growing pension funds and to continue tackling the money laundering risk in all areas of the financial sector. They supported the authorities' request for an Financial Sector Assessment Program (FSAP) update.

Directors observed that structural reform efforts, as well as buoyant economic growth, have resulted in a strong pick-up in employment, but the unemployment rate remains high. The recently adopted rules on investment incentives according to regional criteria and project profile should help reduce unemployment in less economically advanced regions. Directors welcomed the authorities' consideration of measures to improve access to capital for start-up companies and to introduce an earned income tax credit for low-income workers, with a view to enhancing employment growth and further increasing incentives to work.

Slovak Republic: Selected Economic and Financial Indicators, 2000-06


2000 2001 2002 2003 2004 2005 2006
            Estimate Staff

  (Percent change, period average)

Real sector


Real GDP

2.0 3.8 4.6 4.5 5.5 6.0 6.3

Output gap (in percent of potential GDP)

-1.0 -0.8 -0.3 -0.5 -0.4 -0.2 0.0

Gross industrial output (constant prices)

-1.5 3.8 -1.3 9.1 11.5 4.7 ...

Consumer prices (HICP)


Period average

14.1 7.2 3.5 8.4 7.5 2.8 3.6

End of period

8.4 6.7 3.2 9.4 5.8 3.9 2.8



Nominal wages

6.4 8.3 9.3 6.3 10.2 9.3 7.4

Real wages

-5.0 0.9 5.8 -2.1 2.5 6.6 4.0

Employment (LFS)

-1.4 1.0 0.2 1.8 0.3 2.0 1.0

Unemployment rate (annual average, in percent, ILO definition)

18.8 19.3 18.6 17.5 18.1 16.4 15.9
  (In percent of GDP)

Public finance (ESA-95 basis)


General government balance

-12.3 -6.0 -7.8 -3.7 -4.0 -3.1 -2.0

Structural general government balance

-7.0 -6.2 -5.5 -3.6 -3.8 -3.0 -1.9

General government debt

49.9 48.7 43.8 43.1 42.6 36.8 35.8
  (Percent change, end of period, unless otherwise indicated)

Money and credit


Broad money

15.4 11.8 3.4 5.6 5.8 1.9 ...

Credit to enterprises and households 1/

7.8 7.5 14.8 14.8 10.9 24.7 ...

Interest rates (in percent, end-of-period)


NBS policy rate (two-week repo rate)

8.00 7.75 6.50 6.00 4.00 3.00  

Lending rate (short-term, national methodology)

10.7 8.8 7.5 7.2 7.5 6.1 ...

Deposit rate (one month)

6.2 5.9 4.5 4.6 3.0 2.5 ...
 (In billions of US dollars, unless otherwise indicated)

Balance of payments


Merchandise exports

11.9 12.6 14.4 21.8 27.8 31.9 36.6

Merchandise imports

12.8 14.8 16.5 22.5 29.2 -34.3 -39.0

Current account balance

-0.7 -1.8 -1.9 -0.3 -1.4 -2.4 -3.2

(in percent of GDP)

(-3.5) (-8.4) (-8.0) (-0.9) (-3.5) (-7.2) (-6.4)

Official reserves, end-period

4.1 4.2 9.2 12.1 14.9 15.5 18.8

(in months of imports of goods and nonfactor services)

(3.4) (3.0) (5.9) (5.7) (5.5) (4.9) (5.2)

(in percent of broad money)

(31.8) (29.9) (52.4) (53.9) (54.1) (61.8) (65.2)

Gross external debt, end-period

10.8 11.0 13.1 18.1 23.7 25.3 28.8

(in percent of GDP)

(54.9) (52.9) (50.0) (50.8) (53.6) (56.2) (56.6)

Short-term debt (in percent of GDP, original maturity basis)

12.3 14.7 16.2 21.9 23.5 30.0 33.0

Short-term debt (in percent of GDP, remaining maturity basis)

20.7 21.1 26.6 31.5 32.2 36.7 38.4

Official reserves to short-term debt (percent, remaining maturity basis)

100.2 95.2 132.1 108.4 104.4 93.6 95.9

Exchange rate


Slovak koruna per U.S. dollar


Period average

46.2 48.4 45.3 36.8 32.3 31.0 ...

End of period

47.4 48.5 40.0 32.9 28.5 31.9 ...

Slovak koruna per Euro


Period average

42.6 43.3 42.7 41.5 40.1 38.6 ...

End of period

44.0 42.8 41.7 41.2 38.8 37.8 ...

Nominal effective exchange rate (percent change, period average) 2/

2.3 -3.5 -0.6 5.4 4.0 1.6 ...

Real effective exchange rate (percent change, period average) 2/



11.1 0.2 0.7 12.9 9.2 2.2 ...

ULC-based 3/

7.2 -3.6 10.0 8.5 5.4 6.7 ...

Memorandum items:


GDP (current prices, Sk billions)

934 1,010 1,099 1,201 1,325 1,440


Sources: Statistical Office of the Slovak Republic; Ministry of Finance; National Bank of Slovakia; and IMF staff calculations.

1/ Adjusted for bank restructuring. Figure for 2005 shows the change from December 2004 to November 2005.
2/ Partner countries comprise Austria, Czech Republic, France, Germany, Hungary, Italy, Netherlands, Poland, United Kingdom, and United States.
3/ Figure for 2005 is for the period January through September.

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.


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