IMF Executive Board Concludes 2007 Article IV Consultation with the Slovak Republic

Public Information Notice (PIN) No. 07/71
June 22, 2007

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 June 6, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Slovak Republic.1


Economic performance strengthened further in 2006. Real GDP growth accelerated to 8¼ percent supported by strong productivity gains. Domestic demand remained robust, while the contribution of net foreign demand rose. Exports increased sharply, as exports of cars and durable consumption goods speeded up, and outpaced imports. However, because of a deterioration of terms of trade, the external current account narrowed only marginally to 8¼ percent of GDP. Much of the external deficit was covered by inflows of foreign direct investment.

Strong economic growth boosted employment and the unemployment rate fell sharply to 13¼ percent. Despite the strengthening labor demand, real wage increases moderated and lagged productivity gains. Thus, profitability continued to rise.

Inflation was on an upward path for much of 2006, but this trend reversed in the fourth quarter. Harmonized consumer price inflation reached 5 percent in July-August 2006 but declined subsequently to 2 percent in February-April 2007. Inflation developments were influenced by trends in world energy prices, the unwinding of the base effects of the large increases in regulated utility prices in October 2005, and decreases in regulated prices in January 2007.

The National Bank of Slovakia (NBS) has been following a hybrid monetary framework focused on restraining inflation and on maintaining the exchange rate within the Exchange Rate Mechanism 2 (ERM2) requirements. Concerns about a negative inflation outlook prompted the NBS to raise its policy interest rate in four steps by a total of 175 basis points during the first three quarters of 2006. During May-July 2006, negative investor sentiment on emerging markets and concerns about the election outcome and courses of policies led to depreciation pressures on the koruna. In July 2006, the NBS intervened heavily in the foreign exchange rate market to stem depreciation pressures when the koruna dropped below the central parity under ERM2.

Favorable growth and export performance and positive investor sentiment toward the region led to appreciation pressures from October 2006 onward. In end-December, as the koruna approached the upper edge of the ERM2 band, the NBS began countering appreciation pressures through interventions and prolonged rejection of bids during repo auctions. Eventually in mid-March 2007, with appreciation pressures persisting, the central parity was revalued with the approval of the European Union member states by 8.5 percent. The NBS has continued to counter appreciation pressures since the parity revaluation and has held the koruna at around 6 percent above the new central parity. With inflation declining markedly in the first quarter of 2007 and judging upside risks to be low, the NBS lowered its policy rate by 50 basis points in two steps since late March.

The general government deficit in 2006, estimated at 3.4 percent of GDP, was smaller than envisaged in the budget. Collections of tax and non-tax revenues and social insurance contributions surpassed the budgeted levels. There was also some underspending in cofinancing of EU-funds projects because of shortfalls in drawdown of funds from the EU budget. These gains were mostly offset by higher outlays on goods and services, pensions and health benefits, and transport subsidies.

Growth is projected to remain strong during 2007-09. The commencement of production and increasing capacity in export-oriented projects and increased downstream integration with domestic supply chains will be the main engines of growth. The current account deficit is expected to narrow progressively over the medium term. Slovakia is well poised to adopt the euro in January 2009. Barring major shocks, the Maastricht inflation criterion seems within reach, and the 2007-09 budget framework aims at meeting the euro zone objectives.

Executive Board Assessment

Executive Directors commended Slovakia's strong economic performance in recent years, which was underpinned by prudent macroeconomic management, a wide range of structural reforms, and increasing integration with the EU. Directors welcomed the new government's commitment to continue policies aimed at ensuring euro adoption in January 2009.

Looking forward, Directors concurred that Slovakia is well poised to adopt the euro, although several challenges remain. Chief among them are to satisfy the test of exchange rate stability under ERM2, to enhance fiscal and labor market flexibility to allow the economy to absorb shocks in the monetary union, and to continue with structural reforms to sustain growth and further reduce unemployment. Directors also noted that the authorities' objective of socially inclusive growth would need to be coordinated with the policy framework for euro zone entry and strong performance in the monetary union.

Directors agreed that the current level of competitiveness was satisfactory. However, they observed that the favorable prospects for growth and euro adoption may generate further currency appreciation pressure with potential for volatility and overshooting. Directors encouraged the NBS to conduct its policy, and its communications with market participants, in a manner that would limit opportunities for one-way bets in the foreign exchange market. Given the favorable inflation outlook, some Directors also saw scope for prudently lowering the policy interest rate. However, a number of other Directors stressed the need for caution in considering further easing monetary policy, noting that there are still risks for the inflation outlook given that the economy is operating at or near full capacity, and that the interest rate spread to the euro area is already low.

Directors recommended a more ambitious fiscal consolidation than envisaged in the 2007-2009 budgetary framework, to ensure that fiscal policy remains consistent with the Maastricht deficit limit, to contain potential re-emerging inflationary pressures, and to counter further currency appreciation pressures. They called on the authorities to save revenue windfalls, and to adhere to the existing medium-term expenditure ceilings. Directors stressed the need to bolster the fiscal management of local governments and to improve policy coordination among different levels of government, to ensure achievement of the national fiscal consolidation objective.

Directors highlighted the importance of strengthening the medium-term expenditure framework. They welcomed the initiation of background work by the authorities to increase spending efficiency and to streamline public administration, and, in this context, called for efforts to increase efficiency and contain costs in the health care system. Given that higher socially-oriented current spending would reduce expenditure flexibility, Directors recommended putting greater emphasis on infrastructure spending and on employment promotion in the underdeveloped regions of Slovakia.

Directors emphasized that wage moderation and flexibility in wage-setting procedures are essential to restrain inflation and maintain competitiveness. In this regard, the recent legislation that extended sectoral wage agreements to all firms in the sector was a source of concern. Directors also cautioned against further large increases in the minimum wage, as they could lead to wage drift and worsen employment prospects for low-skilled workers.

In view of the still high unemployment rate among the low-skilled and in the less-developed regions, Directors saw a need to improve the effectiveness of active labor market policy schemes. They also stressed the importance of ensuring that the labor code amendments under consideration would not raise labor costs and reduce labor market flexibility. Directors encouraged the authorities to give consideration to introducing an earned-income tax credit for low-income workers, as this would enhance job creation and increase incentives to work.

Directors welcomed the finding that Slovakia's financial system is generally sound and resilient to adverse shocks, while supporting continued efforts to further enhance financial institution supervision. They called for close monitoring of banks' loan portfolios, as continued rapid credit growth has increased banks' exposure to credit risks. Given the high foreign ownership of banks, further strengthening of cooperation with home country supervisors should also remain a priority. Directors commended the strengthening of the regime against money laundering and terrorism financing, and encouraged the authorities to move expeditiously to address the remaining gaps.

Slovak Republic: Selected Economic Indicators, 2002-07

  2002 2003 2004 2005 2006 2007

  (Percent change, period average)

Real sector


Real GDP

4.1 4.2 5.4 6.0 8.3 8.8

Output gap (in percent of potential GDP)

-0.2 -0.5 -0.5 -0.3 -0.1 0.0

Gross industrial output (constant prices)

-1.3 9.1 11.5 4.7 9.9 ...

Consumer prices


CPI (period average)

3.3 8.5 7.5 2.7 4.5 2.3

HICP (period average) 1/

3.5 8.4 7.5 2.8 4.3 1.8



Nominal wages

9.3 6.3 10.2 9.2 8.0 7.1

Real wages

5.8 -2.1 2.4 6.3 3.3 4.7

Employment (ESA 95 basis)

-0.5 1.8 -0.3 1.4 2.3 2.0

Unemployment rate (annual average, in percent) 2/

18.6 17.5 18.1 16.2 13.3 11.8
  (In percent of GDP)

Public finance (ESA 95 basis)


General government balance 3/

-7.7 -2.7 -3.2 -2.8 -3.4 -2.9

Structural general government balance 3/

-7.5 -2.4 -3.0 -2.6 -3.4 -2.9

General government debt

43.3 42.4 41.5 34.5 30.7 29.5
  (Percent change, end of period, unless otherwise indicated)

Money and credit


Broad money 4/

3.4 5.6 15.0 7.8 15.3 ...

Credit to enterprises and households 4/

14.8 14.8 6.2 26.0 22.9 ...

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


NBS policy rate (two-week repo rate)

6.50 6.00 4.00 3.00 4.75 ...

Lending rate (floating rate and up to 1 year initial rate fixation) 4/

7.5 7.2 5.4 5.8 7.8 ...

Deposit rate (up to one month) 4/

4.5 4.6 3.6 2.7 4.6 ...
  (In billions of U.S. dollars, unless otherwise indicated)

Balance of payments


Merchandise exports

14.4 21.8 27.6 32.0 41.7 53.2

Merchandise imports

16.5 22.5 29.2 34.5 44.8 55.4

Current account balance

-1.9 -2.0 -3.3 -4.1 -4.6 -3.7

(in percent of GDP)

(-8.0) (-6.0) (-7.8) (-8.6) (-8.3) (-5.3)

Official reserves, end-period

9.2 12.1 14.9 15.5 13.4 17.6

(in months of imports of goods and nonfactor services)

(5.8) (5.7) (5.5) (4.8) (3.2) (3.5)

Gross external debt, end-period


18.1 23.8 27.1 32.2 33.9

(in percent of GDP)

(49.4) (50.4) (52.4) (59.9) (55.6) (48.5)

Exchange rate


Nominal effective exchange rate (percent change, period

average) 5/

-0.6 5.4 4.0 1.6 2.6 ...

Real effective exchange rate (percent change, period average) 5/


0.8 12.8 9.2 2.3 6.5 ...


8.9 -0.8 8.4 -3.7 -1.7 ...

Memorandum item:


GDP (current prices, Sk billions)

1,111 1,213 1,355 1,471 1,636 1,822

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

1/ The harmonized index of consumer prices (HICP) is an internationally comparable measure of inflation calculated by each member state of the European Union.

2/ ILO definition as in Labor Force Survey.

3/ In 2004, includes forgiveness of domestic debt claims on the health sector falling due, equivalent to 0.8 percent of GDP. From 2005 onward, includes second pillar pension costs.

4/ There is a break in the series in 2004. Data for 2004-2006 are in accordance with European Central Bank methodology.

5/ Trade-weighted. Partner countries comprise Austria, Czech Republic, France, Germany, Hungary, Italy, Netherlands, Poland, United Kingdom, and United States.

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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