## _cr0571

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### Executive Summary
- Real GDP expanded by an estimated 5¼ percent in 2004, driven by a strong recovery in domestic demand, continued export strength, and productivity growth.
- Employment stagnated; the unemployment rate remained at 17¾ percent—of which two-thirds is long term.
- Headline inflation remained high (about 6 percent at end-2004), driven by administered price and indirect tax increases.
- External current account deficit widened from 1 percent of GDP in 2003 to an estimated 3 percent in 2004; this widening largely reflected dividend repatriation.
- Fiscal deficit is estimated to have expanded to 3.8 percent of GDP in 2004.

Outlook
- Growth expected to remain close to 5 percent in 2005–06, slightly above potential.
- Staff expects headline inflation to approach 4 percent in 2005, at the top end of the central bank’s target range (3.5 ±0.5 percent).
- Current account deficit should widen temporarily to about 5 percent of GDP in 2005 and is projected to be below 2 percent of GDP in 2007–08.
- Staff estimate current account deficit remains within sustainability boundaries, estimated at 6 percent of GDP.

Key issues
- Balancing disinflation with containing real appreciation pressures.
- Ensuring an appropriate speed and path of fiscal adjustment, addressing backloading in the authorities’ three-year fiscal framework and meeting the 2007 target (3 percent of GDP).
- Reducing unemployment and sustaining noninflationary growth through continued structural reforms.

Policy recommendations (summary)
- Monetary: adopt flexible approach to exchange rate in pursuing disinflation; avoid further cuts in official interest rates given inflation outlook; enhance communication to guide expectations.
- Fiscal: accelerate and deepen fiscal consolidation; make medium-term fiscal framework more ambitious about the 2007 target; eliminate back-loading and strengthen expenditure framework.
- Structural: continue reforms (tax, pension, health, labor); prioritize education reform, labor mobility, infrastructure, and reducing tax burden on labor.

_Source: IMF staff Executive Summary from the Slovak Republic Article IV consultation._

### Recent developments and outlook (2004 detailed)
- Exports: export volumes grew by 13 percent in 2004.
- Growth drivers: strong domestic demand recovery, continued export strength, stimulative fiscal policy, strong household credit growth, record high nonprivatization FDI.
- Employment: despite productivity-driven growth, employment gains were small and uneven across sectors.
- Output gap estimates:
  - NBS: 1½ percent below potential in 2004.
  - Staff: negative 0.6 percent output gap in 2004.
  - Ministry of Finance: negative 0.1 percent output gap.
- Wage pressures: economy strength prompted acceleration in wage growth; specific skill shortages could slow disinflation.
- External financing: authorities expected 2005 current account deficit about 5 percent of GDP because of investment imports (Peugeot and Kia plants); expected temporary and largely covered by FDI.

### Monetary policy, exchange rate, and inflation
- Interest rate actions:
  - NBS reduced main policy rate by a cumulative 200 basis points in the year through September (prior to the Article IV mission).
  - In late November the NBS cut interest rates by another 50 basis points, bringing the main policy rate to 4 percent.
  - Two-week standard tender repo rate end-of-period values reported: 8.00, 7.75, 6.50, 6.00, 4.00 (years shown in Table 1).
- Sterilization and interventions:
  - By end-September, NBS sterilization position amounted to twice the monetary base and was costing about 1 percent of GDP annually.
  - NBS intervened extensively in 2004, enlarging its balance sheet; interventions were sporadic in December.
- Exchange rate movements:
  - Koruna appreciated by over 6 percent against the euro in 2004 (about 3 percent in the twelve months through September noted elsewhere).
- Inflation:
  - 12-month core inflation reached 1½ percent at end-2004, down from 2¾ percent at end-2003.
  - Headline inflation about 6 percent at end-2004, against 9⅓ percent at end-2003.
  - NBS targets 3.5 percent for headline inflation with a ± 0.5 percent range at end-2005.
  - Staff expected headline inflation to approach 4 percent in 2005.
- Identified upside inflation risks:
  - Rapid nominal wage growth in 2004 (correlation between lagged inflation and wages is 85 percent for 2002–04).
  - Low food-price inflation in 2004 may not repeat.
  - Closing output gap due to rising domestic demand and prior rate cuts.
  - Potential second-round effects from oil and administered price increases.
- NBS policy framework change:
  - December: NBS announced explicit inflation targets for 2005–08 and stated primary focus of monetary policy will be inflation; new targets: end-year inflation targets of 3 to 4 percent in 2005, below 2.5 percent in 2006, and below 2 percent thereafter.
- Staff recommendations:
  - Maintain flexible exchange-rate approach; avoid interventions beyond smoothing.
  - Refrain from further reducing official interest rates given inflation outlook and low real rates.
  - Tighten fiscal policy to contain overheating and share burden of adjustment if capital inflows threaten competitiveness.
  - Enhance communication to anchor expectations and reduce disinflation costs.

### Fiscal policy: recent developments, projections, and recommendations
- Fiscal outcomes:
  - Fiscal deficit widened to an estimated -3.8 percent of GDP in 2004 from -3.4 percent in 2003.
  - Fiscal impulse (including net EU transfers) was 1 percent of GDP in 2004.
- Revenue and spending changes:
  - Reduction in revenues of over 1 percentage point of GDP in 2004 due to tax reform and lower social contributions, offset by lower spending on wages, benefits, and interest.
  - Net transfers from the EU budgeted as 1¼ percent of GDP in context; table shows net transfers: 0.3 (2004), 1.3 (2005), 1.6 (2006), 1.7 (2007).
- Pension and health reforms fiscal effects:
  - Second pillar launch (January 2005) estimated to cause general government revenue loss of 0.4 percent of GDP in 2005, rising to about 1 percent of GDP in 2006 and beyond (projections hinge on participation).
  - Greater than expected participation could imply annual transition costs reaching 1¾ percent of GDP in 2006 and beyond.
  - Health insurance reforms will entail higher public spending by 0.3 percent of GDP from 2005, partly financed through higher contributions.
- Budget and framework:
  - 2005 budget envisages a deficit close to the estimated 2004 outcome (3.8 percent of GDP).
  - Authorities noted that excluding second-pillar losses, the deficit would actually be reduced by ½ percent of GDP.
  - Staff estimates the budget implies a small positive fiscal impulse, around ⅓-½ percent of GDP when accounting for EU transfers and pension reform costs.
  - Three-year framework envisages declining fiscal deficit to 3 percent of GDP in 2007 (Maastricht ceiling) even with transition costs.
- Fiscal metrics (selected table values)
  - Overall fiscal balance: -3.8 (2004), -3.8 (2005), -3.9 (2006), -3.0 (2007) [Proj. Fiscal Framework]
  - Fiscal balance including second pillar 1/: -3.8 (2004), -3.4 (2005), -2.9 (2006), -1.9 (2007)
  - Cyclically adjusted primary balance 1/ 2/: -1.7 (2004), -1.2 (2005), -0.8 (2006), -0.2 (2007)
  - Fiscal impulse after net transfers from the EU 1/ 2/ 3/: 1.1 (2004), 0.4 (2005), -0.1 (2006), -0.4 (2007)
- Staff recommendations:
  - Accelerate fiscal consolidation in 2005 via durable spending measures to enhance credibility, avoid pro-cyclicality, and support monetary policy.
  - Make medium-term fiscal framework more ambitious (consider 2½ percent of GDP target suggested elsewhere) and introduce binding nominal expenditure ceilings.
  - Reduce growth of real primary spending from about 6 percent to about 1 percent annually to meet recommended 2007 targets (staff estimate).
  - Find growth-enhancing expenditure savings outside EU-financed projects (e.g., restructuring railways, reviewing agricultural subsidies).
  - Strengthen fiscal management and maintain transparency; caution against re-establishing extrabudgetary funds as precedent.

### Fiscal adjustment views, timing risks, and euro adoption
- Authorities’ framework implies most adjustment in 2007 (back-loaded); staff viewed this as risky given 2007 euro-adoption test date.
- Staff concern: targeting the 2007 test-date deficit with no margin risks missing Maastricht criterion after minor shocks; staff support lower deficits in both 2006 and 2007.
- Authorities argued current targets balance EU-related spending pace and political-economy considerations tied to 2006 elections; expected conservative budgeting and improved fiscal management to contain slippage.
- Euro timetable:
  - Authorities envisage ERM2 entry in 2006 and euro adoption in 2009; timetable assessed as appropriate but ambitious.
  - Preconditions for ERM2 participation include boosting resilience to shocks and sustained structural measures.

### Structural policies, labor markets, and business environment
- Structural reforms implemented in 2004:
  - Tax reform: single 19 percent rate for VAT, personal and corporate income taxes from 2004.
  - Welfare reform (2003–04); pension reform (raising retirement ages; second funded pillar from 2005); health reform (co-payments from 2003 and restructuring legislation); labor market reform (2003 amendments).
- Remaining priorities:
  - Reform education to match labor market demands and enable life-long learning.
  - Promote labor mobility; address housing/rental market constraints that discourage geographic mobility.
  - Develop infrastructure to connect less developed areas; reduce tax burden on labor to encourage employment.
- Business environment and investment:
  - World Bank singled out Slovakia as the world’s top reformer in improving investment climate.
  - Improvements: time to start a business halved; time to recover debt fell by three quarters; new private credit registry; simplified commercial registry; draft bankruptcy law to speed procedures.
  - A 12 percent jump in new business registrations followed simplification of entry procedures.
  - Investment incentives to attract projects to disadvantaged areas exist; staff urged careful project evaluation.
  - Privatization: planned 2005 sale of Slovenske Elektrarne to conclude major privatizations.
  - Energy markets to be liberalized for all commercial consumers from 2005; staff caution on high access fees limiting competition.

### Financial sector soundness and vulnerabilities
- Overall assessment: financial system appears sound; strengthening supervisory capacity ongoing.
- Banking sector facts:
  - Slovak Republic capital adequacy ratio (percent): 21.6 (Visegrad 2003 comparison).
  - Nonperforming loans (percent of total loans): 6.4 (Slovak Republic, Visegrad 2003).
  - Provisions (percent of nonperforming loans): 88.3 (Slovak Republic, Visegrad 2003).
  - Return on assets (percent): 1.2 (Slovak Republic, Visegrad 2003).
  - Return on equity (percent): 14.9 (Slovak Republic, Visegrad 2003).
- Time-series banking indicators (2001–Aug 04):
  - Capital adequacy ratio (percent): 2001 19.8; 2002 21.3; 2003 21.6; Aug 04 21.0.
  - Nonperforming loans (percent of total loans) 1/: 2001 12.3; 2002 9.2; 2003 6.4; Aug 04 5.4.
  - Provisions (percent of nonperforming loans) 1/: 2001 79.7; 2002 86.1; 2003 88.3; Aug 04 89.1.
  - Return on assets (percent): 2001 1.0; 2002 1.2; 2003 1.2; Aug 04 0.9.
  - Return on equity (percent): 2001 15.4; 2002 17.1; 2003 14.9; Aug 04 11.9.
  - Household loans (percent of total loans): 2001 15.5; 2002 18.0; 2003 22.1; Aug 04 26.0.
  - Mortgage loans (percent of total household loans): 2001 8.6; 2002 18.4; 2003 29.2; Aug 04 32.4.
- Additional notes:
  - Banks are about 90 percent foreign-controlled and among best capitalized in the region.
  - Nonperforming loans declining and well provisioned; bank lending rebounding, especially to households.
  - Staff cautioned growth in household lending risks may be underestimated due to nonbank credit not captured in statistics.
  - Supervisory improvements: examinations of all banks completed; plan to integrate Financial Markets Authority into NBS in 2006 to improve oversight of conglomerates and cross-border transactions.

### External position, debt dynamics, and risks
- External debt projected to decline from 45 percent of GDP in 2004 to 28½ percent of GDP in 2009, reflecting strong non-debt creating inflows in 2005–06 and decline in current account deficit in 2007–09.
- Stress tests (higher external interest rates, lower GDP growth, or exchange-rate depreciation) indicate external debt dynamics remain manageable, generally below 60 percent of GDP under most adverse scenarios.
- Public debt projected to decline to about 42 percent of GDP by 2009 and remain sustainable in the medium term.
- Adverse scenarios: slippages in fiscal adjustment or adverse growth/interest rate developments could raise public debt by up to 14 percentage points of GDP but remain below Maastricht limit of 60 percent of GDP.

Selected external and vulnerability indicators (reported series)
- Private sector credit (12-month percent change): "5.8", "4.5", "7.0", "8.1", "12.0", "13.7", "12.3".
- Credit to households (12-month percent change): "29.9", "35.5", "22.0", "18.5", "18.1", "38.8", "39.3".
- Gross official reserves (US$ million): "4,077", "4,189", "9,196", "12,149", "14,912", "16,420", "18,816", "20,374", "21,913".
- Current account balance (percent of GDP): "-3.5", "-8.4", "-8.0", "-0.9", "-3.1", "-5.2", "-5.2", "-1.5", "-1.2".
- Total external debt (percent of GDP): "53.4", "52.9", "54.1", "55.4", "45.1", "38.4", "37.4", "34.2", "32.1".

### Medium-term growth projections and decomposition
- Assuming TFP growth of about 3½ percent in the medium term, Slovakia projected to grow at around 4½ percent.
- Decomposition of projected real GDP growth (2005–06 vs. 2007–09):
  - Real GDP growth: 4.9 (2005–06), 4.5 (2007–09)
  - Contribution to growth—Labor: 0.5 (2005–06), 0.5 (2007–09)
  - Contribution to growth—Capital: 0.4 (2005–06), 0.5 (2007–09)
  - Contribution to growth—TFP: 4.0 (2005–06), 3.5 (2007–09)
- Selected projections and series excerpts:
  - Real GDP growth (Table 2): "1.5", "2.0", "3.8", "4.6", "4.5", "5.3", "4.9", "4.9", "6.2", "3.2".
  - Inflation (CPI, Table 2): "10.7", "12.0", "7.3", "3.3", "8.5", "7.5", "3.7", "2.9", "2.9", "2.9".
  - Gross national savings (percent of GDP, Table 2): "22.7", "22.5", "21.4", "21.2", "24.0", "23.9", "23.4", "24.1", "27.0", "27.6".

### Fund relations, technical assistance, and statistical issues
- Fund relations (As of December 31, 2004):
  - Joined: 01/01/1993; Article VIII.
  - Quota: 357.50 SDR Million.
  - Fund Holdings of Currency: 357.50 SDR Million.
  - Outstanding Purchases and Loans: None.
  - Financial Arrangements (Stand-by): Approval Date 07/22/1994; Expiration Date 03/21/1996; Amount Approved 115.80 (SDR Million); Amount Drawn 32.15 (SDR Million).
  - Exchange rate (December 31, 2004): Sk 28.496 per U.S. dollar and Sk 38.796 per euro.
  - Regime classification: managed float with no preannounced path for the exchange rate.
- Technical assistance highlights (1991–2004) from MAE, FAD, LEG, STA — missions on monetary operations, taxation, legal drafting, statistics, FSAP, and other areas (selected mission dates and topics preserved in source).
- Data ROSC (February–March 2004) assessment:
  - Quality, integrity, and reliability overall satisfactory despite shortcomings in data revision policy.
  - Outstanding issues: weaknesses in import/export price and volume data; lack of timely general government operations data; slow national accounts compilation and benchmarking.
  - Slovakia subscribes to SDDS since 1996 and observes or exceeds related standards.
  - Reported typical publication lags for core variables: foreign exchange reserves: a week or less; general government financing: a month or less; consumer prices/reserve money: 10 days to a month; foreign trade data: two months; other fiscal/BOP/National Accounts: about three months.
  - Monetary statistics: NMS and HMS broadly in line with the IMF Monetary and Financial Statistics Manual with exceptions (treatment of government foreign liabilities corrected; money market funds included as memo item; market valuation not applied to certain instruments).

### Operational next steps and priorities (aggregate)
- Monetary:
  - Implement new NBS monetary framework emphasizing inflation targeting and interest-rate-based policy.
  - Do not lower interest rates in 2005 given upside inflation risks; use exchange-rate intervention only to smooth volatility.
  - Enhance NBS communications to anchor expectations.
- Fiscal:
  - Seek fiscal tightening opportunities; accelerate consolidation in 2005 via durable spending measures.
  - Consider a more ambitious medium-term deficit target (e.g., 2½ percent of GDP) to provide margin against shocks.
  - Introduce binding and primary expenditure ceilings; bring forward some 2007 savings to 2006.
  - Ensure central-local fiscal coordination and preserve transparency (fold environmental fund back into state budget).
- Structural and institutional:
  - Continue structural reforms (privatization, energy market competition, education, infrastructure).
  - Prioritize reducing labor taxation and improving tertiary education to match labor market needs.
  - Strengthen financial supervision: consolidated supervision, broaden household asset/liability data, implement integration of Financial Markets Authority into NBS with care.
- Statistics and data:
  - Address Data ROSC outstanding issues: import/export price indices, timeliness of government operations data, faster national accounts benchmarking, and market valuation of financial instruments.

*Source: IMF staff report content provided in the supplied PDF chapter.*

### Executive Summary ......................................................................................................

### Executive Summary

### Background
- Real GDP expanded by an estimated 5¼ percent in 2004, driven by a strong recovery in domestic demand, continued export strength, and productivity growth.
- Employment stagnated; the unemployment rate remained at 17¾ percent—of which two-thirds is long term.
- Headline inflation remained high (about 6 percent at end-2004), driven by administered price and indirect tax increases.
- The external current account deficit widened from 1 percent of GDP in 2003 to an estimated 3 percent in 2004; this widening largely reflected dividend repatriation.
- The fiscal deficit is estimated to have expanded to 3.8 percent of GDP.

### Outlook
- Growth is expected to remain close to 5 percent in 2005–06, slightly above potential.
- On present trends, staff expects headline inflation to approach 4 percent in 2005, at the top end of the central bank’s target range (3.5 ±0.5 percent).
- The current account deficit should widen temporarily to about 5 percent of GDP in 2005, owing to strong consumption and investment-related imports, and is projected to be below 2 percent of GDP in 2007–08.
- Staff estimate that the current account deficit remains within sustainability boundaries, estimated at 6 percent of GDP.

### Key Issues Identified
- Balancing disinflation with containing real appreciation pressures.
- Ensuring an appropriate speed and path of fiscal adjustment, including addressing backloading in the authorities’ three-year fiscal framework and meeting the 2007 target (3 percent of GDP).
- Reducing unemployment and sustaining noninflationary growth through continued structural reforms.

### Policy Discussions and Recommendations

- Monetary policy
  - Policies face pressure from large capital inflows despite strong appreciation of the koruna and cumulative cuts in interest rates.
  - Staff recommend a tightening of fiscal policy to contain overheating risks, and, given upside inflation risks and strong external competitiveness, argue for a flexible approach to the exchange rate in pursuing disinflation.
  - Interest rates were reduced by a cumulative 200 basis points in 2004; the koruna appreciated by over 6 percent against the euro in 2004.

- Fiscal policy
  - Fiscal stance turned expansionary in 2004 and is set to remain so in 2005; the 2004 stimulus was judged timely but with the economy growing above potential in 2005 staff emphasize accelerating and deepening fiscal consolidation.
  - Staff highlight the desirability of making the medium-term fiscal framework more ambitious about the 2007 target (3 percent of GDP), eliminating back-loading, and strengthening the expenditure framework to enhance credibility.
  - Authorities were confident that strict implementation of their policies would be consistent with fiscal targets and macroeconomic objectives.

- Structural policies
  - Authorities implemented a strong set of structural reforms in 2004, including tax reform (single 19 percent rate for VAT, personal and corporate income tax from 2004), welfare reform (2003–04), pension reform (raising retirement ages; second funded pillar from 2005), health reform (co-payments from 2003 and comprehensive restructuring legislation), and labor market reform (2003 amendments to remove many restrictions).
  - Remaining structural priorities: reforming the education system to match evolving labor market demands, promoting labor mobility, developing infrastructure to connect less developed areas, and reducing the tax burden on labor.

### Recent Developments and Outlook (detailed)
- 2004 developments
  - Export volumes grew by 13 percent in 2004 as Slovakia continued to gain market share in Europe.
  - Growth in 2004 reflected strong domestic demand recovery, continued export strength, stimulative fiscal policy, strong household credit growth, and record high nonprivatization FDI.
  - Despite productivity-driven growth, employment gains were small and uneven across sectors.

- Output gap and wage pressures
  - The NBS estimated an output gap of 1½ percent below potential in 2004; staff estimate a negative 0.6 percent output gap in 2004; the Ministry of Finance estimated a negative 0.1 percent output gap.
  - The strength of the economy has prompted an acceleration in wage growth; specific skill shortages in some regions could imply slower disinflation if earnings pick up.

- External position and financing
  - Authorities expected the current account deficit to widen to about 5 percent of GDP in 2005 because of investment imports associated with Peugeot and Kia plants; this is expected to be temporary as investment expands export capacity.
  - Under the baseline, the deficit is almost fully covered by FDI and additional financing, if needed, would be readily available.

- Risks
  - Near-term risks are balanced: upside from faster-than-expected expansion of export capacity or stronger response of domestic demand to past interest rate cuts; downside mainly external—slower EU demand recovery or sustained high oil prices.

### Medium-term Growth Prospects
- Continued productivity gains supported by capital deepening and technological adoption from large investments, particularly in the car industry.
- Assuming TFP growth of about 3½ percent in the medium term, Slovakia is projected to be able to grow at around 4½ percent.
- Decomposition of projected real GDP growth (2005–06 vs. 2007–09):
  - Real GDP growth: 4.9 (2005–06), 4.5 (2007–09)
  - Contribution to growth—Labor: 0.5 (2005–06), 0.5 (2007–09)
  - Contribution to growth—Capital: 0.4 (2005–06), 0.5 (2007–09)
  - Contribution to growth—TFP: 4.0 (2005–06), 3.5 (2007–09)

_Source: IMF staff Executive Summary from the Slovak Republic Article IV consultation._

### 11.      In a context of strong growth potential, risks associated with public and external

### _cr0571 - 11.      In a context of strong growth potential, risks associated with public and external

### Public and External Debt Risks
- External debt projected to decline from 45 percent of GDP in 2004 to 28½ percent of GDP in 2009, mainly reflecting strong non-debt creating inflows in 2005–06 and a decline in the current account deficit in 2007–09.
- Stress tests (higher external interest rates, lower GDP growth, or exchange-rate depreciation) indicate external debt dynamics remain manageable, with the debt level generally remaining below 60 percent of GDP under most adverse scenarios.
- Public debt projected to decline to about 42 percent of GDP by 2009, remaining sustainable in the medium term.
- Under adverse scenarios (slippages in fiscal adjustment, or adverse growth or interest rate developments), public debt could rise by up to 14 percentage points of GDP but would remain below the Maastricht limit of 60 percent of GDP.

### Monetary Policy: Recent Actions and Effects
- The NBS reduced its main policy rate by a cumulative 200 basis points in the year through September (the month prior to the Article IV mission).
- By end-September, the NBS’s sterilization position amounted to twice the monetary base and was costing about 1 percent of GDP annually.
- The koruna appreciated by about 3 percent against the euro in the twelve months through September.
- In late November the NBS cut interest rates by another 50 basis points, bringing the main policy rate to 4 percent.
- The NBS intervened extensively in the foreign exchange market in 2004, enlarging its balance sheet and increasing sterilization operations; thereafter interventions were sporadic in December.

### Inflation Outlook and Risks
- 12-month core inflation rate reached 1½ percent at end-2004, down from 2¾ percent at end-2003 (core inflation excludes administered prices and indirect taxes).
- Headline inflation about 6 percent at end-2004, against 9⅓ percent at end-2003, largely driven by administered price and indirect tax increases.
- Staff expected headline inflation to approach 4 percent in 2005, the top end of the NBS-targeted range.
- The NBS targets 3.5 percent for headline inflation with a ± 0.5 percent range at end-2005.
- Several upside risks to inflation identified:
  - Nominal wage growth was rapid in 2004; correlation between lagged inflation and wages is 85 percent for 2002–04.
  - Low food-price inflation in 2004 partly reflected a very good harvest that may not be repeated.
  - The output gap is closing rapidly owing to rising domestic demand, supported by previous interest rate cuts.
  - Potential second-round effects from increases in oil and administered prices, particularly if wage setting remains backward looking.
- Staff projection and NBS target implications:
  - On present trends staff expected headline inflation would approach 4 percent in 2005, leaving no room for the materialization of upside risks.

### NBS Strategy, Communication, and Staff Recommendations
- The NBS viewed its inflation target as attainable and was more concerned about negative competitiveness effects from exchange rate appreciation on traditional manufacturing sectors.
- NBS rationale included:
  - Observed wage increases in 2004 were temporary (partly delayed bonuses from 2003).
  - Food prices should remain subdued given world commodity trends, barring adverse weather.
  - Substantial slack in the economy with high unemployment limits second-round effects.
- NBS favored slowing nominal appreciation to protect competitiveness of SMEs and to act as insurance against external shocks.
- Staff recommended:
  - Maintain a flexible approach to exchange rate management; avoid intervention beyond smoothing as it could entrench inflationary expectations and be costly for the NBS.
  - Enhance communications policy to guide inflation expectations and reduce disinflation costs.
  - Refrain from further reducing official interest rates given the inflation outlook and already low real interest rates.
  - Emphasize the merits of tightening fiscal policy to contain risks of overheating; if capital inflows remained strong and threatened competitiveness, fiscal policy should share the burden of adjustment.

### Monetary Framework Change
- In December the NBS announced explicit inflation targets for 2005–08 and stated the primary focus of monetary policy will be inflation, with exchange rate developments assessed depending on their inflationary impact.
- New monetary program targets: end-year inflation targets of 3 to 4 percent in 2005, below 2.5 percent in 2006, and below 2 percent thereafter.

### Fiscal Policy: Recent Developments and Medium-Term Considerations
- Fiscal deficit widened to an estimated 3.8 percent of GDP in 2004 from 3.4 percent of GDP in 2003.
- The fiscal impulse (taking into account net transfers from the EU) was 1 percent of GDP in 2004.
- Revenue and spending changes:
  - Reduction in revenues of over 1 percentage point of GDP in 2004 owing to tax reform and lower social contributions, offset by lower spending on wages, benefits, and interest.
  - Net transfers from the EU add to domestic demand; budgeted net transfers from the EU are noted as 1¼ percent of GDP in context.
- Pension and health reform fiscal effects:
  - Launch of privately funded pension second pillar in January 2005 estimated to cause general government revenue loss of 0.4 percent of GDP in 2005, rising to about 1 percent of GDP in 2006 and beyond (projections hinge on participation).
  - Greater than expected participation could imply annual transition costs reaching 1¾ percent of GDP in 2006 and beyond.
  - Health insurance reforms will entail higher public spending by 0.3 percent of GDP from 2005, though partly financed through higher contributions; in the short term they entail a higher budget allocation to the sector.
- Fiscal projections and metrics (staff/authorities):
  - 2005 budget envisages a deficit close to the estimated 2004 outcome (3.8 percent of GDP), with some further fiscal expansion implied by transition costs and higher EU-related expenditure.
  - Authorities noted that excluding second-pillar losses, the deficit would actually be reduced by ½ percent of GDP.
  - Staff estimates the budget implies a small positive fiscal impulse, around ⅓-½ percent of GDP, when accounting for budgeted net transfers from the EU and adjusting for pension reform costs.
  - The 2005 budget is part of a three-year framework envisaging a declining fiscal deficit—to 3 percent of GDP in 2007 (the Maastricht ceiling)—even with transition costs.
- Staff recommendation on fiscal policy:
  - Accelerate fiscal consolidation in 2005 based on durable spending measures to: (i) enhance credibility of the medium-term fiscal framework; (ii) avoid pro-cyclical fiscal policy; and (iii) support monetary policy by reducing the risk of overheating.
  - A tighter fiscal policy should remain an essential instrument to contain appreciation pressures.
- Fiscal indicators table (selected values preserved as in source):
  - Overall fiscal balance: -3.8 (2004), -3.8 (2005), -3.9 (2006), -3.0 (2007) [Proj. Fiscal Framework]
  - Fiscal balance including second pillar 1/: -3.8 (2004), -3.4 (2005), -2.9 (2006), -1.9 (2007)
  - Cyclically adjusted primary balance 1/ 2/: -1.7 (2004), -1.2 (2005), -0.8 (2006), -0.2 (2007)
  - Net transfers from the EU: 0.3 (2004), 1.3 (2005), 1.6 (2006), 1.7 (2007)
  - Fiscal impulse after net transfers from the EU 1/ 2/ 3/: 1.1 (2004), 0.4 (2005), -0.1 (2006), -0.4 (2007)

*Source: IMF staff report content provided in the supplied PDF chapter.*

### 24.      Views differed on the path of fiscal adjustment over 2006–07. The authorities’

### _cr0571 - 24.      Views differed on the path of fiscal adjustment over 2006–07. The authorities’

### Fiscal adjustment: views and risks (paras 24–25)
- Authorities’ three-year fiscal framework implies that most of the adjustment would take place in 2007 (text chart).
- Abstracting from pension reform costs would yield a smoother fiscal adjustment path, although still back-loaded.
- Staff assessment and concerns:
  - While consistent with medium-term sustainability (Table 8), staff regarded the back-loaded approach as risky given the 2007 test date for euro adoption.
  - Targeting a test-date deficit with no margin risks missing the Maastricht criterion in case of even relatively minor shocks.
  - This approach leaves no room for implementation slippages, whether ahead of the 2006 elections or from delays that the next government could encounter preparing fiscal measures.
  - Delaying most of the fiscal adjustment to 2007 could compound these risks.
  - Therefore, staff supported a lower deficit target in both 2006 and 2007.
- Authorities’ position:
  - Preferred to maintain current targets, arguing their approach balanced considerations including the pace of EU-related spending and political-economy aspects associated with the elections in 2006.
  - Expected that conservative budgeting, improved fiscal management systems in place, and cutting waste would provide a margin on expenditures in 2007 to contain slippage risk.

### Required fiscal action and policy recommendations (para 25)
- Fiscal challenge: combine additional consolidation with pension reform and higher spending on EU-financed projects.
- Revenue constraint: recent direct-tax cuts constrain revenues.
- Staff estimate of spending-growth reduction needed:
  - Reduce the growth of real primary spending by the general government from current annual rates of about 6 percent to about 1 percent to meet the recommended target for 2007.
  - Note: current 6 percent rate reflects temporarily higher spending growth financed with EU resources.
- Staff recommendations:
  - Find growth-enhancing expenditure savings in areas unrelated to EU-financed projects.
  - Potential savings sources: continued restructuring of inefficient sectors (e.g., the railways); careful review of subsidies unlikely to enhance potential economic growth, particularly agricultural subsidies.
  - Introduce binding nominal expenditure ceilings in the medium-term fiscal framework to complement deficit targets.
- Authorities’ note on expenditure control:
  - Their framework does not contain formal expenditure ceilings, but the budget law for 2005 allows for a nominal expenditure increase of only 1 percent compared to the budget baseline before resorting to a supplementary budget.

### Fiscal management and decentralization (para 26)
- Improvements taken:
  - Abolished most extrabudgetary funds at end-2001.
  - Restricted the issue of new government guarantees from end-2002.
  - Other steps over the past two years to improve fiscal transparency.
- Concern:
  - Parliament’s decision to re-establish an extrabudgetary environmental fund would reduce oversight over environmental spending; staff and authorities hoped it would not set a precedent for further reversals of transparency.
- Institutional improvements and effects:
  - New Debt and Liquidity Management Agency generating significant savings on government debt.
  - Recently established State Treasury contributing to fiscal control, despite some temporary gaps in state budget expenditure data.
- Decentralization:
  - New funding formulas for education spending and revenue-sharing for personal income tax effective from 2005.
  - Transfer of spending responsibilities (some education, healthcare, transport) from central to local governments has not affected fiscal discipline in most local governments, which operate within a framework of balanced current budgets.
  - Subnational governments account for 16 percent of general government expenditures in the 2005 budget.

### Euro adoption timetable and prerequisites (para 27)
- Authorities envisage ERM2 entry in 2006 and euro adoption in 2009.
- Assessment:
  - Timetable appears appropriate; early euro adoption is ambitious and provides incentives for appropriate macroeconomic policy mix and reforms.
  - Preconditions for successful ERM2 participation go beyond fiscal and monetary policies; need to boost the economy’s resilience to shocks, especially important after losing the exchange rate instrument.
  - Sustained structural measures are required to increase resilience.

### Structural issues affecting labor markets and mobility (paras 28–30)
- Overall: recent reforms to the labor code and benefits system should encourage employment by reducing restrictions on part-time employment, easing separation arrangements, and improving incentives to work, but additional policies are needed to reduce unemployment.
- Enumerated constraints and recommendations:
  - Tertiary education:
    - Employers reported tertiary education reform needed to keep up with evolving labor market demands and create possibilities for life-long learning.
    - Authorities reported recent agreements among private sector, universities, and the Ministry of Education to tailor graduate training to market needs.
  - Housing and geographic mobility:
    - Lack of affordable new housing for low- and middle-income households discourages unemployed from moving between regions.
    - Rental market is small and illiquid; bias towards tenant rights impedes development of affordable rental housing.
  - Regional mismatches:
    - Economic activities and FDI concentrated in western part of the country, particularly Bratislava, where unemployment is low (text chart).
    - To reduce regional mismatch, policies should ease labor mobility constraints and support provision of basic transport and business infrastructure to attract jobs to high-unemployment regions.
  - Nonwage labor costs:
    - Nonwage labor costs remain amongst the highest in the region.
    - Recent tax reforms shifted tax burden from capital toward labor, encouraging capital-intensive activity rather than job creation.

### Business environment, investment incentives, and privatization (paras 29–32)
- Business environment improvements:
  - A World Bank study singled out Slovakia as the world’s top reformer in improving its investment climate over the past year.
  - 2004 outcomes: time to start a business was cut in half; time to recover debt fell by three quarters; a new private credit registry opened.
  - Draft bankruptcy law aims to make procedures faster, improve creditor rights, reduce judges’ discretion, and randomize case allocation to judges.
  - New commercial registry act has shortened and simplified registration procedures to two weeks.
  - According to the World Bank, a jump of 12 percent in new business registrations followed the simplification of entry procedures.
- Investment incentives:
  - Government intends to attract new investment, particularly in disadvantaged areas, through significant fiscal incentives (widely used in the region).
  - Staff encouraged careful project evaluation to avoid spending scarce public resources on investments that would have occurred anyway.
- Privatization and product-market reform:
  - Envisaged 2005 sale of Slovenske Elektrarne would conclude major privatizations.
  - Electricity and gas markets to be liberalized for all commercial consumers from 2005.
  - Staff caution: high access fees for imported energy could discourage entry of foreign energy suppliers, limiting competition.

### Financial sector soundness and supervision (para 31 and text tables)
- General assessment:
  - Financial system appears sound (Table 5); ongoing strengthening of supervisory capacity should improve risk monitoring.
  - Bank profitability is solid but lower than in comparable EU member states and expected to remain under pressure due to increased competition following EU entry.
- Key indicators (Banking Sector Soundness and Profitability Indicators for Visegrad Countries, 2003):
  - Capital adequacy ratio (percent): Slovak Republic 21.6; Czech Republic 14.5; Hungary 11.6; Poland 13.8.
  - Nonperforming loans (percent of total loans): Slovak Republic 6.4; Czech Republic 4.9; Hungary 3.4; Poland 20.9.
  - Provisions (percent of nonperforming loans): Slovak Republic 88.3; Czech Republic 77.1; Hungary 47.7; Poland 51.7.
  - Return on assets (percent): Slovak Republic 1.2; Czech Republic 1.2; Hungary 1.9; Poland 1.0.
  - Return on equity (percent): Slovak Republic 14.9; Czech Republic 23.8; Hungary 25.8; Poland 5.9.
- Time-series indicators (Banking Sector Soundness and Profitability Indicators, 2001–04):
  - Capital adequacy ratio (percent): 2001 19.8; 2002 21.3; 2003 21.6; Aug 04 21.0.
  - Nonperforming loans (percent of total loans) 1/: 2001 12.3; 2002 9.2; 2003 6.4; Aug 04 5.4. (1/ Excluding Konsolidačná Banka in 2001.)
  - Provisions (percent of nonperforming loans) 1/: 2001 79.7; 2002 86.1; 2003 88.3; Aug 04 89.1.
  - Return on assets (percent): 2001 1.0; 2002 1.2; 2003 1.2; Aug 04 0.9.
  - Return on equity (percent): 2001 15.4; 2002 17.1; 2003 14.9; Aug 04 11.9.
  - Household loans (percent of total loans): 2001 15.5; 2002 18.0; 2003 22.1; Aug 04 26.0.
  - Mortgage loans (percent of total household loans): 2001 8.6; 2002 18.4; 2003 29.2; Aug 04 32.4.
- Other financial-sector notes:
  - Slovak banks are about 90 percent foreign-controlled and are among the best capitalized in the region.
  - Nonperforming loans are declining and well provisioned; bank lending is rebounding, especially to households.
  - Authorities noted banks’ exposure to households is low and that household credit growth reflects expected move to equilibrium from a very low base.
  - Staff stressed that growth in household lending exposes the financial sector to risks that may be underestimated because available statistics do not capture additional credit granted by nonbank institutions (including credit from manufacturing companies for purchases of consumer durables).
  - Supervisory progress: examinations of all banks completed over the past two years; plans to improve supervision of financial conglomerates and cross-border transactions by integrating the Financial Markets Authority into the NBS in 2006.

### Trade policy alignment with EU (para 33)
- Following EU accession, Slovakia adopted the EU's Common Commercial Policy.
- Tariffs and preferential trade agreements were modified to ensure EU-conformity.
- Expected effects: minor, since Slovakia's tariff system was not significantly different from the EU and trade with third countries affected by changes in preferential agreements is small.

*Source: _cr0571 - 24.      Views differed on the path of fiscal adjustment over 2006–07. The authorities’*

### 34.      Slovakia’s accession to the European Union took place amidst promising near-

### _cr0571 - 34.      Slovakia’s accession to the European Union took place amidst promising near-

### Macroeconomic outlook and performance
- Near-term prospects were described as "promising" with a "favorable medium-term outlook."
- Despite a difficult external environment:
  - Growth has been "resilient" and core inflation has "declined."
  - Domestic demand was "recently gaining momentum" and investor interest remained strong.
- Risks to the outlook depend on completing pending reforms and deft macroeconomic policy management.

### Monetary policy assessment and recommendations
- Given upside inflation risks and a closing output gap, "monetary conditions need to tighten."
- The recent koruna appreciation was noted as "already contributing to tighter monetary conditions."
- Guidance on interest rates:
  - "Since inflation is likely to remain close to the upper end of the targeted range in 2005, with significant upside risks, interest rates should not be lowered."
  - Rates "should be guided in the future by the need to achieve inflation targets."
- Exchange rate guidance:
  - The NBS should smooth excessive exchange rate volatility but "avoid fine-tuning" and adopt a "flexible approach to the exchange rate in pursuing disinflation."
  - Excessive intervention beyond smoothing could be counterproductive and entrench inflationary expectations and "also enlarge the NBS balance sheet and increase its losses."
- New NBS monetary framework:
  - "Appropriately place[s] a clear emphasis on inflation targets."
  - Expected effects: anchoring inflation expectations, generating more forward-looking wage-setting, supporting disinflation, relying primarily on the interest rate instrument rather than foreign exchange intervention, and enhancing policy credibility.
- Projection-specific numeric guidance present in tables:
  - NBS policy rate (two-week standard tender repo rate) end-of-period values: 8.00, 7.75, 6.50, 6.00, 4.00 (years shown in Table 1).

### Fiscal stance, targets, and recommendations
- Stronger fiscal stance than authorities envisaged would have "clear benefits" and authorities should take "any available opportunity" to achieve this.
- 2005 deficit target:
  - "The deficit target for 2005 is reachable, provided the authorities take measures to ensure that the collections of social security contributions recover as the budget envisages."
  - Additional adjustment desirable given projected above-trend growth and back-loading risks in the three-year budget framework.
  - Authorities should "reduce the planned deficit" at a minimum if growth turns out higher than the budget projection "4.5 percent", or if VAT collections improve.
  - Tighter fiscal stance would help reduce appreciation pressures and support monetary policy in reducing inflation.
- Medium-term fiscal targets and Maastricht compatibility:
  - European Commission concluded Slovakia "is on track" to bring down the fiscal deficit to the Maastricht level of "3 percent of GDP by 2007."
  - The report recommends a more ambitious target, "say 2½ percent of GDP," to provide margin against shocks and improve credibility, minimizing the possibility of a prolonged ERM2 stay if the 3 percent ceiling were breached.
  - Suggested focus: eliminate subsidies that do not enhance potential economic growth.
- Fiscal framework strengthening:
  - Introduce "binding expenditure ceilings" to complement nominal deficit targets.
  - Establish "primary expenditure ceilings" to clarify durable deficit-reducing measures and underlying policy needs.
  - To smooth adjustment, "bring forward to 2006 some of the expenditure savings planned in 2007."
- Fiscal decentralization and transparency:
  - Achieving objectives requires "participation of all levels of government" and close central-local cooperation for expenditure control.
  - Fiscal transparency has "significantly improved," but the recently established environmental fund is a "setback" and should "remain an exception" and be folded back into the state budget "as early as possible."

### Structural reform priorities
- Continue implementation of the "successful structural reform program."
  - Privatization and restructuring have attracted investment, unleashed private initiative, strengthened the financial sector, and accelerated growth.
  - Imminent completion of the government's privatization program welcomed, but the authorities should ensure energy market relationships among buyers, providers, and alternative suppliers "will indeed encourage competition."
- Labor market and employment:
  - Institutional labor market framework has "become more flexible."
  - Key tasks: ensure policies in education and public infrastructure support reductions in "high unemployment."
  - Essential to prepare projects to use available EU structural funds.
  - High wage taxes from social contributions remain an impediment to employment; further tax reform should prioritize "reducing labor taxation."
- Legal and institutional improvements:
  - "Legal framework has improved significantly" but implementation challenges remain, including "improving the functioning of the courts."

### Financial sector supervision and vulnerabilities
- NBS supervisory role:
  - NBS should "strengthen the financial system by building supervisory capacity to monitor risks."
  - Although institutional supervisory capacity improved, greater risks arise from:
    - "Rapid credit growth to households,"
    - Operations of financial conglomerates,
    - Cross-border transactions.
  - Recommendations: improve consolidated supervision, broaden data coverage of household assets and liabilities, and react appropriately and promptly to examination findings.
  - Plan to establish a single financial sector supervisor should be implemented "with care not to distract from effective oversight."
- Selected vulnerability and stability indicators (as reported):
  - Private sector credit (12-month percent change): series includes "5.8", "4.5", "7.0", "8.1", "12.0", "13.7", "12.3" (Table 5).
  - Credit to households (12-month percent change): series includes "29.9", "35.5", "22.0", "18.5", "18.1", "38.8", "39.3" (Table 5).
  - Gross official reserves (US$ million, Table 4): "4,077", "4,189", "9,196", "12,149", "14,912", "16,420", "18,816", "20,374", "21,913".
  - Current account balance (in percent of GDP, Table 4): "-3.5", "-8.4", "-8.0", "-0.9", "-3.1", "-5.2", "-5.2", "-1.5", "-1.2".
  - Total external debt (in percent of GDP, Table 4): "53.4", "52.9", "54.1", "55.4", "45.1", "38.4", "37.4", "34.2", "32.1".

### Projections and medium-term framework (selected numeric excerpts)
- Real GDP growth (Table 2, percent): historical and projections include "1.5", "2.0", "3.8", "4.6", "4.5", "5.3", "4.9", "4.9", "6.2", "3.2".
- Inflation (CPI, Table 2): "10.7", "12.0", "7.3", "3.3", "8.5", "7.5", "3.7", "2.9", "2.9", "2.9".
- Gross national savings (percent of GDP, Table 2): series includes "22.7", "22.5", "21.4", "21.2", "24.0", "23.9", "23.4", "24.1", "27.0", "27.6".
- Current account balance (US$ millions, Table 4): "-700", "-1,756", "-1,939", "-280", "-1,282", "-2,599", "-2,880", "-966", "-841".
- Exports, f.o.b. (US$ millions, Table 4): "11,872", "12,631", "14,365", "21,838", "27,812", "31,371", "35,173", "42,405", "47,747".
- Imports, f.o.b. (US$ millions, Table 4): "-12,777", "-14,766", "-16,497", "-22,479", "-29,086", "-33,597", "-37,775", "-43,224", "-48,488".
- Public finances (Table 1, percent of GDP):
  - General government balance: "-12.3", "-6.0", "-5.7", "-3.4", "-3.8", "-3.8".
  - General government debt: "49.9", "48.7", "43.3", "42.6", "43.5", "44.9".

### Operational next steps
- Implement the new NBS monetary framework emphasizing inflation targeting and interest-rate-based policy.
- Do not lower interest rates in 2005 given upside inflation risks; use exchange-rate intervention only to smooth volatility.
- Authorities should seek fiscal tightening opportunities, reduce planned deficits if growth exceeds the budget projection "4.5 percent", and consider a medium-term deficit target of "2½ percent of GDP."
- Strengthen fiscal framework with binding and primary expenditure ceilings; consider bringing forward expenditure savings from 2007 to 2006.
- Ensure central-local fiscal coordination, fold the environmental fund back into the state budget, and preserve fiscal transparency.
- Continue structural reforms (privatization, competition in energy, education, infrastructure) and prioritize reducing labor taxation.
- Strengthen NBS supervisory capacity: consolidated supervision, better household asset/liability data, prompt responses to findings, and cautious implementation of a single supervisor.

*Source: IMF staff report content provided in the supplied PDF excerpt.*

### APPENDIX                                                                        I

### APPENDIX I

### Fund relations (As of December 31, 2004)
- Membership Status:
  - Joined: 01/01/1993; Article VIII
- General Resources Account (SDR Million):
  - Quota: 357.50 100.0 %Quota
  - Fund Holdings of Currency: 357.50 100.0
- SDR Department (SDR Million):
  - Holdings: 0.87 N/A
- Outstanding Purchases and Loans:
  - None
- Financial Arrangements:
  - Type: Stand-by
  - Approval Date: 07/22/1994
  - Expiration Date: 03/21/1996
  - Amount Approved (SDR Million): 115.80
  - Amount Drawn (SDR Million): 32.15
- Projected Obligations to Fund:
  - None
- Exchange Rate Arrangement:
  - Currency: Slovak koruna (created on February 8, 1993)
  - Single exchange rate applies to all transactions within the convertible currency area.
  - Currency floated on October 1, 1998.
  - Exchange rate (December 31, 2004): Sk 28.496 per U.S. dollar and Sk 38.796 per euro.
  - NBS policy: does not support koruna’s exchange rate; intervenes primarily to smooth large fluctuations and when the exchange rate moves to an unacceptable level.
  - Regime classification: managed float with no preannounced path for the exchange rate.
  - The Slovak Republic maintains an exchange system free of restrictions on payments and transfers for current international transactions consistent with Article VIII.
- Article IV Consultation:
  - Last consultation concluded on July 23, 2003 (EBM 03/72).
- Technical Assistance:
  - See attached table (summarized below under Technical Assistance).
- Resident Representative Post:
  - None (closed at end-April 2004).

### Technical assistance, 1991–2004 (selected highlights by department)
- MAE (Monetary and Exchange Affairs):
  - April 1991; September/October 1991; February/March 1992 — Mission to the State Bank of Czechoslovakia: design of monetary policy instruments and operating procedures; development of foreign exchange operations and legal framework for central and commercial banking; reorganization of the State Bank.
  - December 1992 — Mission to the newly established Slovak Central Bank: monetary instruments, operations and analysis, foreign exchange operations, and banking supervision.
  - Since January 1993 — Several expert visits on banking supervision.
  - Since November 1993 — Resident advisor on banking supervision, co-sponsored by the EC-PHARE.
  - February/March 1994 — Mission on monetary analysis and operations, foreign exchange operations, banking supervision and regulation, central bank accounting, clearing and payment system, and central bank organization.
  - February 2000 — Mission on pros and cons, and modalities of moving to an inflation targeting framework, operational issues (money markets and policy instruments), and dealing with potential problems posed by capital inflows for monetary operations.
  - December 2001 — Long-term resident expert on banking supervision (still ongoing as of the source).
  - February–March 2002 — Financial Sector Assessment Program (FSAP).
  - May 2002 — Two missions on inflation modeling.
- FAD (Fiscal Affairs Department):
  - February and July 1991 — Advice on the design of new corporate and personal income taxes.
  - May and September 1991 — Advice on policy and administrative aspects of the introduction of VAT.
  - Since December 1991 — Regular visits by FAD consultant on VAT administration.
  - March 1992; April 1992; April 1993; May 1993 — Missions on administration, public financial management, and tax policy and administration.
  - September/October 1999 — Review of macro fiscal management, public expenditure management, and progress in establishing state treasury.
  - August 2001 — Tax administration: installation of resident expert to advise on establishment of Large Taxpayer Unit (LTU).
  - December 2001; June 2002 — Tax administration follow-ups and preparation of ROSC (Fiscal Transparency Module).
  - February 2003; March 2003; May 2003 — Missions on tax policy, tax administration, and expenditure policy.
- LEG (Legal Department):
  - April and July 1991; October 1991; January 1992; March 1992; May 1993; September 1993; May 1995 — Assistance with drafting of tax laws, tax administration law, revision of tax reform legislation, foreign exchange act, and acceptance of Article VIII obligations.
- STA (Statistics Department):
  - June 1991; September 1991; May 1993; December 1993; January 1994; February 1994; November 1994; November 1995 — Missions on government finance statistics, balance of payments statistics, money and banking statistics, and national accounts statistics.
  - November/December 1995 — Mission on balance of payments statistics.
  - October 1997; September/October 1998; February 1999; February 2000 — Missions on money and banking statistics, dissemination standards, national accounts and price statistics.
  - March 2001; July 2003; February–March 2004 — Multisector mission; mission on government finance statistics; Data ROSC Mission.

### Statistical issues and data quality (Appendix II)
- Overall assessment:
  - Data ROSC mission to Bratislava during February–March 2004 found that the quality, integrity, soundness and reliability of the data were overall satisfactory, despite some shortcomings in the data revision policy.
  - Finalization of the Data ROSC report is pending the authorities’ response to the draft.
- Main outstanding issues:
  - (i) Weaknesses in the data on prices and volumes of imports and exports.
  - (ii) Lack of timely data on the overall general government operations.
  - (iii) Slow compilation cycle of the annual national accounts and lack of proper benchmarking of quarterly data.
- Data dissemination and timeliness:
  - Slovakia subscribes to the Special Data Dissemination Standard (SDDS) since 1996 and observes or exceeds all related standards.
  - Authorities generally follow a free and open data publication policy; data are promptly released to news services and published in monthly and quarterly publications and on the Internet according to a pre-announced schedule.
  - Reported typical lags for core surveillance variables:
    - Foreign exchange reserves: a week or less.
    - General government financing and detailed state budget implementation data: a month or less.
    - Consumer prices, reserve money, broad money, and interest rates: 10 days to a month.
    - Foreign trade data: two months.
    - Other fiscal, balance of payments, and national accounts data: about three months.
  - The 2004 Data ROSC mission reported difficulties in reconciling balance of payments statistics with national accounts, monetary, or government finance statistics.
- Real sector and prices:
  - Significant progress in national accounts statistics, but output estimates for recent years may require future revision.
  - Quarterly national accounts expenditure data exhibit weaknesses and a significant statistical discrepancy between the supply side and the demand side (representing more than 1 percent of GDP in 2003Q2 and 2003Q4).
  - Outstanding issue: compilation of reliable price deflators for imports and exports; unit value trade price indices are published with long delays and are not appropriately adjusted for quality changes.
  - Consumer price indices: important that historical data be produced on the basis of the new basket for core inflation and total CPI.
  - Retail sales and consumption may be underestimated due to fast development of chain stores not fully captured in surveys; wages statistics might be biased.
  - Enterprise sector: recommendation that line ministries produce systematic accounts of financial positions of public enterprises under their purview.
- Fiscal sector:
  - General government statistics are compiled annually in accordance with GFSM 1986 for internal use, GFS Yearbook publication, and dissemination on MoF website in compliance with SDDS.
  - In line with the EU acquis communautaire, authorities report semi-annually on general government net lending/borrowing.
  - Monthly reconciliation of government operations above and below the line is restricted to budget transactions.
  - A modern treasury system began operating in January 2004; it will improve fiscal control by recording expenditures at planning and commitment stages.
  - From mid-2004, monthly state budget data have not included breakdowns of revenues or expenditures; it is not yet clear whether these gaps reflect teething problems with the treasury system or other factors related to EU accession.
  - MoF is converting fiscal accounts to ESA 95 standards.
  - MoF has begun compiling statistics in accordance with GFSM 2001; data are available on a cash basis for 2000–02, and on an accrual basis for 2003.
- External sector:
  - Balance of payments statistics are provided in a timely manner, presented in analytical and standard formats, and reported monthly.
  - Banks report arbitrage transactions accurately; reporting of nonresidents’ claims and liabilities in domestic currency has improved.
  - Balance of payments statistics are compiled and disseminated monthly on a cumulative basis during the year; dissemination on a cumulative basis does not follow best practices.
  - Weekly information on Gross International Reserves is reported timely via the reserves template.
  - NBS revised, with effect from January 1, 2002, its methodology of reporting foreign exchange reserves: valuation of gold at market price and changes in reporting of repo operations and gold swaps; reporting of foreign exchange reserves by commercial banks was revised to include selected long-term assets in the item “foreign exchange reserves.”
  - Remaining problem areas include: (i) recording of most interest payments on a cash basis; and (ii) the need to disseminate discrete balance of payments statistics as required by the SDDS.

*Source: APPENDIX I and APPENDIX II (Slovak Republic: Fund Relations; Technical Assistance; Statistical Issues), as of December 31, 2004.*

### 10. Monetary statistics are of good quality, and are reported on a timely basis to the Fund.

### 10. Monetary statistics are of good quality, and are reported on a timely basis to the Fund.

### Data ROSC mission findings (2004)
- The 2004 Data ROSC mission found that the two sets of monetary data compiled by the National Bank of Slovakia (NBS)—the national monetary statistics (NMS), for internal use, and the harmonized monetary statistics (HMS), submitted to international organizations—are broadly in line with the IMF Monetary and Financial Statistics Manual.
- Identified exceptions:
  - The treatment, in the NMS, of government’s foreign liabilities as part of the NBS foreign liabilities, with a counterpart adjustment in NBS claims on the government. In response to the mission’s comments, the authorities changed this treatment to exclude government foreign liabilities from NBS foreign liabilities.
  - The exclusion of money market funds from the NMS; the authorities recently started including these funds as a memo item in the NMS.
  - Market valuation is not applied to certain financial instruments under both the NMS and HMS.

### Reporting practices and timeliness
- The NBS compiles two sets of monetary statistics:
  - NMS (national monetary statistics) for internal use.
  - HMS (harmonized monetary statistics) submitted to international organizations, including the Fund.
- The title and accompanying text indicate monetary statistics are reported on a timely basis to the Fund.
- Reporting modalities shown in the companion table (Core Statistical Indicators) indicate:
  - Mode of Reporting: E (Electronic data transfer) for listed series.
  - Frequency of Reporting: D, W, M, Q as appropriate to the data series (daily, weekly, monthly, quarterly).
  - Confidentiality: C (Unrestricted use) for the listed series.

### Implications and follow-up actions implied by findings
- The NBS adjusted its NMS methodology to correct the government foreign liabilities treatment, improving alignment with international standards.
- The inclusion of money market funds as a memo item in the NMS addresses a prior coverage gap.
- Remaining methodological issue: lack of market valuation for certain instruments under both NMS and HMS — implies a need for further methodological alignment with the IMF Monetary and Financial Statistics Manual to apply market valuation where appropriate.

*Source: _cr0571 - 10. Monetary statistics are of good quality, and are reported on a timely basis to the Fund.*

### Introduction

### _cr0571 - Introduction

### Overview and recent macro performance
- Fiscal deficit shrank from 5.7 percent of GDP in 2002 to 3.4 percent in 2003.
- External current account deficit fell from 8.0 percent of GDP to 0.9 percent during the same period.
- A broad-based privatization program, large cuts in subsidies and transfers, pension and healthcare reforms, and adoption of a single tax rate for personal and corporate income taxes and VAT contributed to reforms and earned Slovakia recognition as the World Bank's "top reformer of the year" in 2004.
- Slovakia acceded to the European Union on May 1, 2004.
- In December 2004, Standard and Poor's upgraded Slovakia's sovereign rating to A-, with a positive outlook.
- In January 2005, Moody’s upgraded Slovakia to A2.

### Real Sector Development
- Slovakia is described as one of the fastest growing economies in Central and Eastern Europe.
- Growth and drivers
  - Higher-than-expected growth of about 5.3 in 2004 driven by strong domestic demand, higher wages, vigorous export performance, and high nonprivatization FDI.
  - Authorities' medium-term projection for GDP growth is around 5 percent in the period 2005-2007.
- External balance projections and financing
  - External current account deficit widened by more than 2 percentage points in the prior year due mainly to strong investment inflows and repatriation of profits.
  - Authorities expect the external current account deficit to increase to 5 percent of GDP in 2005 because of imports connected with construction of Peugeot, Kia, Ford, and other greenfield investments; this will be fully financed by FDI inflows.
  - Authorities project a current account deficit of about 4.5 percent of GDP for 2006.
  - In 2007-2008, the current account deficit is expected to be less than 2 percent of GDP.
- Competitiveness and Lisbon Strategy
  - Authorities adopted the Lisbon Strategy and will implement it through 2010, focusing on improving education and human resources, developing information technology skills, developing scientific potential, and promoting a business environment that supports market competition.

### Fiscal Policy
- Maastricht and convergence efforts
  - Authorities aimed to adopt the euro as soon as possible and brought the ESA-95 general government deficit below 4 percent of GDP in 2004.
- Fiscal outcomes and targets
  - Overall fiscal deficit in 2004 turned out better than budgeted and is estimated at 3.8 percent of GDP.
  - Authorities and staff agree further consolidation is needed, but election cycles make faster consolidation difficult.
  - The updated Convergence Programme covers 2004 to 2007 with indicative projections to 2010.
  - Budget plans for 2005 and 2006 are in line with the Convergence Programme.
  - Authorities target the general fiscal deficit for 2005 and 2006 to be 3.8 percent and 3.9 percent of GDP, respectively.
  - Target for 2007 is to reduce the fiscal deficit to 3 percent of GDP reference value, supported by the European Council of Ministers in December 2004.

### Monetary Policy
- Exchange rate and policy response
  - Strong competitive position, strong capital inflows, and EU membership caused the Slovak koruna to strengthen vis-à-vis the euro and the US dollar.
  - The National Bank of Slovakia (NBS) cut interest rates by a cumulative 250 basis points and intervened substantially in foreign exchange markets in 2004.
  - Despite interventions, appreciation in 2004 exceeded 6 percent vis-à-vis the euro, higher than NBS expectations.
- Inflation outcomes and targets
  - In 2004, headline inflation dropped to 5.9 percent and core inflation to 1.5 percent.
  - Administered price increases toward cost-recovery levels and indirect taxes contributed to relatively high inflation.
  - In December 2004, NBS approved the monetary program and new monetary policy framework for 2005-2008 focusing primarily on inflation.
  - Explicit inflation targets: 3.5 percent within a ± 0.5 percent range for 2005; below 2.5 percent for 2006; and below 2 percent thereafter.

### Banking Sector
- Restructuring and soundness
  - Banking sector successfully restructured and aligned with EU and Basel requirements.
  - World Bank support via an Enterprise and Financial Sector Adjustment Loan assisted recapitalization and privatization of formerly state-owned banks and legal framework overhauls for banking, insurance, and securities market.
  - Banking sector described as profitable, the best capitalized in the region, and almost fully owned by foreign partners.
- Supervision
  - Authorities and NBS decided to integrate the Financial Markets Authority into NBS’s Banking Supervision Department in 2006.

### Foreign Direct Investment
- Stable macro framework, structural reforms, improved investment climate, and tax reform created an environment attractive to foreign investors.
- EU membership further strengthens the stimulus for private sector development.
- New greenfield investments, particularly in the automotive industry, will make Slovakia the largest per capita car producer in the world by 2007.

### Reform Agenda and Structural Reforms
- Implementation status
  - Ambitious reform agenda almost fully implemented within the first two years of the government’s term; next election scheduled for September 2006.
  - Education system reform remains outstanding and is expected to be discussed in parliament within the next two or three weeks (from the report date).
- Tax reform
  - Comprehensive tax reform introduced in 2004 to improve incentives for entrepreneurship and work, increase transparency, and reduce distortions.
  - Reform based on a single flat rate of 19 percent for all personal and corporate incomes taxes and also for VAT.
  - Almost all tax exemptions eliminated; estate transfer, gift, and inheritance taxes abolished.
- Social protection
  - Modern, cost-effective, and efficient social protection system established.
  - 2004 reforms corrected disincentives to work while providing assistance to poorer Slovaks.
  - Measures include multi-pillar pension reform, improved collection and administration of social contributions, and strengthened institutional capacity of the Ministry of Labor, Social Affairs and the Family, the Social Insurance Agency, and the National Labor Office.
- Public finance management
  - Public Finance reform strengthened institutional capacity for budgetary and financial management, and improved macroeconomic analysis and forecasting capabilities of the Ministry of Finance.
  - A Debt Management Agency and the State Treasury System have been established.
- Pension reform
  - Pension reform from 2004 enhanced PAYG balances by gradually increasing statutory retirement age from 60 for men and 55 for women to 62 for both genders.
  - A fully-funded second pillar was introduced in January 2005.
- Health sector
  - Comprehensive health sector reform launched to promote fiscal sustainability while maintaining quality and increasing capacity.
- Legal and judicial systems
  - World Bank assessed legal and judicial systems and institutions; Ministry of Justice began implementing recommendations.
  - Weaknesses remain; authorities committed to strengthening business and legal environment.
- Unemployment and human capital
  - Despite Labor Code amendment in July 2003, unemployment remains a major concern and is still relatively high by regional standards, though some improvement is visible.
  - World Bank approved a Human Capital Technical Assistance Project on January 25, 2005 to strengthen policy infrastructure in Ministry of Labor, Social Affairs and Family and Ministry of Education to promote employment, education, and social cohesion.
  - Authorities plan to address skills and regional mismatches through education improvements and infrastructure development prioritizing less-developed regions.

### Euro Adoption
- Updated Convergence Programme approved in November 2004 in anticipation of euro adoption.
- Expected milestones and fiscal outlook
  - Expected that Slovakia will join ERM-II during the first half of 2006.
  - Expected euro adoption in 2009.
  - Ministry of Finance envisages general government finances in balance by 2010.
  - Authorities strongly committed to fulfilling all Maastricht criteria for euro adoption in a timely manner; goal also supported by opposition parties.

### Conclusion and medium-term challenges
- Recent positive economic trends and favorable structural reform outcomes since the last Article IV consultation (concluded in July 2003) were supported by broad-based technical assistance and advice from Bretton Woods institutions.
- Remaining priorities identified by authorities:
  - Reforming the education system.
  - Reducing unemployment.
  - Strengthening the judiciary and law enforcement.
  - Improving the knowledge-based economy.
- Main medium-term challenge: fulfill all criteria for adoption of the euro.

*Source: _cr0571 - Introduction.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr0571.pdf_