## _cr06119

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### Executive Summary — background and recent performance
- Real GDP growth accelerated to 6 percent in 2005.
- External current account deficit doubled to about 7¼ percent of GDP in 2005.
- Inflation (HICP) declined to 3.9 percent at end-2005.
- Fiscal deficit (general government, ESA-95 basis) fell to an estimated 3.1 percent of GDP in 2005.
- Slovakia entered ERM2 on November 28, 2005 (central parity Sk 38.455 per euro).
- Parliamentary elections scheduled for June 2006.

### Outlook (staff projections and authorities’ expectations)
- Economic growth projected to reach 6¾ percent in 2007 (staff projection).
- Real GDP growth projections: about 6¼ percent in 2006; 6¾ percent in 2007; 5¾ percent in 2008.
- External current account deficit projected to narrow to about 5 percent of GDP over the medium-term.
- NBS expects inflation to fall to 2¾ percent at end-2006 and has announced a target of below 2 percent for end-2007.
- Continued positive investor sentiment and Balassa-Samuelson effects likely to result in some appreciation of the koruna.

### Policy discussions — major findings and recommendations (summary)
- Euro adoption
  - Finding: Slovakia is well poised to adopt the euro, planned for January 2009, but challenges remain.
  - Recommendation: Strengthen fiscal policy and enhance structural flexibility; meet Maastricht criteria quickly to avoid a prolonged stay in ERM2.
  - Trade-off: Bring down inflation without undermining exchange rate stability and competitiveness.
- Monetary and exchange rate policy
  - Finding: NBS adopted “inflation targeting under ERM2 conditions” in January 2005 and announced end-year inflation targets for 2005–08.
  - Staff concern: Scope for sustained real appreciation is small; avoid excessive appreciation under ERM2 to protect competitiveness and conversion rate.
  - Authorities’ view: Some cushion on competitiveness; ready to increase interest rates if second-round inflation effects emerge.
- Fiscal policy
  - Finding: 2005 fiscal outturn better than budgeted; withdrawal of stimulus of 1 percent of GDP in 2005.
  - Recommendation: Tighten fiscal policy to support disinflation and contain koruna appreciation; avoid a pro-cyclical stimulus in 2006 and aim for significant withdrawal of stimulus in 2007.
  - Authorities: Agreed to safeguard revenue over-performance but additional measures deferred until post-election 2007–09 budget preparation.
- Wage policy
  - Finding: Real wage growth about 6½ percent in 2005 (from 2½ percent in 2004); nontradable-sector real wage growth exceeded productivity gains.
  - Recommendation: Encourage forward-looking wage adjustment, public sector wage restraint, slower minimum wage increases, and greater enterprise-level wage bargaining.
- Banking and structural issues
  - Finding: Banking system healthy but rising household credit increases credit risk.
  - Recommendation: Vigilant supervision, strengthen oversight (unified supervision from January 2006), monitor foreign-currency credit (about 21 percent share in 2005), and supervise rapidly growing pension funds.

### Key statistics and indicators (selected exact figures from the text)
- Real GDP growth: 6 percent (2005); staff projection 6¾ percent (2007).
- Current account deficit: about 7¼ percent of GDP (2005); projected about 5 percent of GDP (medium-term).
- Inflation (HICP): 3.9 percent at end-2005; NBS expects 2¾ percent at end-2006; target below 2 percent at end-2007.
- Fiscal deficit (general government, ESA-95): 3.1 percent of GDP (2005); envisaged 3.4 percent (2005 budget); outturn 4 percent (2004).
- Withdrawal of fiscal stimulus in 2005: 1 percent of GDP.
- NBS policy interest rate: lowered by 100 basis points to 3 percent (end-February 2005); increased by 50 basis points to 3.5 percent on February 28, 2006.
- ERM2 central parity: Sk 38.455 per euro.
- Koruna appreciation: nearly 3 percent above the central parity by January 2006.
- Real wage growth: about 6½ percent in 2005 (from 2½ percent in 2004).
- Unemployment rate: declined by 2 percentage points to about 15½ percent in September 2005; Bratislava about 5¼ percent; eastern regions around 22–24 percent.
- Share of foreign currency loans in total bank credit: about 21 percent (2005).
- Receipts from the EU budget in 2005: 60 percent of envisaged level.
- General government deficit target in 2006–08 budget framework: about 1¼ percent of GDP by end of framework.
- Total external debt: about 56 percent of GDP at end-2005 (from 54 percent at end-2004); net debt position 2 percent of GDP.
- Reserves in months of imports of goods and services: 4.9 (2005).
- External debt service ratio: 12 percent (2005).

### Competitiveness and exchange rate
- CPI-based and ULC-based REER appreciated further in 2005; relative profitability index remained close to the reference level of 1998.
- Staff study: koruna was undervalued by about 25 percent during 1997–2002; undervaluation declined from 2003 and expected to disappear in 2005.
- Slovakia’s market share in EU-15 imports increased rapidly and outpaced neighboring new EU-member states; continued export penetration driven by FDI linkages and commencement of FDI-supported projects.
- Monitoring required as bilateral REER and relative profitability vis-à-vis neighboring new EU-member states deteriorated.

### External debt, reserves, and vulnerability — stress-test outcomes
- Baseline external debt-to-GDP trajectory (in percent): 56.2 (2005), 56.5 (2006), 55.5 (2007), 54.2 (2008), 51.4 (2009), 48.1 (2010).
- Adverse scenarios (external debt-to-GDP, percent series reported):
  - Nominal interest rate shock: 56.2, 57.7, 57.8, 56.3, 53.4, 50.0.
  - Real GDP growth shock: 56.2, 59.2, 60.9, 59.1, 55.8, 52.1.
  - Change in euro GDP deflator shock: 56.2, 61.5, 65.0, 62.9, 59.2, 55.1.
  - Non-interest current account shock: 56.2, 63.6, 70.2, 68.0, 64.3, 60.2.
  - Combination of shocks (one standard deviation): 56.2, 65.3, 73.7, 71.7, 67.9, 63.6.
  - One-time 30 percent nominal depreciation in 2006: 56.2, 78.6, 75.8, 72.8, 68.0, 63.0.
- Under severe adverse conditions external debt-to-GDP could rise temporarily to 70–80 percent and fall to around 63 percent over the medium term.
- Staff assessment: depreciation scenario likelihood seems small given anticipated productivity gains and capital inflows supporting appreciation.

### Fiscal stance, budget framework (2006–08) and staff recommendations
- Budget framework implied: expansionary fiscal stance in 2006; broadly neutral in 2007; withdrawal of stimulus in 2008.
- Staff observed budget framework understated revenue prospects and noted large increases in net transfers from the EU in 2006–07, assuming full execution.
- Budget framework table (selected in percent of GDP):
  - Total Revenue: 37.0 (2005), 36.9 (2006), 37.1 (2007), 36.4 (2008).
  - Total Expenditure: 40.1 (2005), 39.8 (2006), 38.8 (2007), 37.7 (2008).
  - Headline fiscal balance: -3.1 (2005), -2.9 (2006), -1.6 (2007), -1.3 (2008).
  - Net transfers from the EU: 0.4 (2005), 1.3 (2006), 2.2 (2007), 2.1 (2008).
- Staff two-pronged fiscal strategy:
  - Safeguard additional revenues by adhering to nominal expenditure targets.
  - Durable expenditure savings via cutting waste, restructuring inefficient sectors (e.g., railways), and keeping real growth of subsidies below real GDP growth.
- Authorities agreed to safeguard revenue over-performance at the central government level; additional expenditure-side measures deferred until post-election.

### Public debt sustainability and fiscal projections
- General government debt: about 37 percent of GDP at end–2005.
- Over nine-tenths of debt is long-term; repayment profile lacks significant bunching.
- Assuming staff-recommended consolidation, debt ratio projected to decline to below 30 percent in 2010.
- Vulnerability low: about two-thirds of general government debt at fixed interest rates; foreign-currency-denominated debt about 10 percent of GDP at end–2005.
- Including second pension pillar costs, deficit estimates: 4¼ percent of GDP (2006), 3 percent of GDP (2007), 2¾ percent of GDP (2008) under authorities’ projections.

### Monetary policy, inflation targets, and risks
- NBS inflation targets for 2006–08: below 2½ percent for end-2006; below 2 percent thereafter.
- Baseline conditions assumed: some nominal koruna appreciation, gradual fall in oil-price contribution, retail competition, negative output gap, wage moderation.
- Main threats: higher oil and regulated energy prices; NBS acknowledged end-2006 target likely to be breached narrowly due to January 2006 regulated utility price increases.
- Staff projection: inflation about 2½ percent in 2007.
- NBS monitoring priorities: bank credit to private sector; inflation excluding fuel and energy; wages. NBS readiness to raise rates if second-round effects materialize.

### Financial sector soundness and supervision
- Banking system indicators (selected):
  - Nonperforming loans to gross loans: 2.0 (2005).
  - Regulatory capital to risk-weighted assets: 15.9 (2005).
  - Return on assets (after tax): 0.9 (2005).
- Credit developments: bank credit to private sector accelerated in 2005; household consumer and housing loans grew strongly; housing loans accounted for three-fifths of new household loans.
- Funding: slow resident deposit growth and increased channeling to mutual funds led banks to fund lending largely via foreign financing from parent banks.
- Supervisory actions: unified supervision of entire financial sector in January 2006; new reporting forms; six-monthly bank lending surveys; preparations for Basel II planned for January 2007; need to strengthen pension fund oversight and anti-money laundering measures.

### Structural reforms, labor market, and employment policies
- Employment picked up but unemployment remains high, especially long-term and in eastern regions.
- Initiatives: November 2005 adoption of new regional criteria for investment incentives; scheme to improve start-up SME access to capital (partly EU-funded); consideration of an earned income tax credit for low-income workers from 2007.
- Staff recommendations: expand enterprise-level wage bargaining, improve targeting of active labor market programs, reduce bureaucracy in licenses and permits, and speed up contract enforcement.

### Staff appraisal and main policy conclusions
- With ERM2 entry accomplished, priority is smooth transition to euro adoption and competitiveness in the monetary union.
- Major challenge: reduce inflation without undermining exchange rate stability and competitiveness.
- Fiscal policy should support disinflation and provide buffer for automatic stabilizers; tighter fiscal stance than in the 2006–08 budget framework is necessary:
  - Avoid pro-cyclical stimulus in 2006.
  - Aim for significant withdrawal of stimulus in 2007.
  - Save anticipated revenue over-performance and undertake durable expenditure restraint across all government levels.
- NBS should guard against upside inflation risks and ensure exchange rate developments align with fundamentals; better communication on regulated price adjustments recommended.

*Source: IMF staff Executive Summary (as provided).*

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

### Executive Summary

### Background and recent performance
- Real GDP growth accelerated to 6 percent in 2005, driven by an improvement in the contribution of net foreign demand while domestic demand growth maintained momentum.
- The external current account deficit doubled to about 7¼ percent of GDP in 2005, owing to a deterioration in the terms of trade and higher reinvested earnings on foreign investment.
- External competitiveness remains satisfactory.
- Inflation (HICP) declined to 3.9 percent at end-2005.
- The fiscal deficit fell to an estimated 3.1 percent of GDP in 2005 (ESA-95 basis).
- Slovakia entered ERM2 on November 28, 2005.
- Parliamentary elections are scheduled for June 2006.

### Outlook (staff projections and authorities’ expectations)
- Economic growth supported by strong exports is projected to reach 6¾ percent in 2007.
- The current account deficit is projected to narrow to about 5 percent of GDP over the medium-term.
- Continued positive investor sentiment together with Balassa-Samuelson effects are likely to result in some appreciation of the koruna.
- The NBS expects inflation to fall to 2¾ percent 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, but the implied fiscal stance is expansionary in 2006 and broadly neutral in 2007.

### Policy discussions — major findings and recommendations

- Euro adoption
  - Finding: Slovakia is well poised to adopt the euro, planned for January 2009, but challenges lie ahead.
  - Recommendation: Further efforts are required to strengthen fiscal policy and enhance structural flexibility. Policies should focus on meeting the Maastricht criteria quickly to avoid a prolonged stay in ERM2.
  - Key trade-off: A major challenge will be to bring down inflation without undermining exchange rate stability and competitiveness.

- Monetary and exchange rate policy
  - Finding: In January 2005 the NBS adopted a hybrid framework of “inflation targeting under ERM2 conditions” and announced explicit end-year inflation targets for 2005–08.
  - Finding: The NBS intervened in foreign exchange markets in 2005 facing portfolio inflows and appreciation pressures, and lowered its policy rate in end-February by 100 basis points to 3 percent.
  - Finding: Upon ERM2 entry the central parity was set at Sk 38.455 per euro; the koruna strengthened to nearly 3 percent above the central parity by January 2006.
  - Staff concerns and recommendation:
    - Staff were concerned that the scope for sustained real appreciation was small.
    - Staff stressed the importance of ensuring appreciation under ERM2 was not excessive to avoid eroding competitiveness and producing an overly strong conversion rate.
  - Authorities’ view:
    - NBS officials were less concerned than staff about disinflation risks and believed Slovakia had some cushion on competitiveness.
    - They were ready to increase interest rates at the first signs of second-round effects from higher energy prices and of demand and wage pressures (as demonstrated by the increase in the NBS’s key policy interest rate in end-February 2006).

- Fiscal policy
  - Finding: The fiscal outturn in 2005 was better than envisaged in the budget and implied a substantial withdrawal of stimulus (1 percent of GDP).
  - 2005 general government deficit (ESA-95 basis) estimated at 3.1 percent of GDP, compared with 3.4 percent envisaged in the budget and an outturn of 4 percent in 2004.
  - Revenue performance: Collections in most tax categories surpassed expectations; non-tax revenue was boosted by higher dividend payout by a telecom firm; interest payments came in lower than expected; receipts from the EU budget amounted to only 60 percent of envisaged level.
  - Recommendation: Greater priority needs to be put on tightening fiscal policy to support disinflation and contain koruna appreciation.
  - Staff advised avoiding a pro-cyclical stimulus in 2006 and aiming for a significant withdrawal of stimulus in 2007.
  - Authorities’ stance: Agreed to safeguard anticipated revenue over-performance and recognized benefits of more durable expenditure restraint but indicated additional measures would not be forthcoming ahead of the parliamentary elections; they would be considered by the newly elected government during preparation of the 2007–09 budget.

- Wage policy
  - Finding: Real wage growth accelerated to about 6½ percent in 2005, from 2½ percent in 2004.
  - Finding: Real wage increase in the nontradable sector exceeded productivity gains for the first time in many years; real wage increase in the tradable sector fell short of productivity gains but by a narrower margin than in previous two years.
  - Recommendation: Authorities are encouraging social partners to adopt forward-looking wage adjustment to inflation. Public sector wage restraint can be a useful signaling mechanism for wage moderation.
  - Staff suggested slower minimum wage increases and greater enterprise-level wage bargaining to help moderate wage growth and enhance wage flexibility.

- Banking sector and other structural issues
  - Finding: The banking system is healthy.
  - Risk: Increased exposure of banks to credit risk arising from rapid household credit growth calls for vigilance.
  - Developments: The NBS unified supervision of the entire financial sector in January 2006 and has initiated steps to strengthen oversight.
  - Finding: Bank credit to the private sector accelerated in 2005; households saw strong growth in consumer loans, housing loans accounted for three-fifths of new loans to households; share of foreign currency credit in total credit increased to about 21 percent (2005).
  - Funding: With slow growth in resident deposits and increased channeling of household saving to mutual funds, banks largely funded lending through foreign financing from parent banks.

### Key statistics and indicators (selected exact figures from the text)
- Real GDP growth: 6 percent (2005); staff projection 6¾ percent (2007).
- Current account deficit: about 7¼ percent of GDP (2005); projected about 5 percent of GDP (medium-term).
- Inflation (HICP): 3.9 percent at end-2005; NBS expects 2¾ percent at end-2006; target below 2 percent at end-2007.
- Fiscal deficit (general government, ESA-95): 3.1 percent of GDP (2005); envisaged 3.4 percent (2005 budget); outturn 4 percent (2004).
- Withdrawal of fiscal stimulus in 2005: 1 percent of GDP.
- NBS policy interest rate: lowered by 100 basis points to 3 percent (end-February 2005).
- ERM2 central parity: Sk 38.455 per euro.
- Koruna appreciation: nearly 3 percent above the central parity by January 2006.
- Real wage growth: about 6½ percent in 2005 (from 2½ percent in 2004).
- Unemployment rate: declined by 2 percentage points to about 15½ percent in September 2005; Bratislava about 5¼ percent; eastern regions around 22–24 percent.
- Share of foreign currency loans in total bank credit: about 21 percent (2005).
- Receipts from EU budget in 2005: 60 percent of envisaged level.
- General government deficit target in 2006–08 budget framework: about 1¼ percent of GDP by end of framework.

*Source: IMF staff Executive Summary (as provided).*

### 9.      Competitiveness remains satisfactory. The CPI-based and unit labor cost (ULC)-

### 9.      Competitiveness remains satisfactory. The CPI-based and unit labor cost (ULC)-based real effective exchange rates (REER) appreciated further in 2005, but the relative profitability index remained close to the reference level of 1998

### Competitiveness and exchange rate
- CPI-based and unit labor cost (ULC)-based real effective exchange rates (REER) appreciated further in 2005.
- The relative profitability index remained close to the reference level of 1998.
- A staff study suggests the koruna was undervalued by about 25 percent during 1997–2002, with the amount of undervaluation starting to decline steadily from 2003 and expected to disappear in 2005.
- Slovakia’s market share in the EU-15 countries has increased rapidly and outpaced that of neighboring new EU-member states.
- Drivers of continued export market penetration:
  - Market linkages created by large inflows of foreign direct investment (FDI).
  - Scheduled commencement of production in many large FDI-supported projects.
- While the exchange rate is close to its estimated equilibrium and export performance is very strong, competitiveness requires close monitoring because Slovakia’s bilateral real exchange rate and relative profitability index vis-à-vis neighboring new EU-member states have deteriorated.

*Sources cited in text: Nienke Oomes, “Maintaining Competitiveness Under Equilibrium Real Appreciation: The Case of Slovakia,” IMF Working Paper No. 05/65, March 2005.*

### External debt, reserves, and vulnerability
- Total external debt:
  - Increased to about 56 percent of GDP at end-2005, from 54 percent of GDP at end-2004.
  - Net debt position was only 2 percent of GDP.
- Foreign debt exposure of the public and non-bank corporate sectors declined in 2005.
- Bank foreign debt:
  - About ninety percent of banks’ foreign debt was short-term.
  - Consequently, short-term debt (remaining-maturity basis) exceeded the level of gross official reserves at end-2005.
- Reserve coverage comparisons (selected indicators, 2001–05):
  - Slovakia — Reserves/Short-term debt in original maturity (percent): 136.3 (2001), 217.0 (2002), 156.1 (2003), 142.7 (2004), 114.7 (2005).
  - Slovakia — Reserves/Short-term debt in remaining maturity (percent): 95.2 (2001), 132.1 (2002), 108.4 (2003), 104.4 (2004), 93.6 (2005).
  - Slovakia — Reserves in months of imports of goods and services: 3.0 (2001), 5.9 (2002), 5.7 (2003), 5.5 (2004), 4.9 (2005).
- Comparative note: Slovakia’s reserve coverage of short-term debt was smaller than that of neighboring new EU-member states and the gap widened during the past year. However, Slovakia’s reserve coverage of imports was about 5 months equivalent, ahead of the others.
- Slovakia’s external debt service ratio remained unchanged at 12 percent in 2005.
- Financial structure note: Unlike in some other new EU-member states, foreign currency–denominated loans to households are negligible in Slovakia.
- Banking ownership: The Slovak banking system is largely under foreign ownership.

### Growth and external outlook (staff projections and risks)
- Staff projections for Real GDP growth:
  - About 6¼ percent in 2006.
  - 6¾ percent in 2007.
  - 5¾ percent in 2008.
  - These are about 1 percentage point and ½ percentage point, respectively, above the budget projections for 2006 and 2007.
- Export volume growth projection:
  - 14 percent in 2006.
  - 21½ percent in 2007.
  - About 8¾ percent in 2008.
- Growth drivers: commencement of production at two new automobile plants in 2006 and 2007 and associated export pickup.
- Domestic demand: expected to remain important but its contribution may weaken slightly.
- Wages and consumption:
  - Pace of real wage increase was somewhat exceptional in 2005 due to backward-looking indexation when average inflation was falling sharply; real wage growth is expected to slow.
  - Assuming a stable household saving propensity, private consumption growth is projected to moderate somewhat.
- Investment: some easing of investment growth anticipated with completion of several FDI-financed projects.
- Authorities agreed projections but noted upside risks:
  - Household saving propensity might continue to decline.
  - Real wage increases could be higher than assumed.
- Main downside risks: higher oil prices and a deteriorating external environment.
- Output gap views:
  - Staff and Ministry of Finance estimates show the output gap turning positive around 2006–07.
  - NBS estimates show the output gap remaining negative in the next few years, narrowing only in 2008.
- External current account and debt outlook:
  - External current account deficit projected to narrow progressively to about 5 percent of GDP in 2008.
  - With strong prospects and sovereign rating upgrades, large financial account surpluses are likely.
  - External debt ratio projected to decline over the medium-term to below 50 percent of GDP under the baseline.
- Adverse scenario for external debt (stress tests — external debt-to-GDP ratio, in percent):
  - Baseline scenario: 56.2 (2005), 56.5 (2006), 55.5 (2007), 54.2 (2008), 51.4 (2009), 48.1 (2010).
  - 1. Nominal interest rate at historical average (4.9 percent) plus two standard deviations in 2006 and 2007: 56.2, 57.7, 57.8, 56.3, 53.4, 50.0.
  - 2. Real GDP growth at historical average (4.3 percent) minus two standard deviations in 2006 and 2007: 56.2, 59.2, 60.9, 59.1, 55.8, 52.1.
  - 3. Change in euro GDP deflator at historical average (3.7 percent) minus two standard deviations in 2006 and 2007: 56.2, 61.5, 65.0, 62.9, 59.2, 55.1.
  - 4. Non-interest current account deficit at historical average (3.5 percent of GDP) minus two standard deviations in 2006 and 2007: 56.2, 63.6, 70.2, 68.0, 64.3, 60.2.
  - 5. Combination of 1–4 using one standard deviation shocks: 56.2, 65.3, 73.7, 71.7, 67.9, 63.6.
  - 6. One time 30 percent nominal depreciation in 2006: 56.2, 78.6, 75.8, 72.8, 68.0, 63.0.
- Under severe adverse conditions (combination of shocks or large depreciation), external debt-to-GDP ratio could rise temporarily to 70–80 percent and fall to around 63 percent over the medium term.
- Staff assessment: likelihood of a depreciation scenario seems small given anticipated productivity gains and capital inflows likely to produce some nominal and real appreciation of the koruna, with potential for overshooting.
- Authorities’ view: uncertainties around parliamentary elections and regional FX developments could have temporary impact, but ERM2 entry may decouple the koruna somewhat from regional influences.

### Monetary and exchange rate policy
- NBS inflation targets for 2006–08 considered ambitious by NBS officials; targets:
  - Below 2½ percent for end-2006.
  - Below 2 percent thereafter.
- Targets influenced by uncertainty about the reference rate for the Maastricht inflation criterion.
- Baseline inflation projection assumptions:
  - Some nominal appreciation of the koruna.
  - Gradual fall in the contribution of oil prices to inflation.
  - Continued influence of retail competition.
  - Output gap remaining negative.
  - Wage moderation.
  - New monetary framework expected to anchor inflation expectations.
- Main threats to achieving inflation targets: higher prices of oil and regulated energy items.
- NBS acknowledgement: end-2006 inflation target likely to be breached by a narrow margin due to higher-than-expected increases in regulated utility prices in January 2006.
- NBS expectation: risk of second-round effects small; efforts to change wage bargaining basis from backward-looking to forward-looking.
- Staff projection: inflation remaining at about 2½ percent in 2007—within the projected reference rate for the Maastricht criterion—and subject to evenly balanced risks.
- Staff concerns:
  - Uncertainties about lowering inflation further to end-2007 target.
  - Structural influences from catching-up process and upside risks.
  - Rising ULC in the non-tradable sector is a risk for inflationary pressures, especially if wage growth in tradable and non-tradable sectors stays the same while tradable-sector productivity grows faster.
  - Historical strong correlation between ULC in the non-tradable sector and prices of market services.
  - Declining economic slack is an additional risk.
- NBS monitoring priorities: bank credit to the private sector, inflation excluding fuel and energy, and wages; increase interest rates if necessary.
- Policy action noted: With real GDP growth in Q4, 2005 (7.5 percent, year-on-year) and inflation in January 2006 (4.1 percent, year-on-year) turning out higher than expected, on February 28 the NBS increased its key policy interest rate by 50 basis points to 3.5 percent.
- Exchange rate stance:
  - Consensus that choosing central parity equal to the market exchange rate prior to ERM2 entry was appropriate given proximity to real equilibrium exchange rate.
  - NBS has not intervened to counter appreciation of the koruna since ERM2 entry; during the mission NBS signaled support for a stronger koruna, but on January 31, 2006 announced it would no longer comment on exchange rate developments.
  - Staff emphasized avoiding excessive appreciation under ERM2 measured relative to equilibrium real appreciation, since excessive appreciation could harm competitiveness and produce an overly strong conversion rate with serious long-term consequences.
- Authorities’ view:
  - Excessive appreciation should be avoided but Slovakia still had some cushion on competitiveness.
  - Current profit margins in automotive and metal processing industries (accounting for 40 percent of Slovak exports) were substantial.
  - Staff concern: scope for sustained real appreciation is small and appreciation could undermine competitiveness of traditional manufacturing firms and SMEs where productivity gains are lower.
  - ULC (in euros) in manufacturing in Slovakia still lower than in some large euro-area trading partners, but Slovakia’s initial advantage vis-à-vis neighboring new EU-member states had disappeared.

### Fiscal policy
- Staff view: hybrid monetary framework compatible with ERM2 targets only if strong support comes from fiscal policy.
- Staff recommendation: orient fiscal policy toward meeting the Maastricht deficit criterion and toward supporting the disinflation goal while containing koruna appreciation.
- Authorities’ stance:
  - Fiscal policy on track to meet the Maastricht deficit criterion in 2007.
  - The 2006–08 budget framework envisaged the headline general government deficit declining progressively to about 1¼ percent of GDP in 2008.
  - Including the cost of the second pension pillar, the deficit would be:
    - 4¼ percent of GDP in 2006.
    - 3 percent of GDP in 2007.
    - 2¾ percent of GDP in 2008.
  - Fiscal consolidation would rely mainly on expenditure restraint on subsidies and transfers (spread across many categories) and goods and services.

*IMF Article IV staff report content (sections 9–22) from the supplied PDF chapter.*

### 23.      However, the staff observed that

### _cr06119 - 23.      However, the staff observed that

### Fiscal stance and budget framework (2006–08)
- The budget framework implied:
  - an expansionary fiscal stance in 2006,
  - a broadly neutral stance in 2007,
  - a withdrawal of stimulus in 2008.
- Staff observed the budget framework understated revenue prospects because:
  - actual 2005 revenue base was higher for structural reasons,
  - economic growth was anticipated to be stronger.
- Another positive impulse: large increases in net transfers from the EU in 2006 and 2007, assuming full execution.
- Text table excerpts (In percent of GDP):
  - Budget Framework (2005–2008):
    - Total Revenue 37.0 36.9 37.1 36.4
    - Total Expenditure 40.1 39.8 38.8 37.7
    - Headline fiscal balance -3.1 -2.9 -1.6 -1.3
    - Primary fiscal balance 1/ -0.8 -1.3 0.1 0.5
    - Fiscal balance including second pension pillar costs -3.8 -4.2 -3.0 -2.7
    - Cyclically adjusted primary fiscal balance 1/ -0.8 -1.2 -0.1 0.3
    - Net transfers from the EU 0.4 1.3 2.2 2.1
    - Fiscal impulse including the impact of net transfers from the EU 2/ -1.0 1.4 -0.2 -0.5
  - Adjustment Scenario (2005–2008):
    - Total Revenue 37.0 36.1 36.0 35.2
    - Total Expenditure 3/ 40.1 38.1 36.2 35.3
    - Headline fiscal balance -3.1 -2.0 -0.2 -0.1
    - Primary fiscal balance 1/ -0.8 -0.4 1.4 1.6
    - Fiscal balance including second pension pillar costs -3.8 -3.2 -1.6 -1.4
    - Cyclically adjusted primary fiscal balance 1/ -0.8 -0.4 1.2 1.5
    - Net transfers from the EU 4/ 0.4 0.7 1.5 1.4
    - Fiscal impulse including the impact of net transfers from the EU 2/ -1.0 0.0 -0.8 -0.3
  - Memorandum items:
    - Real GDP growth (budget framework) 5.1 5.4 6.1 5.6
    - Real GDP growth (IMF staff projections) 6.0 6.3 6.7 5.7
    - Output gap (in percent of potential GDP) -0.2 0.0 0.6 0.4
- Notes:
  - 1/ The primary balance for 2005 excludes forgiveness of external debt claims on Afghanistan and Sudan.
  - 2/ Change in the cyclically adjusted primary balance plus the change in net transfers.
  - 3/ Assuming a permanent cut, relative to the budget, in subsidies and transfers in 2007.
  - 4/ Execution rate of receipts from EU, EU-earmarked spending, and co-financing is assumed at 75 percent of the budgeted level in 2006 and 2007, and 80 percent in 2008.
  - Receipts from the EU budget generally have a counterpart on the expenditure side—no effect on the fiscal deficit but expansionary impact since receipts do not withdraw resources from the private sector like normal revenue. Payments to the EU budget raise the measured deficit but do not increase domestic demand. An execution rate equivalent to 0.5 percent of GDP is noted.

### Staff recommendations on fiscal policy
- Avoid a pro-cyclical stimulus in 2006 and aim for a significant withdrawal of stimulus in 2007.
- Two-pronged strategy advocated:
  - Safeguarding additional revenues by adhering to the nominal expenditure targets in the budget framework.
  - Durable expenditure saving via:
    - cutting waste,
    - continued restructuring of inefficient sectors (such as the railways),
    - keeping real growth of subsidy expenditures well below the growth of real GDP.

### Authorities' response and implementation constraints
- Authorities acknowledged additional fiscal tightening desirable.
- Agreed to safeguard anticipated revenue over-performance at the central government level (consistent with recent practice).
- Intention to safeguard savings in interest payments considered likely.
- Recognized room for more durable expenditure restraint but indicated additional expenditure-side measures would not be forthcoming ahead of the elections; to be considered by the newly-elected government during preparation of the 2007–09 budget.
- Execution of EU-funded projects likely to fall short of budgeted levels—this would lower the fiscal impulse and reduce need for additional expenditure-side measures.

### Fiscal decentralization and local government fiscal management
- After fiscal decentralization launch in 2005, some 94 percent of personal income tax collections accrue to local governments.
- Fiscal rules for local governments are based on ceilings on their debt stock but do not prevent revenue over-performance from funding additional spending nor ensure automatic fiscal stabilizers operate.
- Authorities planned steps to improve fiscal management at local government level and ensure expenditure control to achieve fiscal consolidation objectives; legal and technical complexities meant no new measures feasible in 2006.
- Efforts continuing to strengthen central government financial management, including diffusion of results-oriented budgeting in all departments.

### Public debt sustainability
- At end–2005, general government debt stood at about 37 percent of GDP.
- Over nine-tenths of the debt is long-term and repayment profile lacks significant bunching.
- Assuming fiscal consolidation per staff recommendation, debt ratio projected to gradually decline to below 30 percent in 2010 (Appendix III).
- Vulnerability to interest rate and exchange rate changes is low: about two-thirds of general government debt at fixed interest rates; foreign currency-denominated debt (mainly in euros) stood at about 10 percent of GDP at end–2005 and projected to remain steady over the medium-term.
- Long-term pressure from ageing population from 2020 onward; authorities intend further pension reform entailing increase in retirement age to 65 years and change in indexation of pensions to only the inflation rate.

### Price policy, regulated prices, and wage issues
- Staff recommended improved policy communication on adjustments in regulated prices; unanticipated increases that lead to overshooting the inflation target could undermine NBS inflation-target anchoring.
- Suggested preparing multi-year plans for regulated price adjustments specifying circumstances allowing deviations.
- Authorities noted regulated prices set on cost-recovery principle; agreed to review scope for efficiency gains and cost savings in regulated sectors.
- Privatization of the largest electricity producer and six largest heating plants expected to contribute to higher efficiency.
- Wage moderation:
  - NBS officials communicated with employers and trade unions to adopt forward-looking adjustment to inflation in wage bargaining.
  - Public sector wage restraint considered useful signaling; authorities would act if inflation outlook warranted and post-election politics allowed.
  - Authorities indicated slower pace of minimum wage increases could be possible with introduction of earned income tax credit for low-income earners (under consideration).
  - Employers saw scope for expanding enterprise-level wage bargaining and productivity-based wage adjustments.

### Financial sector assessment and supervision
- Banking system considered fundamentally sound; banks adequately capitalized and profitable.
- Share of non-performing loans in total loans declined further in 2005.
- NBS not concerned about sizeable negative net open foreign exchange position of banks—much represents contingent liabilities; foreign currency loans and guarantees mainly to exporters or firms with foreign currency revenue.
- NBS stress testing indicated system resilient to increases in non-performing loans, exchange rate changes, and other macro shocks.
- NBS initiatives to strengthen oversight:
  - New reporting forms and six-monthly bank lending surveys,
  - More frequent meetings with banks,
  - Assessing risk management by loan categories during on-site inspections,
  - Regular interaction with home country supervisors,
  - Preparations for Basel II standards planned for January 2007 on track,
  - Publicizing household-sector risks.
- January 2006: NBS unified supervision of the entire financial sector and planned to extend risk-based forward-looking supervision to non-bank financial institutions—task complicated by sector fragmentation.
- Need to strengthen supervisory oversight of rapidly growing pension funds.
- Staff encouraged unified and consistent approach to anti-money laundering and combating financial terrorism as recommended by MONEYVAL examiners.
- Authorities agreed to undertake a FSAP update in 2006 prior to the next Article IV consultation.

### Employment, labor market, and structural reforms
- High unemployment remains a continuing challenge; employment rate increased but further step up needed to catch up with euro area income level.
- Long-term structural unemployment high in central and eastern regions and among low-skill groups.
- Initiatives highlighted by authorities:
  - November 2005 adoption of new criteria for investment incentives to promote investment in high-unemployment regions and high-tech and R&D areas.
  - Scheme under development to improve access to capital for start-up SMEs (partially funded from EU structural funds).
  - Considering introduction of earned income tax credit for low-income workers from 2007 to increase work incentives and slow minimum wage growth.
  - Authorities do not favor targeted cuts in social security contributions due to linkage to benefits and lack of political support.
  - Active labor market policy to focus on better targeting of job-training and increased support for labor mobility.
- Need to reduce bureaucracy in issuance of licenses and permits and speed up enforcement of contracts at courts; World Bank study indicates Slovakia lags other EU countries on contract enforcement.

### Staff appraisal and main policy conclusions
- With ERM2 entry accomplished, focus needed on policies for smooth transition to euro adoption and strong performance in the monetary union.
- Major challenge: bring down inflation without undermining exchange rate stability and competitiveness.
- Upside risks to disinflation from higher energy prices, strong economic growth, and rising unit labor costs in the non-tradable sector.
- Fiscal policy should support disinflation and provide sufficient buffer for automatic stabilizers without breaching the SGP deficit limit.
- A tighter fiscal stance than in the 2006–08 budget framework is necessary:
  - Avoid pro-cyclical stimulus in 2006,
  - Aim for significant withdrawal of stimulus in 2007,
  - Ensure additional fiscal tightening by saving anticipated revenue over-performance and undertaking durable expenditure restraint beyond the budget framework.
  - Participation of all levels of government required; local fiscal management must be consistent with national consolidation strategy.
- NBS should guard against upside inflation risks and ensure exchange rate viability:
  - NBS readiness to increase interest rates at first signs of second-round effects welcomed.
  - Better communication on regulated price adjustments recommended to anchor expectations.
  - Risk of excessive appreciation under ERM2 could harm competitiveness and produce an overly strong conversion rate; ensure real exchange rate developments remain aligned with fundamentals.

*Source: _cr06119 - 23.      However, the staff observed that*

### 37.      Wage moderation would contribute importantly to disinflation and safeguarding

### 37.      Wage moderation would contribute importantly to disinflation and safeguarding

### Wage policy and labor costs
- Wage moderation would contribute importantly to disinflation and safeguarding competitiveness.
- The authorities are encouraging social partners to adopt forward-looking adjustment of wages to inflation.
- They also should aim to influence wage drift by restraining wage increases in the public sector and negotiating a slower pace of minimum wage increase.
- Social partners are encouraged to expand the scope of enterprise-level wage bargaining so as to ensure greater productivity-based wage adjustments and enhance wage flexibility.

### Banking sector: emerging risks and supervisory responses
- While Slovakia’s banking system is generally sound, new challenges call for vigilance.
- Banks are extending credit to households at a rapid pace in a competitive environment and assuming higher credit risk.
- 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 are appropriate.
- The inherent risks in increased foreign financing by banks are mitigated as these represent transactions with parent banks.
- However, the NBS should ensure that these borrowings are based on proper risk analysis by the parent bank and domestic subsidiary, to minimize any vulnerabilities to the banking system.
- Unified supervision of the financial sector will be demanding, given the fragmented nature of the non-bank financial sector.
- NBS’s intention to extend the risk-based supervision approach to non-bank financial institutions is welcome.
- The NBS is encouraged to speedily enhance the supervision of pension funds, which are growing rapidly, and to continue addressing the money laundering risk in all areas of the financial sector.

### Structural reforms and labor market policies
- The momentum behind structural reforms in other areas should be maintained.
- Labor market reforms have contributed to a pick up in the employment rate.
- Nevertheless, the unemployment rate remains very high among the low-skilled and in the less advanced regions.
- The adoption of new rules on investment incentives according to regional criteria and project profile should help attract greater investment in high-unemployment regions and in high value-added projects.
- Considerations being given to improving access to capital for start-up companies and to introducing earned income tax credit for low-income workers, with a view to stimulating job creation and further increasing incentive to work, are welcome.

*Source: _cr06119 - 37.      Wage moderation would contribute importantly to disinflation and safeguarding*

### 40.      It is recommended that the Article IV consultation with Slovakia remain on the

### _cr06119 - 40. It is recommended that the Article IV consultation with Slovakia remain on the standard 12-month cycle.

### Recommendation
- It is recommended that the Article IV consultation with Slovakia remain on the standard 12-month cycle.

### Real sector: growth, output gap, labor, and prices
- Real GDP (annual percent change, staff estimates/projections): 2000: 2.0; 2001: 3.8; 2002: 4.6; 2003: 4.5; 2004: 5.5; 2005: 6.0; 2006: 6.3 (estimate); 2007: 6.7 (proj); 2008: 5.7 (proj).
- Output gap (in percent of potential GDP): 2000: -1.0; 2001: -0.8; 2002: -0.3; 2003: -0.5; 2004: -0.4; 2005: -0.2; 2006: 0.0.
- Gross industrial output (constant prices): 2000: -1.5; 2001: 3.8; 2002: -1.3; 2003: 9.1; 2004: 11.5; 2005: 4.7.
- Consumer prices (HICP) period average: 2000: 14.1; 2001: 7.2; 2002: 3.5; 2003: 8.4; 2004: 7.5; 2005: 2.8; 2006: 3.6 (estimate); 2007: 2.5 (proj); 2008: 2.5 (proj).
- Consumer prices (HICP) end of period: 2000: 8.4; 2001: 6.7; 2002: 3.2; 2003: 9.4; 2004: 5.8; 2005: 3.9; 2006: 2.8 (estimate); 2007: 2.5 (proj); 2008: 2.5 (proj).
- Nominal wages (period average): 2000: 6.4; 2001: 8.3; 2002: 9.3; 2003: 6.3; 2004: 10.2; 2005: 9.3; 2006: 7.4 (estimate).
- Real wages (period average): 2000: -5.0; 2001: 0.9; 2002: 5.8; 2003: -2.1; 2004: 2.5; 2005: 6.6; 2006: 4.0 (estimate).
- Employment (LFS, percent change): 2000: -1.4; 2001: 1.0; 2002: 0.2; 2003: 1.8; 2004: 0.3; 2005: 2.0; 2006: 1.0 (estimate).
- Unemployment rate (annual average, ILO definition): 2000: 18.8; 2001: 19.3; 2002: 18.6; 2003: 17.5; 2004: 18.1; 2005: 16.4; 2006: 15.9 (estimate); 2007: 15.3 (proj); 2008: 14.9 (proj).

### Public finances and fiscal projections
- General government overall balance (ESA-95 basis, percent of GDP): 2000: -12.3; 2001: -6.0; 2002: -7.8; 2003: -3.7; 2004: -4.0; 2005: -3.1; 2006: -2.0; 2007: -0.2; 2008: -0.1.
- Structural general government balance (percent of GDP): 2000: -7.0; 2001: -6.2; 2002: -5.5; 2003: -3.6; 2004: -3.8; 2005: -3.0; 2006: -1.9.
- General government debt (percent of GDP): 2000: 49.9; 2001: 48.7; 2002: 43.8; 2003: 43.1; 2004: 42.6; 2005: 36.8; 2006: 35.8.

Selected fiscal account figures (annual, in local currency units as reported):
- Total revenue: 2005 actual: 468,451; 2006 budget: 521,467; 2006 estimates: 533,290; 2007 budget: 564,520; 2007 staff proj.: 569,690; 2008 budget: 612,225; 2008 staff proj.: 617,752; 2009 budget: 643,665; 2009 staff proj.: 650,366.
- Total expenditure: 2005 actual: 521,045; 2006 budget: 569,072; 2006 estimates: 577,373; 2007 budget: 608,930; 2007 staff proj.: 600,501; 2008 budget: 638,735; 2008 staff proj.: 621,469; 2009 budget: 665,986; 2009 staff proj.: 651,334.
- Net lending/borrowing (+/-): 2005 actual: -52,594; 2006 budget: -47,605; 2006 estimates: -44,083; 2007 budget: -44,410; 2007 staff proj.: -30,810; 2008 budget: -26,510; 2008 staff proj.: -3,717; 2009 budget: -22,321; 2009 staff proj.: -968.
- Primary balance (memorandum): 2005 actual: -30,436; 2006 budget: -19,809; 2006 estimates: -11,978; 2007 budget: -19,316; 2007 staff proj.: -5,716; 2008 budget: 1,000; 2008 staff proj.: 23,793; 2009 budget: 8,377; 2009 staff proj.: 29,730.
- Fiscal deficit including second pension pillar costs (memorandum): 2005 actual: -52,594; 2006: -53,201; 2007: -55,291; 2008: -64,610; 2009: -51,010; 2010: -49,446; 2011 staff proj.: -26,653; 2012 budget: -47,730; 2012 staff proj.: -26,377.

### Money, credit, and interest rates
- Broad money (percent change, period average): 2000: 15.4; 2001: 11.8; 2002: 3.4; 2003: 5.6; 2004: 5.8; 2005: 1.9.
- Credit to enterprises and households (percent change, adjusted for bank restructuring): 2000: 7.8; 2001: 7.5; 2002: 14.8; 2003: 14.8; 2004: 10.9; 2005: 24.7.
- Interest rates (end-of-period): NBS policy rate (two-week repo rate): 2000: 8.00; 2001: 7.75; 2002: 6.50; 2003: 6.00; 2004: 4.00; 2005: 3.00.
- Lending rate (short-term, national methodology, end-of-period): 2000: 10.7; 2001: 8.8; 2002: 7.5; 2003: 7.2; 2004: 7.5; 2005: 6.1.

### External sector, balance of payments, and external debt
- Current account balance (US$ millions): 2000: -700; 2001: -1,756; 2002: -1,939; 2003: -280; 2004: -1,427; 2005: -3,346.
- Current account balance (in percent of GDP): 2000: -3.5; 2001: -8.4; 2002: -8.0; 2003: -0.9; 2004: -3.5; 2005: -7.2.
- Trade balance (US$ millions): 2000: -904; 2001: -2,135; 2002: -2,131; 2003: -641; 2004: -1,456; 2005: -2,387.
- Merchandise exports (US$ millions): 2000: 11,872; 2001: 12,631; 2002: 14,365; 2003: 21,838; 2004: 27,754; 2005: 31,905.
- Merchandise imports (US$ millions): 2000: -12,777; 2001: -14,766; 2002: -16,497; 2003: -22,479; 2004: -29,210; 2005: -34,292.
- Income balance (US$ millions): 2000: -353; 2001: -313; 2002: -456; 2003: -120; 2004: -408; 2005: -1,574.
  - Income receipts: 2000: 269; 2001: 322; 2002: 343; 2003: 908; 2004: 928; 2005: 1,731.
  - Income payments: 2000: -622; 2001: -634; 2002: -800; 2003: -1,028; 2004: -1,336; 2005: -3,305.
  - Of which: Interest (US$ millions): 2000: -187; 2001: -267; 2002: -634; 2003: -536; 2004: -353; 2005: -530.
- Capital and financial account balance (US$ millions): 2000: 1,511; 2001: 1,647; 2002: 5,175; 2003: 1,763; 2004: 3,015; 2005: 5,558.
- Direct foreign investment (US$ millions): 2000: 2,096; 2001: 1,137; 2002: 3,963; 2003: 647; 2004: 1,137; 2005: 1,958.
  - Of which: Privatization receipts (US$ millions): 2000: 1,000; 2001: 699; 2002: 3,352; 2003: 240; 2004: 870.
- Gross official reserves (US$ millions): 2000: 4,077; 2001: 4,189; 2002: 9,196; 2003: 12,149; 2004: 14,912; 2005: 15,480.
  - In months of imports of goods and services: 2000: 3.4; 2001: 3.0; 2002: 5.9; 2003: 5.7; 2004: 5.5; 2005: 4.9.
- Total external debt (US$ millions): 2000: 10,804; 2001: 11,042; 2002: 13,107; 2003: 18,090; 2004: 23,764; 2005: 25,317.
  - External debt (in percent of GDP): 2000: 54.9; 2001: 52.9; 2002: 50.0; 2003: 50.8; 2004: 53.6; 2005: 56.2.
- Short-term external debt (original maturity basis, US$ millions): 2000: 2,415; 2001: 3,073; 2002: 4,237; 2003: 7,782; 2004: 10,448; 2005: 13,497.
  - Short-term external debt (in percent of GDP, original maturity): 2000: 12.3; 2001: 14.7; 2002: 16.2; 2003: 21.9; 2004: 23.5; 2005: 29.9.
- Short-term external debt (remaining maturity basis, US$ millions): 2000: 4,069; 2001: 4,402; 2002: 6,962; 2003: 11,211; 2004: 14,277; 2005: 16,530.
  - Reserves/short-term debt (percent, remaining maturity basis): 2000: 100.2; 2001: 95.2; 2002: 132.1; 2003: 108.4; 2004: 104.4; 2005: 93.6.
- External debt service/Exports of goods and services (percent): 2000: 14.1; 2001: 12.7; 2002: 11.4; 2003: 13.0; 2004: 12.0; 2005: 12.1.

### Competitiveness, wages, productivity, and external indicators (high-level findings from figures and tables)
- Figures and tables document developments in:
  - Real product wages, productivity, and product ULC in manufacturing (indices, 1998q1=100).
  - Relative CPI and ULC vs. trading partners (indices, 1998q1=100).
  - Market share in EU-15 imports (percent and index, 1998=100) for Slovakia and selected New EU-member states through 2005.
  - Wages and productivity by tradable and non-tradable sectors (year-on-year percent changes, 1997–2005).
  - Components of CPI inflation (HICP headline, food prices, regulated prices, gasoline, processed/unprocessed, market services, tradables) for 2000–05.
  - Monetary conditions (nominal interest rates, net inflation, real interest rates, real exchange rate components, Monetary Conditions Index) for 2000–05.
  - Bank credit to private sector (percent of GDP, year-on-year real percent change, share of foreign-currency denominated credit) 2000–Sep-2005.
  - Interest rates on new loans and government bond yields (2004–05).
  - Exchange rate indices and bilateral REER vis-a-vis selected partners (1998–2005).

### Key projections and memorandum items
- Merchandise export volume (percent change): 2000: 15.4; 2001: 6.1; 2002: 5.5; 2003: 28.4; 2004: 13.8; 2005: 10.7.
- Merchandise import volume (percent change): 2000: 12.9; 2001: 11.6; 2002: 5.2; 2003: 14.2; 2004: 16.2; 2005: 10.6.
- Terms of trade (percent change): 2000: 0.6; 2001: -3.2; 2002: 1.5; 2003: -0.8; 2004: -0.1; 2005: -2.2.
- Nominal effective exchange rate (percent change, period average): 2000: 2.3; 2001: -3.5; 2002: -0.6; 2003: 5.4; 2004: 4.0; 2005: 1.6.
- Real effective exchange rate (CPI-based, percent change, period average): 2000: 11.1; 2001: 0.2; 2002: 0.7; 2003: 12.9; 2004: 9.2; 2005: 2.2.
- Real effective exchange rate (ULC-based, percent change, period average): 2000: 7.2; 2001: -3.6; 2002: 10.0; 2003: 8.5; 2004: 5.4; 2005: 6.7.
- Memorandum—GDP (current prices, Sk billions): 2000: 934; 2001: 1,010; 2002: 1,099; 2003: 1,201; 2004: 1,325; 2005: 1,440; 2006: 1,577.

*Sources: Statistical Office of the Slovak Republic; Ministry of Finance; National Bank of Slovakia; World Economic Outlook; Eurostat; and IMF staff estimates and projections.*

### 0.5 percent of GDP.

### _cr06119 - 0.5 percent of GDP.

### Fiscal operations (Consolidated General Government, ESA-95 basis, 2004–08)
- Total revenue: 35.3; 37.1; 37.0; 36.9; 36.1; 37.1; 36.0; 36.4; 35.2
- Tax revenue: 18.0; 17.4; 18.6; 17.6; 18.0; 17.5; 17.7; 17.4; 17.4
  - Personal income tax: 2.8; 2.4; 2.7; 2.6; 2.6; 2.7; 2.7; 2.8; 2.7
  - Wage tax: 2.3; 2.1; 2.4; 2.3; 2.3; 2.3; 2.3; 2.4; 2.4
  - VAT: 7.8; 8.4; 8.6; 7.9; 8.4; 7.9; 8.2; 7.8; 8.0
  - Excises: 3.3; 3.3; 3.5; 3.3; 3.3; 3.3; 3.2; 3.2; 3.1
- Social contributions: 12.8; 13.5; 12.9; 13.2; 12.7; 13.0; 12.6; 12.8; 12.4
- Grants and transfers: 0.7; 2.2; 1.3; 2.3; 1.7; 3.1; 2.4; 3.0; 2.3
  - Of which: from European Union (EU): 0.6; 2.2; 1.3; 2.2; 1.6; 3.1; 2.4; 3.0; 2.3
- Other revenue: 3.8; 4.0; 4.3; 3.9; 3.7; 3.5; 3.4; 3.2; 3.1
  - Of which: interest: 0.6; 0.4; 0.4; 0.3; 0.3; 0.3; 0.2; 0.2; 0.2
- Total expenditure: 39.3; 40.4; 40.1; 39.8; 38.1; 38.8; 36.2; 37.7; 35.3
  - Current expenditure: 35.2; 36.4; 35.6; 35.6; 34.5; 34.8; 32.9; 33.9; 32.1
    - Gross wages: 6.9; 7.0; 7.0; 7.2; 6.9; 6.9; 6.7; 6.8; 6.5
    - Subsidies and transfers: 20.9; 21.7; 21.3; 21.1; 20.5; 20.9; 19.6; 20.4; 19.1
    - Health insurance companies: 4.7; 4.9; 4.6; 4.7; 4.5; 4.7; 4.5; 4.6; 4.4
    - Old-age and disability pensions: 7.5; 7.5; 7.6; 7.6; 7.5; 7.4; 7.3; 7.3; 7.3
  - Interest: 2.2; 2.4; 1.8; 1.9; 1.9; 1.9; 1.8; 1.9; 1.9
  - Capital spending: 4.1; 4.0; 4.5; 4.1; 3.6; 3.9; 3.3; 3.8; 3.2
    - Capital assets: 2.5; 2.6; 2.6; 2.0; 1.9; 1.5; 1.5; 1.3; 1.3
    - Capital transfers: 1.6; 1.4; 1.9; 2.2; 1.7; 2.4; 1.8; 2.4; 1.9
- Net lending/borrowing (+/-): -4.0; -3.4; -3.1; -2.9; -2.0; -1.6; -0.2; -1.3; -0.1
  - Of which: primary balance: -2.3; -1.4; -0.8; -1.3; -0.4; 0.1; 1.4; 0.5; 1.6
- Public debt: 42.6; ...; 36.8; ...; 35.8; ...; 32.9; ...; 31.8

Memoranda:
- Second pension pillar costs: 0.0; 0.4; 0.8; 1.3; 1.3; 1.4; 1.3; 1.4; 1.4
- Fiscal deficit including second pension pillar costs: -4.0; -3.8; -3.8; -4.2; -3.2; -3.0; -1.6; -2.7; -1.4
- Cyclically adjusted primary fiscal balance: -2.2; -1.4; -0.8; -1.2; -0.4; -0.1; 1.2; 0.3; 1.5
- Net transfers from the EU: 0.0; 1.3; 0.4; 1.3; 0.7; 2.2; 1.5; 2.1; 1.4
- Fiscal impulse including the impact of net transfers from the EU: 0.4; 0.4; -1.0; 1.4; 0.0; -0.2; -0.8; -0.5; -0.3

Notes and assumptions:
- Staff projections assume that receipts from EU budget and execution of EU-earmarked spending and co-financing will be 75 percent of the budgeted level in 2006 and 2007, and 80 percent in 2008.
- Staff projections assume a permanent cut, relative to the budget, in expenditure on subsidies and transfers in 2007 equivalent to 0.5 percent of GDP.
- In 2004, includes forgiveness of domestic debt claims on the health sector falling due, equivalent to 0.8 percent of GDP. In 2005, the estimated outturn includes forgiveness of external debt claims on Afghanistan and Sudan, equivalent to 0.8 percent of GDP, not envisaged in the budget.
- In 2005, excludes forgiveness of external debt claims on Afghanistan and Sudan, equivalent to 0.8 percent of GDP, not envisaged in the budget.
- Fiscal impulse definition: Change in cyclically adjusted primary balance plus the change in net transfers from the EU.

### Monetary survey (End of period, in billions of koruny, 2000–2005)
- Net foreign assets: 93.2; 92.0; 228.5; 189.5; 169.5; 144.5
  - Assets: 274.1; 291.0; 417.4; 447.9; 484.0; 550.8
  - Liabilities: 180.9; 199.0; 188.9; 258.4; 314.5; 406.3
- Net domestic assets: 514.7; 587.9; 474.4; 553.0; 615.9; 656.6
  - Net credit to government 1/: 199.9; 355.8; 262.5; 306.5; 354.4; 350.0
  - Credit to enterprises and households: 395.4; 320.8; 326.1; 372.6; 401.3; 499.6
    - In domestic currency: 344.9; 267.3; 271.8; 304.0; 318.2; 392.8
    - In foreign currency: 50.5; 53.5; 54.3; 68.6; 83.1; 106.8
  - Other items, net: -80.6; -88.7; -114.2; -126.1; -139.8; -193.0
- Broad Money: 607.9; 679.9; 702.9; 742.5; 785.4; 801.1
  - Koruna broad money: 513.6; 574.8; 596.2; 650.5; 697.5; 712.7
    - Currency: 67.0; 81.0; 84.2; 91.8; 100.5; 114.9
    - Deposits: 446.6; 493.8; 512.0; 558.7; 597.0; 597.8
  - Foreign currency deposits: 94.3; 105.1; 106.7; 92.0; 87.9; 88.4

Memorandum items:
- Broad money (percent change): 15.4; 11.8; 3.4; 5.6; 5.8; 4.5
- Koruna broad money (percent change): 14.0; 11.9; 3.7; 9.1; 7.2; 6.8
- M2/GDP (percent): 65.1; 67.3; 64.0; 61.8; 59.3; 55.7
- Net credit to government (in percent of GDP): 21.4; 35.2; 23.9; 25.5; 26.7; 24.3
- Credit to private sector (in percent of GDP): 42.3; 31.8; 32.9; 31.0; 30.3; 34.7
  - In domestic currency: 36.9; 26.5; 28.0; 25.3; 24.0; 27.3
  - In foreign currency: 5.4; 5.3; 4.9; 5.7; 6.3; 7.4
- Credit to private sector (percent change) 2/: 7.4; 7.1; 14.3; 14.3; 7.7; 24.2
- Credit to enterprises (percent change) 2/: 5.0; 4.9; 13.4; 8.5; -1.0; 16.9
- Credit to households (percent change): 22.0; 18.5; 18.1; 38.8; 37.1; 42.7
- Share of foreign currency loans in credit to enterprises (percent): 22.7; 22.9; 20.5; 23.8; 29.1; 31.2

Sources: National Bank of Slovakia; and IMF staff estimates. 1/ Includes accumulated interest payments on restructuring bonds. 2/ Adjusted for bank restructuring and reclassification of loans.

### Financial and external indicators (selected)
- Public sector debt (Dec): 49.9; 48.7; 43.8; 43.1; 42.6; 36.8
- Broad money (percent change, 12-month basis, Dec): 15.4; 11.8; 3.4; 5.6; 5.8; 1.9 (Dec latest)
- Private sector credit (percent change, 12-month basis, Nov): 7.8; 7.5; 14.8; 14.8; 10.9; 24.2 (Nov latest)
  - Credit to households (percent change, 12-month basis): 22.0; 18.5; 18.1; 38.8; 37.1; 42.7 (Nov latest)
- BRIBOR (six months, end-of-period, in percent) Nominal: 7.8; 7.7; 5.7; 5.7; 3.5; 3.2 (Dec)
  - Real: -0.5; 1.0; 2.4; -3.4; -2.2; -0.6 (Dec)
- Merchandise exports (percent change, 12-month basis in US$) Dec: 16.1; 6.4; 13.7; 52.0; 27.1; 15.0
- Merchandise imports (percent change, 12-month basis in US$) Dec: 12.9; 15.6; 11.7; 36.3; 29.9; 17.4
- Current account balance (Jan-Sep): -3.5; -8.4; -8.0; -0.9; -3.5; -4.6
- Gross official reserves (in US$ billions) Dec: 4.1; 4.2; 9.2; 12.1; 14.9; 15.5
- Net international reserves (NIR) (in US$ billions) Dec: 3.8; 3.9; 8.8; 11.1; 14.8; 15.3
- Total external debt (Sep): 54.9; 52.9; 50.0; 50.8; 53.6; 59.1
  - Of which: public sector debt: 17.2; 16.5; 14.3; 14.8; 15.5; 14.5
- Total external debt to exports of goods and services (percent) Sep: 76.5; 73.0; 76.4; 72.0; 75.3; 71.5
- Total external debt service payments to exports of goods and services (percent) Jan-Dec: 13.2; 12.7; 11.4; 13.0; 12.0; 12.1

Notes:
- BRIBOR = Bratislava Interbank Offering Rate.
- Data sources: Data provided by the Slovak authorities; and IMF staff estimates.

### Vulnerability indicators and balance of payments medium-term projections (2004–10, staff projections)
- Current account balance (in percent of GDP): -3.5; -7.2; -6.4; -5.5; -4.9; -3.9; -3.2
- Trade balance (in percent of GDP): -3.5; -5.1; -4.8; -3.9; -3.3; -2.6; -1.8
- Exports, f.o.b. (levels): 27,754; 31,905; 36,602; 44,293; 47,941; 52,222; 57,010
- Imports, f.o.b. (levels): -29,210; -34,292; -39,038; -46,540; -50,060; -54,038; -58,453
- Services balance: 268; 445; 452; 443; 469; 492; 510
  - Receipts: 3,725; 4,244; 4,506; 4,865; 5,131; 5,388; 5,657
  - Payments: -3,458; -3,798; -4,054; -4,422; -4,662; -4,896; -5,147
- Income balance: -408; -1,574; -1,697; -1,777; -1,913; -1,935; -2,071
  - Receipts: 928; 1,731; 1,953; 2,136; 2,375; 2,644; 2,973
  - Payments: -1,336; -3,305; -3,650; -3,913; -4,287; -4,579; -5,044
- Capital and financial account balance: 3,015; 5,558; 6,508; 6,550; 5,779; 5,012; 4,965
  - Direct foreign investment: 1,137; 1,958; 3,417; 2,816; 2,266; 2,453; 2,663
- Gross reserves (US$ million) projections: 14,912; 15,480; 18,750; 22,148; 24,819; 27,038; 29,468
  - In months of imports of goods and services: 5.5; 4.9; 5.2; 5.2; 5.4; 5.5; 5.6
- Total external debt (in percent of GDP): 53.6; 56.2; 56.5; 55.5; 54.2; 51.4; 48.1
- Short-term external debt (remaining maturity basis, percent of GDP): 32.2; 36.7; 38.3; 38.6; 37.4; 35.3; 32.7
- Reserves/short-term debt (percent, remaining maturity basis): 104.4; 93.6; 95.9; 100.1; 103.9; 108.1; 114.2
- External debt service/Exports of goods and services (percent): 12.0; 12.2; 9.3; 7.2; 7.1; 6.3; 6.0

Sources: National Bank of Slovakia; and IMF staff estimates.

### Banking sector soundness indicators (2001–05, end of period)
- Capital adequacy
  - Regulatory capital to risk-weighted assets: 19.6; 21.3; 22.4; 18.6; 20.4; 15.9
  - Regulatory Tier 1 capital to risk-weighted assets: 15.9; 18.5; 21.6; 18.9; 20.5; 16.4
  - Capital to assets: 7.1; 7.7; 8.9; 7.7; 8.1; 7.2
- Asset quality
  - Nonperforming loans to gross loans: 11.1; 7.9; 3.7; 2.6; 2.8; 2.0
  - Nonperforming loans net of provisions to capital 1/: 12.7; 6.0; 4.2; 3.1; 3.5; 5.6
- Earnings and profitability
  - Return on assets (after tax): 1.0; 1.2; 1.2; 1.2; 1.0; 0.9
  - Return on equity (after tax): 16.3; 13.9; 12.5; 14.1; 11.5; 12.4
- Liquidity
  - Liquid assets to total assets 2/: 21.7; 28.9; 16.8; 13.3; 14.0; 15.4
  - Liquid assets to short-term liabilities 2/: 61.5; 81.3; 55.9; 40.3; 40.3; 43.0
- Foreign exchange risk
  - Net open position in foreign exchange to capital: -41.0; -77.0; -53.0; -40.0; -47.0; -30.0
  - Foreign currency-denominated loans to total loans: 17.2; 17.1; 20.7; 22.8; 23.5; 24.8
  - Foreign currency-denominated liabilities to total liabilities: 17.3; 15.6; 19.0; 19.3; 17.7; 24.0

Memorandum items:
- Ownership of banking sector (percent of equity capital): Foreign 56.3; 83.2; 88.1; 88.9; ...; 88.8
- Share of the three largest banks in total assets of banking sector: 54.5; 55.5; 54.0; 53.0; ...; 49.0

Sources: National Bank of Slovakia.

Notes:
- Nonperforming loans are defined as loans that are 90 days or more past due.
- Liquid assets include cash, sight deposits in other banks, T-bills and NBS bills.

### Fund relations, exchange rate, and technical assistance (as of February 27, 2006)
- Membership: Joined: 01/01/1993; Article VIII
- Quota: 357.50 (100.00 percent)
  - Fund Holdings of Currency: 357.50 (100.00 percent)
  - Reserve Position: 0.00 (0.00 percent)
- SDR holdings: 0.90 (N/A)
- Outstanding purchases and loans: None
- Stand-by arrangement: Approval Date 07/22/1994; Expiration Date 03/21/1996; Amount Approved 115.80 (SDR Million); Amount Drawn 32.15 (SDR Million)
- Exchange rate arrangement
  - Currency: Slovak koruna (Sk)
  - Joined ERM2 on November 28, 2005 at central parity Sk 38.455 per euro.
  - Exchange rate stood at Sk 37.270 per euro on February 27, 2006.
  - Regime classified as pegged exchange rate within horizontal band.
  - Slovak Republic aims to adopt the euro in January 2009.
- Article IV Consultation: Last consultation concluded on February 11, 2005 (IMF Country Report No. 05/71).
- FSAP and ROSCs: FSAP concluded with completion of the 2002 Article IV consultation on August 7, 2002. FSSA report published (IMF Country Report No. 02/198). Fiscal ROSC issued August 2002 (IMF Country Report No. 02/189) with updates August 2003 (IMF Country Report No. 03/236) and March 2005 (IMF Country Report No. 05/73). Data ROSC issued May 2005 (IMF Country Report No. 05/161).
- Technical assistance (2000–2005) by department and timing (selected):
  - MFD: February 2000 mission on inflation targeting framework; December 2001 long-term resident expert on banking supervision; May 2002 two missions on inflation modeling.
  - FAD: April 2000 tax administration; February 2001 tax administration follow-up; April 2001 Public Finance Management; August 2001 LTU establishment and August 2001–August 2002 resident expert; December 2001 tax administration follow-up; June 2002 ROSC Fiscal Transparency; February 2003 tax policy; March 2003 tax administration; May 2003 expenditure policy.
  - STA: February 2000 national accounts and price statistics; March 2001 multisector mission; July 2003 government finance statistics; February–March 2004 Data ROSC Mission.
- Resident Representative Post: None (closed at end-April 2004).

### Statistical issues and data quality
- Coverage, periodicity, and timeliness of data provided to the Fund are adequate for surveillance purposes.
- Recent significant improvements in national accounts; Data ROSC mission (Feb–Mar 2004) found integrity, methodological soundness, and reliability satisfactory despite shortcomings in data revision policy.
- Remaining main issues:
  - Weaknesses in data on prices and volumes of imports and exports.
  - Lack of timely data on general government operations.
  - Slow compilation cycle of annual national accounts and lack of proper benchmarking of quarterly data.
- Dissemination and timeliness:
  - Slovakia subscribes to the Special Data Dissemination Standard (SDDS) since 1996 and observes or exceeds all related standards.
  - Authorities follow a free and open data publication policy; data released promptly to news services and published regularly.
  - Typical data release lags reported:
    - Foreign exchange reserves: a week or less
    - Monthly state budget implementation data: a day
    - Consumer prices, reserve money, broad money, 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 fully reconciling the balance of payments with the national accounts, monetary, and government finance statistics.

*Source: IMF staff estimates and projections and data provided by Slovak authorities as presented in the source PDF.*

### 3. Significant progress has been made in the elaboration of the national accounts

### 3. Significant progress has been made in the elaboration of the national accounts

### National accounts: coverage, weaknesses, and outstanding issues
- Significant progress has been made in the elaboration of the national accounts statistics.
- Output estimates for the last few years may yet have to be revised in the future.
- Quarterly national accounts data on expenditures exhibit weaknesses and there is a significant statistical discrepancy between the supply side and the demand side.
- An important outstanding issue is the compilation of reliable price deflators for imports and exports to enable better decomposition into volume and price changes.
- The unit value trade price indices—on which the national accounts trade price deflators are based—are published with long delays and are not appropriately adjusted for quality changes; improvements are pending.
- Following the fast development of chain stores, which are not fully captured in surveys, the authorities consider that retail sales and the level of consumption might be underestimated (especially if compared to VAT receipts), and wage statistics might be biased.
- In the enterprise sector, it would be very useful if the line ministries produced systematic accounts of the financial positions of the public enterprises under their purview.

### Fiscal sector: compilation and systems
- General government statistics are compiled annually in accordance with the methodology of the ESA95, and disseminated on the Ministry of Finance (MOF) website.
- In accordance with the EU acquis communautaire, the authorities report semi-annually on general government net lending/borrowing on ESA95 basis.
- Monthly reconciliation of government operations above and below-the-line is restricted to state budget transactions on a cash basis.
- A modern treasury system has been operating since January 2004; the new system has improved fiscal control and public debt management by allowing the recording of expenditures at the planning and commitment stages.
- The MOF has converted its fiscal accounts to ESA95 standards.
- The MOF compiles Government Finance Statistics according to the Government Finance Statistics Manual 2001 (GFSM 2001) analytical framework; data are available and disseminated on a cash basis for 2000–02, and on an accrual basis for 2003.

### External sector: reporting, revisions, and remaining problems
- The Slovak Republic provides monthly balance of payments in a timely manner.
- Balance of payment statements are presented in two formats: an analytical presentation and the standard presentation.
- Banks are now reporting their arbitrage transactions accurately.
- Improvements made in reporting nonresidents’ claims and liabilities in domestic currency.
- The balance of payments is compiled and disseminated quarterly on a cumulative basis during the year; however, dissemination on a cumulative basis does not follow best practice.
- Weekly reports of information on gross international reserves are timely.
- The NBS revised in 2002 its methodology for reporting foreign exchange reserves in line with IMF guidelines and STA technical recommendations to: include the valuation of gold at market prices and to change the reporting of repo operations and gold swaps.
- The reporting of foreign exchange reserves by commercial banks has been revised to include selected long-term assets in the item “foreign exchange reserves.”
- Remaining problem areas include:
  - (i) the measurement of inward portfolio investment;
  - (ii) the need for more detailed and timely information on publicly guaranteed external debt;
  - (iii) more timely reporting of information on external debt, including short-term debt;
  - (iv) the recording of most interest payments on a cash basis; and
  - (v) the need to improve data compilation on the composition of exports.

### Monetary sector: quality, alignment, and exceptions
- Monetary statistics are of good quality, and are reported on a timely basis to the Fund.
- 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.
- Exceptions identified:
  - In the NMS, government’s foreign liabilities had been treated as part of NBS foreign liabilities with a counterpart adjustment in NBS claims on the government; the authorities changed this treatment to exclude government foreign liabilities from NBS foreign liabilities in response to the mission’s comments.
  - Money market funds were excluded from the NMS, but the authorities recently started including these funds as a memorandum item in the NMS.
  - Market valuation is not applied to certain financial instruments under both the NMS and HMS.

### Data dissemination and periodicity (selected indicators and dates)
- Exchange Rates: latest observation 02.02.2006; date received 02.02.2006; Frequency of Data D; Frequency of Reporting D; Frequency of Publication D.
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities: latest observation 31.12.2005; date received 31.01.2006; Frequency M, Reporting M, Publication M.
- Reserve/Base Money: latest observation 31.12.2005; date received 31.01.2006; Frequency M, Reporting M, Publication M.
- Broad Money: latest observation 31.12.2005; date received 31.01.2006; Frequency M, Reporting M, Publication M.
- Central Bank Balance Sheet: latest observation 10.01.2006; date received 24.01.2006; Frequency of Data 10 Day; Frequency of Reporting 10 Day; Frequency of Publication 10 Day.
- Consolidated Balance Sheet of the Banking System: latest observation 31.12.2005; date received 31.01.2006; Frequency M, Reporting M, Publication M.
- Interest Rates: latest observation 1/2006; date received 02.02.2006; Frequency M, Reporting M, Publication M.
- Consumer Price Index: latest observation 1/2006; date received 2/2006; Frequency M, Reporting M, Publication M.
- Revenue, Expenditure, Balance and Composition of Financing – General Government: latest observation 31.12.2004; date received 25.03.2005; Frequency A, Reporting A, Publication A.
- Revenue, Expenditure, Balance and Composition of Financing – Central Government: latest observation 31.01.2006; date received 02.02.2006; Frequency M, Reporting M, Publication M.
- Stocks of Central Government and Central Government-Guaranteed Debt: latest observation 30.09.2005; date received 15.11.2005; Frequency Q, Reporting Q, Publication Q.
- External Current Account Balance: latest observation 11/2005; date received 31.01.2006; Frequency M, Reporting M, Publication M.
- Exports and Imports of Goods and Services: latest observation 11/2005; date received 31.01.2006; Frequency M, Reporting M, Publication M.
- GDP/GNP: latest observation Q3/2005; date received 8.12.2005; Frequency Q, Reporting Q, Publication Q.
- Gross External Debt: latest observation 10/2005; date received 31.01.2006; Frequency M, Reporting M, Publication M.

### Debt sustainability: external and fiscal assessments and stress-test results
- External Sustainability:
  - Stress testing suggests external debt sustainability is not seriously at risk, although the external debt ratio surges temporarily under a sizable depreciation of the currency or a significant current account balance deterioration.
  - Staff’s baseline scenario assumes rising exports, driven by automobile production, and strong FDI inflows throughout the period.
  - Under the baseline, the external debt stock falls to 48 percent of GDP due to a gradual improvement in current account balance.
  - Dynamics of external debt ratio are resilient to shocks to nominal interest rate, real GDP growth, and terms-of-trade as the debt ratio falls to the range of 50-55 percent by 2010.
  - A combination of these shocks together with worsening of the overall external environment and one-time 30 percent nominal depreciation in 2006 raise the external debt ratio temporarily to the range of 70-79 percent in 2006-07.
  - Even under these adverse conditions, the debt ratio starts declining in 2007-08 and falls to the range of 60-63 percent by 2010.
- Fiscal Sustainability:
  - Stress testing suggests fiscal sustainability is not at risk over the medium-term.
  - Staff’s baseline scenario assumes forceful fiscal consolidation efforts throughout the period and completion of privatization by 2007.
  - Under the baseline, the public debt ratio steadily falls to about 29 percent by 2010.
  - Dynamics of public debt ratio are resilient to shocks to nominal interest rate, economic growth, and primary balance as the debt ratio remains below 40 percent throughout the period.
  - Under a no policy change scenario, the debt ratio starts increasing marginally after the completion of privatization in 2007, but it remains below 40 percent throughout the period.
  - One-time 30 percent real depreciation and 10 percent of GDP shock to contingent liabilities in 2006 raise the debt ratio temporarily to the range of 42-47 percent in 2006.

*Source: _cr06119 - 3. Significant progress has been made in the elaboration of the national accounts (IMF PDF).*

### 2006. However, even under these adverse conditions, the debt ratio starts declining in 2007

### 2006. However, even under these adverse conditions, the debt ratio starts declining in 2007

### Debt trajectory and stress-test findings
- Under the baseline, the debt ratio starts declining in 2007 and falls to below 40 percent by 2009, well below the Maastricht public debt ratio ceiling of 60 percent.
- Figure-based scenario summaries (Slovak Republic: Debt Ratio and Gross External Financing Need, 2004-10):
  - Debt-to-GDP Ratio (in percent) plotted for 2004–2010 with series:
    - Baseline
    - Alternative scenario 1/ (Reduction in real GDP growth to 4 percent throughout the projection period)
    - Second most extreme stress test 2/ (Combination of shocks to nominal interest rate, real GDP growth, current account, and the exchange rate)
    - Most extreme stress test 3/ (A depreciation of 30 percent in 2006)
  - Gross External Financing Need (in billions of euros) plotted for 2004–2010 with series:
    - Baseline
    - Second most extreme stress test 4/ (Non-interest current account at historical average minus two standard deviations in 2006 and 2007)
    - Most extreme stress test 5/ (Key variables at their historical averages)

### External debt sustainability metrics and identified drivers (Table 1 excerpts)
- External debt (in percent of GDP):
  - 2000: 54.9
  - 2001: 52.9
  - 2002: 50.0
  - 2003: 50.8
  - 2004: 53.6
  - 2005: 56.2
  - 2006: 56.5
  - 2007: 55.5
  - 2008: 54.2
  - 2009: 51.4
  - 2010: 48.1
- Change in external debt:
  - 2000: 0.6
  - 2001: -2.0
  - 2002: -2.9
  - 2003: 0.8
  - 2004: 2.7
  - 2005: 2.6
  - 2006: 0.4
  - 2007: -1.0
  - 2008: -1.3
  - 2009: -2.8
  - 2010: -3.3
- Identified external debt-creating flows (4+8+9):
  - 2000: -13.3
  - 2001: -1.3
  - 2002: -13.3
  - 2003: -6.7
  - 2004: -5.3
  - 2005: -2.8
  - 2006: -6.6
  - 2007: -5.4
  - 2008: -4.0
  - 2009: -4.7
  - 2010: -5.2
- Components (selected):
  - Current account deficit, excluding interest payments:
    - 2000: 0.8; 2001: 6.0; 2002: 5.5; 2003: -1.2; 2004: 2.1; 2005: 5.3; 2006: 4.5; 2007: 3.5; 2008: 2.9; 2009: 2.4; 2010: 1.6
  - Net nondebt creating capital inflows (negative):
    - 2000: -10.1; 2001: -6.3; 2002: -16.3; 2003: -2.1; 2004: -2.5; 2005: -4.2; 2006: -6.9; 2007: -5.0; 2008: -3.6; 2009: -3.5; 2010: -3.5
  - Automatic debt dynamics 1/:
    - 2000: -4.1; 2001: -1.0; 2002: -2.4; 2003: -3.3; 2004: -4.8; 2005: -3.9; 2006: -4.3; 2007: -3.9; 2008: -3.2; 2009: -3.5; 2010: -3.3
  - Contribution from nominal interest rate:
    - 2000: 2.6; 2001: 2.4; 2002: 2.5; 2003: 2.1; 2004: 1.4; 2005: 1.9; 2006: 2.0; 2007: 2.1; 2008: 2.1; 2009: 1.7; 2010: 1.7
  - Contribution from real GDP growth:
    - 2000: -1.0; 2001: -2.0; 2002: -2.2; 2003: -2.0; 2004: -2.4; 2005: -2.9; 2006: -3.2; 2007: -3.4; 2008: -2.8; 2009: -2.4; 2010: -2.4
  - Contribution from price and exchange rate changes 2/:
    - 2000: -5.8; 2001: -1.4; 2002: -2.7; 2003: -3.4; 2004: -3.8; 2005: -2.9; 2006: -3.1; 2007: -2.6; 2008: -2.5; 2009: -2.8; 2010: -2.6
- External debt-to-exports ratio (in percent):
  - 2000: 78.8; 2001: 73.0; 2002: 70.9; 2003: 66.2; 2004: 70.0; 2005: 72.0; 2006: 68.5; 2007: 63.2; 2008: 63.6; 2009: 61.8; 2010: 59.2
- Gross external financing need (in billions of euros) 3/:
  - 2000: 5.5; 2001: 6.5; 2002: 6.9; 2003: 7.7; 2004: 11.9; 2005: 18.2; 2006: 23.5; 2007: 27.8; 2008: 31.5; 2009: 34.0; 2010: 35.2
- Gross external financing need (in percent of GDP):
  - 2000: 24.9; 2001: 28.0; 2002: 26.8; 2003: 26.6; 2004: 36.0; 2005: 48.9

### Bound tests and scenario outcomes (Figure 2 and table B)
- Bound tests apply permanent one-half standard deviation shocks individually and present average projections.
- Selected scenarios (public debt, percent of GDP) under A (alternative) and B (bound tests):
  - A1. Key variables at historical averages in 2006–10:
    - Public sector debt series (selected): 56.2; 60.1; 61.2; 60.6; 59.1; 57.8; Debt-stabilizing non-interest current account: -6.9
  - A2. Reduction in real GDP growth (relative to baseline; real GDP growth drops to 4 percent throughout 2006–10):
    - Public sector debt series (selected): 56.2; 57.8; 58.2; 57.8; 55.3; 52.4; Debt-stabilizing non-interest current account: -6.6
  - B1–B6 (individual and combined shocks):
    - B1 (nominal interest rate at historical average plus two standard deviations in 2006 and 2007): Public sector debt series include 56.2; 57.7; 57.8; 56.3; 53.4; 50.0; Debt-stabilizing non-interest current account: -6.7
    - B2 (real GDP growth at historical average minus two standard deviations in 2006 and 2007): 56.2; 59.2; 60.9; 59.1; 55.8; 52.1; Debt-stabilizing non-interest current account: -7.2
    - B3 (change in euro GDP deflator at historical average minus two standard deviations in 2006 and 2007): 56.2; 61.5; 65.0; 62.9; 59.2; 55.1; Debt-stabilizing non-interest current account: -7.8
    - B4 (non-interest current account at historical average minus two standard deviations in 2006 and 2007): 56.2; 63.6; 70.2; 68.0; 64.3; 60.2; Debt-stabilizing non-interest current account: -7.3
    - B5 (combination of B1–B4 using one standard deviation shocks): 56.2; 65.3; 73.7; 71.7; 67.9; 63.6; Debt-stabilizing non-interest current account: -8.2
    - B6 (one-time 30 percent nominal depreciation in 2006): 56.2; 78.6; 75.8; 72.8; 68.0; 63.0; Debt-stabilizing non-interest current account: -9.2

### Public sector debt sustainability (Table 2 excerpts)
- Baseline: Public sector debt (in percent of GDP):
  - 2000: 49.9
  - 2001: 49.4
  - 2002: 43.8
  - 2003: 43.1
  - 2004: 42.6
  - 2005: 36.8
  - 2006: 35.8
  - 2007: 32.9
  - 2008: 31.8
  - 2009: 30.1
  - 2010: 28.8
- Change in public sector debt:
  - 2000: 2.7; 2001: -0.5; 2002: -5.5; 2003: -0.7; 2004: -0.6; 2005: -5.7; 2006: -1.0; 2007: -2.9; 2008: -1.1; 2009: -1.7; 2010: -1.3
- Identified debt-creating flows (4+7+12):
  - 2000: 1.7; 2001: 13.1; 2002: -15.7; 2003: -2.8; 2004: -1.8; 2005: 1.0; 2006: -3.0; 2007: -3.2; 2008: -1.2; 2009: -1.8; 2010: -2.2
- Primary deficit (percent of GDP):
  - 2000: 4.7; 2001: 3.5; 2002: 2.0; 2003: 1.2; 2004: 1.7; 2005: 2.0; 2006: 1.4; 2007: -0.3; 2008: -0.4; 2009: -1.0; 2010: -1.3
- Automatic debt dynamics 3/:
  - 2000: -0.3; 2001: -0.3; 2002: -3.3; 2003: -3.6; 2004: -3.3; 2005: -0.3; 2006: -1.8; 2007: -1.4; 2008: -0.7; 2009: -0.8; 2010: -0.9
- Public sector debt-to-revenue ratio:
  - 2000: 129.1; 2001: 134.5; 2002: 111.7; 2003: 119.4; 2004: 120.4; 2005: 101.6; 2006: 102.8; 2007: 94.8; 2008: 93.9; 2009: 88.0; 2010: 85.5
- Gross financing need (percent of GDP and in billions of U.S. dollars):
  - In percent of GDP:
    - 2000: 16.1; 2001: 15.7; 2002: 14.4; 2003: 14.2; 2004: 15.1; 2005: 12.6; 2006: 11.5; 2007: 9.3; 2008: 8.8; 2009: 7.5; 2010: 6.7
  - In billions of U.S. dollars:
    - 2000: 3.2; 2001: 3.3; 2002: 3.5; 2003: 4.6; 2004: 6.2; 2005: 5.9; 2006: 5.8; 2007: 5.3; 2008: 5.6; 2009: 5.2; 2010: 5.0
- Scenario outcomes:
  - Scenario with key variables at their historical averages 8/: public sector debt series (selected) 36.8; 36.7; 36.0; 36.8; 37.8; 39.7; debt-stabilizing primary balance: -0.9
  - Scenario with no policy change (constant primary balance) in 2005–2010: public sector debt series (selected) 36.8; 35.2; 34.7; 35.8; 37.1; 38.8; debt-stabilizing primary balance: -1.3

### Key macroeconomic and fiscal assumptions underlying the baseline
- Real GDP growth (in percent):
  - Historical and projected series include values: 2.0; 3.8; 4.6; 4.5; 5.5; 6.0; 6.3; 6.7; 5.7; 5.0; 5.2
- Exchange rate appreciation (Euro value of local currency, change in percent):
  - Series includes: 3.5; -1.7; 1.4; 2.9; 3.6; 3.5; -0.5; 4.2; 3.1; 3.1; 3.1; 3.1; 3.1; 3.2
- GDP deflator in euros (change in percent):
  - Series includes: 12.3; 2.4; 5.5; 7.7; 8.4; 6.1; 5.4; 4.7; 6.2; 5.2; 5.1; 5.7; 5.7; 5.6
- Nominal external interest rate (in percent):
  - Series includes: 5.5; 4.6; 5.3; 4.7; 3.2; 4.0; 4.9; 0.7; 4.0; 4.2; 4.2; 3.4; 3.6; 3.9
- Growth of exports (Euro terms, in percent):
  - Series includes: 32.6; 10.5; 7.6; 22.3; 14.0; 14.6; 13.3; 9.9; 19.6; 19.3; 7.6; 8.3; 8.6; 13.0
- Growth of imports (Euro terms, in percent):
  - Series includes: 27.9; 18.7; 6.4; 13.2; 16.4; 16.4; 14.8; 10.8; 19.0; 18.0; 7.0; 7.5; 7.8; 12.6
- Current account balance, excluding interest payments:
  - Series includes: -0.8; -6.0; -5.5; 1.2; -2.1; -5.3; -3.5; 4.0; -4.5; -3.5; -2.9; -2.4; -1.6; -3.4
- Net nondebt creating capital inflows:
  - Series includes: 10.1; 6.3; 16.3; 2.1; 2.5; 4.2; 4.4; 5.2; 6.9; 5.0; 3.6; 3.5; 3.5; 4.5
- Debt-stabilizing non-interest current account definition 6/: Long-run, constant balance that stabilizes the debt ratio assuming key variables remain at their levels of the last projection year.

### IMF Executive Board conclusion and country context (Public Information Notice No. 06/32)
- Date and action:
  - FOR IMMEDIATE RELEASE March 22, 2006
  - IMF Executive Board concluded the 2005 Article IV consultation with the Slovak Republic on March 20, 2006.
- Economic performance in 2005:
  - Real GDP growth accelerated to 6 percent.
  - External current account deficit doubled to 7¼ percent.
  - Real wage growth estimated at about 6½ percent in 2005, up from 2½ percent in 2004.
  - Economy-wide unemployment rate declined by 2 percentage points to about 15½ percent in September 2005.
  - Much of the external deficit was covered by inflows of foreign direct investment; external liabilities increased as banks resorted to external finance.
- Inflation:
  - Statement: "Inflation declined further in 2005." (text continues beyond supplied excerpt)

*Source: IMF staff calculations and Public Information Notice (PIN) No. 06/32, March 22, 2006*

### 1.9 percentage points to 3.9 percent at end-December—at the upper end of the NBS’s target

### 1.9 percentage points to 3.9 percent at end-December—at the upper end of the NBS’s target

### Inflation and monetary policy
- Headline HICP inflation moderated from 5.8 (end of period 2004) to 3.9 percent at end-December, at the upper end of the NBS’s target range of 3–4 percent.
- Disinflation drivers:
  - Koruna appreciation.
  - Increased competition at the retail level following EU membership.
  - Lower increases in regulated utility prices.
- Constraint on disinflation: higher gasoline prices (which are not regulated).
- Monetary framework:
  - In January 2005, NBS adopted “inflation targeting under ERM2 conditions” and announced explicit end-year inflation targets for 2005–08.
  - NBS intervened in the foreign exchange market in both directions on several occasions.
  - Slovakia entered ERM2 on November 28, 2005; central parity set at Sk 38.455 per euro.
  - Koruna appreciated to nearly 3 percent above the central parity in January 2006.
  - Policy interest rate path: cut in February 2005; rate unchanged at 3 percent until February 2006; increased by 50 basis points to 3½ percent in February 2006.
- Expectations and targets:
  - Staff projection: NBS expects inflation to fall to 2¾ at end-2006, and NBS announced a target of below 2 percent for end-2007.
  - Directors considered authorities’ inflation targets for 2006–08 ambitious.

### Fiscal outcomes and recommendations
- 2005 general government deficit estimated at 3.1 percent of GDP, better than envisaged in the budget, implying a substantial withdrawal of stimulus.
- Revenue and spending details:
  - Collections in most tax categories and non-tax revenues surpassed expectations.
  - Interest payments came in lower than expected.
  - Receipts from the EU budget were at 60 percent of the envisaged level, so co-financing of projects was below budgeted amounts.
  - Some gains were partly offset by forgiveness of certain foreign debt claims not envisaged in the budget.
- 2006–08 budget framework envisages general government deficit declining progressively to about 1¼ percent of GDP.
- Directors’ fiscal recommendations:
  - Orient fiscal policy toward meeting the Maastricht deficit criterion and supporting the inflation goal while containing koruna appreciation.
  - Most Directors encouraged a tighter fiscal stance than envisaged in the 2006–08 budget framework.
  - Suggested means: save revenues collected above targeted amounts and durably restrain expenditure beyond budgeted levels.
  - Caution against foregoing EU-funded public investment projects, as these generate long-term convergence gains.
  - Need for continued political commitment, more binding expenditure ceilings, and a stronger fiscal framework for local governments consistent with national consolidation strategy.

### Growth, external sector, and exchange rate outlook
- Staff projection: economic growth to strengthen and reach 6¾ percent in 2007, driven by commencement of production at two new automobile plants in 2006–07 and associated export pickup.
- Current account: projected to narrow progressively to about 5 percent of GDP over the medium-term.
- Exchange rate outlook:
  - Fundamental improvements and continued positive investor sentiment likely to result in some appreciation of the koruna.
  - Directors noted some appreciation could help with disinflation but cautioned that significant appreciation under ERM2 would erode competitiveness and risk an excessively strong conversion rate with serious long-term consequences.
  - Emphasis on maintaining sufficient competitiveness within the monetary union to reduce unemployment over time.

### Executive Board assessment and labor market
- Directors’ overall appraisal:
  - Congratulated authorities for early ERM2 entry and noted sound macroeconomic management and wide-ranging structural reforms.
  - Identified key challenges: reduce still-high unemployment, address wide regional disparities in unemployment, and bring down inflation without undermining exchange rate stability and competitiveness.
- Concerns and risks highlighted:
  - Tight fiscal policy needed to defend ambitious inflation targets could negatively affect the real sector.
  - Risks to inflation include higher energy prices, strong economic growth, and rising unit labor costs in nontradable sector.
- Directors’ monetary and wage guidance:
  - Welcomed NBS readiness to increase key policy rate to counter second-round inflation effects.
  - Urged improved policy communication on adjustments of regulated prices to anchor inflation expectations.
  - Highlighted importance of wage moderation to lower inflation and maintain competitiveness.
  - Recommended authorities encourage social partners to adopt forward-looking wage adjustments and restrain public sector wage increases.
  - Suggested slower pace of minimum wage increases and greater enterprise-level wage bargaining to moderate wage growth and enhance wage flexibility.
- Labor market measures:
  - Noted strong pickup in employment but persistent high unemployment.
  - Welcomed rules on investment incentives by regional criteria and project profile to help reduce regional unemployment.
  - Supported measures to improve access to capital for start-up companies and introduce an earned income tax credit for low-income workers to enhance employment incentives.

### Financial sector and supervision
- Banking system: generally sound, but rapid household credit growth requires vigilance.
- Supervisory measures and recommendations:
  - Commended NBS initiatives to improve data collection, monitor bank risk management more closely, and interact regularly with home supervisors of foreign-owned banks.
  - Welcomed NBS intention to extend risk-based supervision to non-bank financial institutions.
  - Encouraged enhanced supervision of rapidly growing pension funds.
  - Urged continued efforts to tackle money laundering risk across the financial sector.
  - Supported authorities’ request for a Financial Sector Assessment Program (FSAP) update.

### Selected economic and financial indicators (highlights from table)
- Real GDP (period average): 2000: 2.0, 2001: 3.8, 2002: 4.6, 2003: 4.5, 2004: 5.5, 2005 Estimate: 6.0, 2006 Staff Proj.: 6.3
- Output gap (in percent of potential GDP): 2000: -1.0, 2001: -0.8, 2002: -0.3, 2003: -0.5, 2004: -0.4, 2005: -0.2, 2006: 0.0
- Consumer prices (HICP) period average: 2000: 14.1, 2001: 7.2, 2002: 3.5, 2003: 8.4, 2004: 7.5, 2005 Estimate: 2.8, 2006 Staff Proj.: 3.6
- Consumer prices (HICP) end of period: 2000: 8.4, 2001: 6.7, 2002: 3.2, 2003: 9.4, 2004: 5.8, 2005 Estimate: 3.9, 2006 Staff Proj.: 2.8
- Unemployment rate (annual average, ILO definition): 2000: 18.8, 2001: 19.3, 2002: 18.6, 2003: 17.5, 2004: 18.1, 2005 Estimate: 16.4, 2006 Staff Proj.: 15.9
- General government balance (ESA-95 basis, percent of GDP): 2000: -12.3, 2001: -6.0, 2002: -7.8, 2003: -3.7, 2004: -4.0, 2005 Estimate: -3.1, 2006 Staff Proj.: -2.0
- General government debt (percent of GDP): 2000: 49.9, 2001: 48.7, 2002: 43.8, 2003: 43.1, 2004: 42.6, 2005 Estimate: 36.8, 2006 Staff Proj.: 35.8
- NBS policy rate (two-week repo rate, end-of-period): 2000: 8.00, 2001: 7.75, 2002: 6.50, 2003: 6.00, 2004: 4.00, 2005: 3.00
- Merchandise exports (billions of US dollars): 2000: 11.9, 2001: 12.6, 2002: 14.4, 2003: 21.8, 2004: 27.8, 2005 Estimate: 31.9, 2006 Staff Proj.: 36.6
- Merchandise imports (billions of US dollars): 2000: 12.8, 2001: 14.8, 2002: 16.5, 2003: 22.5, 2004: 29.2, 2005 Estimate: -34.3, 2006 Staff Proj.: -39.0
- Current account balance (billions of US dollars): 2000: -0.7, 2001: -1.8, 2002: -1.9, 2003: -0.3, 2004: -1.4, 2005 Estimate: -2.4, 2006 Staff Proj.: -3.2
- Official reserves, end-period (billions of US dollars): 2000: 4.1, 2001: 4.2, 2002: 9.2, 2003: 12.1, 2004: 14.9, 2005 Estimate: 15.5, 2006 Staff Proj.: 18.8
- Gross external debt, end-period (billions of US dollars): 2000: 10.8, 2001: 11.0, 2002: 13.1, 2003: 18.1, 2004: 23.7, 2005 Estimate: 25.3, 2006 Staff Proj.: 28.8
- Slovak koruna per euro (end of period): 2000: 44.0, 2001: 42.8, 2002: 41.7, 2003: 41.2, 2004: 38.8, 2005 Estimate: 37.8

*Source: IMF staff report excerpt for the 2005 Article IV Consultation with the Slovak Republic.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06119.pdf_