Slovak Republic: Staff Concluding Statement of the 2017 Article IV Mission
IMF News, February 1, 2017
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- Published: February 1, 2017
Economic performance and outlook
- Slovakia is described as an economic success story: "Twenty years of sustained economic convergence has lifted real incomes to more than 70 percent of the European Union average."
- Economic growth:
- The economy grew by an estimated 3.3 percent last year.
- Growth is expected to remain at 3.3 percent this year.
- In the medium-term, higher investment in the automotive sector is projected to accelerate growth.
- Labor market and inflation:
- Rising employment, low inflation, and rapid household credit growth boosted consumption.
- The economy is operating at close to its full potential; unemployment rate has returned to its pre-crisis level.
- Supply of available, highly-skilled workers nearly exhausted; labor market began to absorb lower-skilled individuals and those coming off long spells of unemployment.
- Tight labor markets pushed up wages even as average productivity growth slowed.
- Investment and EU funds:
- Low absorption of EU funds, reflecting the beginning of the new programming period, dampened investment and imports.
Risks and vulnerabilities
- External and political risks:
- The United Kingdom’s plans to exit the European Union increase uncertainty and could affect Slovakia through slower growth in key trading partners.
- Europe’s political calendar in 2017 (elections in the Netherlands, France, and Germany) adds to uncertainty.
- Strong external fundamentals along with moderate public indebtedness and financing needs provide a cushion against possible external shocks.
- Domestic financial risks:
- Rapid growth of credit to households is a potential domestic risk, particularly if the labor market falters following a negative external shock.
- Long-term challenges:
- Productivity growth has nearly halved since 2008.
- With population aging, a further slowdown in productivity is likely unless countered by structural reforms.
- Regional disparities: gains heavily concentrated in the Bratislava region; underdeveloped infrastructure, lower educational attainment, and low labor mobility have held back the Eastern and Central regions.
- Pension and health care spending is projected to grow by one-third between 2013 and 2060, roughly 4.5 percent of GDP.
- Lower productivity growth and further openings of the Pillar II pension system could further aggravate rising pension expenditures.
Fiscal stance and policy recommendations to create fiscal space
- Recent fiscal developments:
- Overall fiscal balance improved in 2016.
- The headline deficit narrowed to an estimated 2 percent of GDP largely driven by much lower EU funds absorption due to the start of a new programming period.
- 2017–2019 budget and risks:
- The 2017-2019 budget relies on lower capital expenditure, modest revenue measures, and an intention to contain growth in public sector wages and social benefits to reach a balanced budget by 2019.
- The mission notes pressures to increase wages in a tight labor market and demand for higher social spending could undermine the objective.
- Mission recommendations to support fiscal consolidation:
- Spend more effectively:
- Support the authorities’ “value for money” initiative as a first step toward a comprehensive spending review.
- Savings identified through reviews should, at least in part, be used to support consolidation rather than fully reallocated within the same sector.
- Any revenue over-performance should be allocated transparently.
- Enhance tax efficiency:
- Increasing Slovakia’s value-added tax efficiency to the EU average could produce an additional 0.9 percent of GDP in revenues.
- A compliance strategy underpinned by further tax administration reforms would complement recent legal and administrative measures.
- Establishing a well-defined corporate income tax base and targeting compliance efforts on sectors with highest evasion rates would support revenue gains.
- Broaden the tax base:
- Convergence of property and environmental tax collections to EU average levels would entail:
- Basing the property tax on market values instead of surface area;
- Removing the zero-rate applied to inheritance when property is held for more than five years; and
- Increasing environmental taxes.
- These measures could produce added revenues of up to 2 percent of GDP.
- Use of fiscal space:
- These measures will create space to address regional disparities and population aging.
- A comprehensive strategy to reduce regional disparities will require sizable investment in infrastructure and human capital.
- Improving education quality in poorer regions will require stronger commitment and additional resources beyond small-scale initiatives currently supported by EU funds.
- Pension and health sector recommendations:
- Steady implementation of the 2012 pension reforms is imperative; successful implementation is projected to reduce pension expenditures through 2030 before aging dynamics drive expenditures up.
- Additional measures to ease fiscal burden could include:
- Linking social contributions to annual rather than monthly income;
- Indexing pensions awarded upon retirement to inflation and the retirement age to life expectancy more closely.
- Recourse to Pillar II openings should be avoided.
- In health care, advance efforts to centralize procurement and restructure the hospital network to meet evolving needs of an aging population in a cost-effective manner.
- Fiscal Responsibility Act and cash management:
- Any modification to the Fiscal Responsibility Act should be carefully considered.
- To strengthen cash management, modifications to allow government cash balances to be netted out from gross debt can be considered when assessing performance relative to the debt ceiling.
- The introduction of any escape clause for investment spending should be avoided.
- For the 2014-20 EU programming period, focus on identifying priority infrastructure projects that facilitate investment and increased labor mobility in under-developed regions, establish clear selection criteria, and follow competitive procurement.
Financial stability and macroprudential measures
- Banking system indicators:
- The banking system is stable and well capitalized.
- Banks are profitable despite low interest rate environment and regulatory fees.
- Asset quality: non-performing loans at 4.6 percent.
- After five years of double-digit loan growth to households, real estate loans now account for over half of total private sector credit.
- Household indebtedness in Slovakia is now one of the highest in central and eastern Europe.
- Interest rates on over 80 percent of new mortgage loans reset in less than five years.
- Authorities’ actions:
- National Bank of Slovakia (NBS) tightened requirements on loan-to-value (LTV) ratios for new loans and announced a tightening of the debt-service-to-income ratio in 2017.
- NBS increased required capital for other significant institutions by as much as 2 percent and imposed a systemic risk buffer of up to 1 percent in 2017.
- NBS announced that the countercyclical buffer would rise from zero to 0.5 percent on August 1.
- These macro-prudential measures are intended to preserve lending standards and increase capital buffers.
- Additional measures the mission encourages:
- Impose higher risk weights on mortgage loans with LTV ratios over 80 percent or on mortgage loans for investment properties, in line with the latest Basel proposals.
- Further lower the maximum LTV ratio, which is among the highest in the euro area, to reduce average credit risk on new loans.
- Eliminate preferential treatment of capital gains from housing investment to curb demand for real estate investment.
- Lower the bank tax to 0.1 percent as originally planned to relieve pressures on banks’ profitability.
Structural reforms to sustain convergence and productivity
- Productivity and competitiveness:
- Slowing productivity growth poses risks to long-term convergence.
- Slovakia increased its market share within the EU via strong cost competitiveness and early links with German automotive supply chains.
- Sustaining convergence requires reforms to ensure optimal and efficient use of the labor force and a better business environment.
- Labor market policies:
- Current de-emphasis on activation programs in favor of measures to place the long-term unemployed into steady jobs and stimulate on-the-job training are appropriate.
- Efficiency savings from the ongoing expenditure review of labor market policies should help ensure value-for-money.
- To address skills mismatch in the Bratislava region, procedures for granting work permits to foreign workers could be simplified.
- In the long run, vocational training needs strengthening to ensure better skills match.
- Business environment and governance reforms:
- Surveys indicate perceptions of corruption and lack of impartiality in the judiciary negatively affect views of Slovakia’s business climate.
- Recommended actions:
- Improve the efficiency, transparency, and independence of the judicial system.
- Enforce the ban on offering and accepting unethical advantages by government officials in the management of public property.
- Extend mandatory disclosure rules for public companies, government contracts, and government officials to cover local government as well.
IMF Staff Concluding Statement, February 1, 2017.