Slovak Republic: Staff Concluding Statement of the 2019 Article IV Mission
IMF News, May 17, 2019
Source details
- Canonical URL
- Slovak Republic: Staff Concluding Statement of the 2019 Article IV Mission
Other formats
Bibliographic details
- Published: May 17, 2019
Overview
- Slovakia is described as an economic success story driven by sizable productivity gains from strong integration with global value chains over the past two decades, delivering sustained income convergence toward the EU average.
- As the economic cycle turns and structural shifts reshape the automotive industry—the core engine of Slovakia’s export-led economy—policies should re-energize the growth model by:
- strengthening institutions,
- improving public sector efficiency,
- investing in infrastructure and skills.
- Strong fiscal discipline and vigilant micro- and macroprudential measures are recommended to ensure continued fiscal and financial stability.
Growth outlook and risks
- Recent performance:
- The economy grew briskly over the past five years supported by strong household credit growth, robust labor market dynamics, and new investments in the automotive industry.
- Job creation has been particularly strong, bringing unemployment to its lowest level and pushing up wages in private and public sectors.
- Inflation has risen above 2 percent while competitiveness relative to trading partners has been preserved.
- 2019 projection and medium-term:
- Real GDP growth is projected at 3½ percent for 2019 and is expected to moderate further toward its potential over the medium-term.
- Domestic demand is expected to propel economic activities supported by robust wage and credit growth, albeit at a slower pace than in the recent past.
- Contributions from net exports are projected to improve due to recent capacity expansion in the automotive sector more than compensating weaker external demand.
- Key risks and vulnerabilities:
- Heavy dependence on exports and a concentrated export structure increase sensitivity to global trade tensions and risks of a no-deal Brexit.
- Negative shocks to the export sector could be amplified through ripple effects on domestic firms and consumer confidence.
- A decade of strong credit growth has significantly raised household indebtedness and made banks vulnerable to downturns.
- Sufficient fiscal policy space and financial sector buffers are needed to insure against possible cascading effects from adverse shocks.
Structural policies: tapping into full benefits of global value chains
- Current position and challenges:
- Slovakia is highly integrated into global value chains but remains engaged mostly in assembly of final products.
- Rising automation and shortage of skilled labor risk eroding the country’s comparative advantage.
- The automotive industry is heavily invested in combustion-engine cars and faces medium-term risk from a shift in demand toward electric cars, which may trigger reshoring.
- Policy directions to capture higher-value activities:
- Provide an enabling environment for domestic firms to become suppliers of key intermediate inputs and participate in process and product innovation.
- Government support for skills development and innovation is instrumental.
- Recent policy efforts noted as welcome:
- higher remuneration and pedagogical development for teachers,
- strengthening dual-track vocational training.
- Complementary actions recommended:
- improve quality of tertiary education and align higher education with technical skills needs,
- consolidate the fragmented public research system to improve coordination,
- strengthen linkages between businesses and universities,
- ensure full use of EU funds for R&D.
- Institutions, logistics, and labor force utilization:
- Improve public sector efficiency, regulatory predictability, competitive public procurement, judicial independence, and minimize conflict of interest in public administration.
- Address fast ageing (expected to be among the fastest in the EU) by fully utilizing the domestic labor force.
- Recent measures easing hiring of foreign workers are helpful; further actions needed to counter ageing:
- make schooling mandatory starting at age 5 (legislative proposal welcomed to increase Roma integration),
- adopt active labor market policies to invest in skills and facilitate job placement,
- improve absorption of EU funds,
- expand availability of affordable childcare and pursue more gender-neutral parental leave policies to increase female labor participation and reduce the gender gap.
Fiscal policies: build policy space by safeguarding fiscal discipline and raising efficiency
- Recent fiscal performance:
- Overall fiscal deficit is estimated to have decreased to 0.7 percent of GDP in 2018.
- Public debt level was 49 percent of GDP in 2018, below the lower limit of the national Fiscal Responsibility Act (FRA).
- Earlier pension and health sector reforms delivered spending savings despite notable increases in public sector wages.
- Risks to fiscal space:
- Fiscal space created by recent consolidation may not be sufficient to cushion significant economic downturns.
- Under EU fiscal rules there is flexibility to counter sizable shocks, but fiscal room is more limited under the national FRA; a sizable drop in real GDP growth may trigger pro-cyclical consolidation to stay within FRA limits.
- Recommendations and targets:
- Sustained fiscal consolidation is important to create adequate policy space.
- With growth expected to remain above potential, a balanced budget target is appropriate for 2019 and in the medium term.
- The fiscal deficit is projected to be 0.3 percent of GDP in 2019, requiring additional measures to offset costs of rising public sector wages.
- The mission recommends refraining from expansionary measures beyond what is already budgeted.
- Authorities’ proposal to introduce multi-year expenditure ceilings linked to the long-term debt target is seen as useful; a transparent and parsimonious framework is critical for consistency with the Stability and Growth Pact and the FRA.
- Financing growth-enhancing investment:
- Significant new investments and higher spending on maintenance are needed to expand and improve Slovakia’s infrastructure.
- Realigning and improving education quality and increasing inclusion of disadvantaged groups will require sizable public resources.
- The reversal of earlier pension reforms through the passage of the retirement age cap is expected to increase long-term costs of aging.
- Raise resources for investment through higher revenue and spending efficiency and better absorption of EU funds.
- Continue efforts to raise tax efficiency, including e-filing system and planned adoption of online electronic cashiers.
- Strengthen audit capacity in all core tax areas.
- Ensure ownership and political will to implement spending review reforms to materialize savings, especially in health care.
- Establish a more robust public investment framework, including a consolidated pipeline of appraised projects managed by a central unit to improve project selection and prioritization.
- Strengthen financial and operational oversight of state-owned enterprises (which execute half of the capital budget) and address residual weaknesses in public procurement.
Financial policies: insure against vulnerabilities
- Banking sector status and pressures:
- The banking sector is stable and well-capitalized, but strong competition is eroding profitability, especially in smaller banks.
- A prolonged period of low interest rates and a business model focused on lending in a small market have produced severe competition.
- Competition has been exacerbated by too benign credit risk assessments by banks, regulatory cap on the mortgage refinancing fee, and the strong intermediation role of mortgage brokers.
- Rapid expansion of banks’ mortgage portfolios and strong compression of lending margins are noted as the largest in the EU.
- Smaller banks with weaker asset quality and lower profitability are highly vulnerable to economic downturns.
- Household and housing market vulnerabilities:
- During the last decade, high credit growth has nearly doubled household debt relative to disposable income.
- Compared to EU members, Slovak banks have extended a higher share of mortgages to low-income households.
- While the property market on average remains broadly in line with fundamentals, rapidly rising flat prices in urban areas and an appreciating house prices-to-income ratio may indicate accumulating imbalances and rising vulnerabilities.
- Macroprudential and supervisory measures:
- Proactive macro-prudential measures have moderated credit growth and tightened banks’ credit standards for new lending.
- Authorities have increased the countercyclical capital buffers and supervisory capital requirements to enhance resilience.
- The mission strongly supports these measures and the authorities’ readiness to further raise capital buffers as necessary.
- Continued vigilance is urged for smaller banks given higher vulnerability.
- Given historically low default rates, more forward-looking assessment of credit risks is warranted.
- Allowing the bank levy to expire as scheduled in 2021 should help smaller banks build more capital buffers.
Concluding remarks
- The mission emphasizes the need for policy action to:
- strengthen institutions and governance,
- raise investment in infrastructure and skills,
- preserve fiscal discipline while creating space for growth-enhancing investment,
- maintain vigilant macro- and microprudential policies to safeguard financial stability.
- The mission expressed thanks to the authorities and counterparts for frank and thoughtful discussions and hospitable reception.
Slovak Republic: Staff Concluding Statement of the 2019 Article IV Mission — May 17, 2019