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Contents | Executive Summary | How to obtain this publication | Additional information
The following OECD assessment and recommendations summarise Chapter 1 of the Economic survey of the Slovak Republic published on 5 April 2007.
Contents
The major policy challenges are sustaining high economic growth and social cohesion…
Slovakia is enjoying sustained high economic growth. Unemployment has fallen considerably, although long-term unemployment remains stubbornly high. The incoming government has made achieving a more equal distribution of income a priority insofar as this can be done without damaging long-term growth prospects. Ensuring that the benefits of high economic growth are more widely distributed is vital for making such growth sustainable. This objective calls for policies that give more priority to poverty alleviation, strengthen employment and remove barriers to competition in product markets. In the long term, improving education outcomes, including by reducing the impact of socio-economic background on outcomes, will be central to sustaining high economic growth and social cohesion.
…and maintaining macroeconomic stability once inside the euro area
The new government, like its predecessor, is committed to euro area entry in January 2009, with Slovakia being on track to satisfy the entry criteria. This raises the challenge of ensuring that policies support economic performance once in the currency union. A problem that could arise in the first years of euro area membership is that adjustment to the decline in real interest rates associated with the elimination of currency risk and adaptation to a rise in steady-state inflation associated with Balassa-Samuelson effects (estimated to be 1 – 1½ % per year in the long run) in a currency union could contribute to a post-entry boom-bust cycle, calling for a counter-cyclical fiscal policy. In the longer term, adjustment to idiosyncratic shocks will have to occur entirely through changes in domestic wages and prices owing to the absence of a floating national currency. Maintaining macroeconomic stability in these circumstances calls for preserving flexibility in labour and product markets.
The economy is dynamic and short-term unemployment is falling rapidly
Broad based economic growth strengthened markedly in 2006 and the output gap is estimated by the authorities to have turned positive in early 2006. They estimate a potential growth rate of about 7½ per cent in 2006-07, boosted by the coming on stream of two new car plants, falling to 5¼ per cent by 2009. Employment growth accelerated to 2.3% in 2006 and, with many Slovaks working abroad, national employment grew even more rapidly (3.9%), driving the unemployment rate down sharply, to 13% in late 2006. However, long-term unemployment remains stuck at around 10% of the labour force. Despite the sharp decline in short-term unemployment, real wage rate growth over 2005-2006 was on average around the labour productivity growth rate (close to 5% per person employed). With economic growth projected to remain around 8% in 2007 and to fall back to trend in 2008, the economy is likely to rise further above potential output.
Slovakia is on track to satisfy the criteria for entry to the euro area in January 2009
Slovakia is well placed to meet the conditions for euro adoption in 2009. HICP inflation fell to 2¼ per cent (year-on-year) in early 2007, supported by falling international energy prices, regulators taking a tougher line on margins (notably for electricity and gas), and exchange rate appreciation. Inflation is likely to fall somewhat through 2007-2008, which would correspond to an average annual inflation rate over April 2007-March 2008 below the Maastricht reference rate, which is estimated by the authorities to be 2.9%.
The government adopted a budget for 2007 based on very cautious assumptions that provides for a 0.8 percentage point of GDP reduction in the general government deficit to 2.9%, satisfying the 3 per cent of GDP Maastricht deficit reference value; the debt criterion is easily respected as government debt was 33% of GDP in 2006. Further budget consolidation is programmed through the remainder of the decade aimed at cutting the structural deficit to 0.9% of GDP in 2010, in compliance with the medium-term objectives for the sustainability of public finances agreed for Slovakia in the revised Stability and Growth Pact (SGP). Commendably, budget consolidation is being achieved primarily through expenditure restraint, which increases the likelihood that consolidation will prove durable. Although no problems have come to light so far, the considerable decentralisation of government responsibilities since 2004 raises the risk of general government consolidation commitments being undermined by poorly co-ordinated debt accumulation of lower levels of government. To guard against this risk, the government should consider introducing a mechanism that allows fiscal policy to be better coordinated across levels of government.
Concerning the other two Maastricht criteria, the long-term interest rate criterion is likely to be met. Long-term interest rates are already comfortably below the reference value (indeed, 10 year government bond rates are only 40 basis points higher than German rates). As regards the exchange rate criterion, the Slovak koruna has participated in ERM2 since November 2005. The exchange rate has remained within the 15% fluctuation bands around the central ERM2 rate, albeit much closer to the upper band than the lower band. In view of significant inflows of foreign direct investment followed by the progressive acceleration of economic growth and substantial appreciation of the estimated equilibrium real exchange rate, it was mutually agreed in March 2007 to revalue the ERM2 central rate for the Slovak koruna against the euro by 8.5 % to SKK 35.4424. This step was well founded and timely. It will support the authorities in maintaining macroeconomic stability.
Fiscal policy may need to be restrictive to counter post-entry overheating
An immediate issue that the authorities may face following entry to the euro area is a temporary boom. Such a boom could be caused by the decline in real interest rates associated with entry to the euro area, as discussed above. Through multiplier and accelerator effects, adjustment to lower rates would be likely to entail some overheating. In addition to increasing the current account deficit, this would tend to increase domestic inflation (especially for assets such as housing), further reducing real interest rates temporarily and hence reinforcing the boom. The ensuing loss of competitiveness would at some time slow the economy to below the trend rate, eventually enabling competitiveness to be restored and the economy to return to trend, though such an adjustment period could prove painful. It would be desirable to take whatever actions are possible to forestall such a boom-bust cycle. Fortunately, the planned fiscal consolidation through to 2010 means that fiscal policy settings will lean against growth in aggregate demand in the lead up to euro area membership. It would be prudent to allow automatic stabilisers to work fully. In the event that the economy nevertheless appears to be overheating, an even stronger counter-cyclical fiscal policy stance would be required.
Convergence in living standards has been slowed by a decline in the employment rate and uneven productivity performance
Sustained high economic growth in recent years is gradually narrowing the gap in living standards between Slovakia and advanced European countries, but there is still a long way to go. GDP per capita (in PPP terms) rose from 44% of the EU15 average in 1998 to 51% in 2005, mainly achieved through rising labour productivity. However, productivity growth was lower in some of the sectors in which it is more difficult to establish competitive market conditions, notably in the utilities and the distribution sectors, although the recent expansion of large retail outlets suggests that productivity growth should improve. Furthermore, labour utilisation detracted from catching up to EU15 living standards, reflecting a growing gap between the employment rate in Slovakia and the EU15 countries. There clearly is considerable scope to support convergence in living standards by increasing the employment rate, especially if the benchmark is taken to be the best performing OECD countries (11 have employment rates over 70% compared with 58% in Slovakia).
Progress in convergence
1. 15 members of the European Union prior to the 2004 enlargement.
2. Based on current purchasing power parities and current prices.
3. Labour resource utilisation is measured as total number of hours worked divided by population.
4. Labour productivity is measured as GDP per hour worked.
Source: OECD Productivity database, Analytical database, National Accounts database, Burniaux and Causa (2007, forthcoming), and OECD calculations.
How to obtain this publication
The Policy Brief (pdf format) can be downloaded. It contains the OECD assessment and recommendations but not all of the charts included on the above pages.
The complete edition of the Economic survey of the Slovak Republic 2007 is available from:
- SourceOECD for subscribing institutions and many libraries
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OLISnet, under "Publication Locator", for government officials with accounts ( subscribe)
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Additional information
For further information please contact the Slovak Republic Desk at the OECD Economics Department at eco.survey@oecd.org. The OECD Secretariat's report was prepared by David Carey and Andres Fuentes under the supervision of Patrick Lenain.
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