Etudes économiques par pays

Economic Survey of the Slovak Republic 2009: Key Challenges

 

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The following OECD assessment and recommendations summarise chapter 1 of the Economic Survey of the Slovak Republic published on 9 February 2009.

 

Contents

 

Economic performance has been impressive …

The Slovak Republic enjoyed several years of very strong growth and has made significant progress in catching-up to the income levels of the more advanced economies. In 2006 and 2007, GDP growth was the highest among OECD countries and the unemployment rate fell substantially. Nevertheless, notwithstanding the stellar economic performance at the national level, the benefits of higher growth remain fairly concentrated in those geographical areas where FDI inflows have been strongest, leaving large regional economic dispersions. Mirroring the progress in catch up, the exchange rate has appreciated by around 20% since 2006. Growth has been underpinned by significant structural reforms. The introduction of a flat tax raised the attractiveness of the Slovak Republic as a business location for domestic and foreign investors and, together with welfare reforms, has raised work incentives. On the fiscal side, the pension reform reduced the future fiscal costs of ageing, while raising the short-term deficit of the defined benefit system. However, recent measures will contribute to increasing future fiscal costs.


Following the successful efforts in meeting the Maastricht criteria, the Slovak Republic adopted the euro at the start of 2009. This marks a major achievement and will be beneficial for the country going forward, not least in light of the current global financial crisis. At the same time, structural reform and a strong fiscal policy framework will be needed to fully reap these benefits. This Survey addresses the following main challenges associated with maintaining high trend growth while being a member of the euro area:

  • Increasing the flexibility of labour and product markets in order to improve the potential of the economy to adjust to shocks and facilitate structural change.
  • Ensuring the working of the automatic fiscal stabilizers and the sustainability of public finances in the face of ageing pressures.
  • Reducing distortions in the housing market in order to improve regional mobility and contain risks to financial stability.

… but the global headwinds will slow growth in 2009

The economy is set to enter a rougher period. Growth is projected to slow down significantly although given high potential growth the economy will be significantly stronger than elsewhere in Europe. The euro will partially shelter the economy against disturbances from the currency markets. As a small open economy with strong trade links, the Slovak Republic cannot escape the adverse effects of the global economic downturn. Both inflows of foreign direct investment and exports will suffer as global demand falls, in particular in Western Europe and the neighbouring central and eastern European countries. The economy’s specialisation in car manufacturing, which has contributed to its past high growth, is a downside risk in the current circumstances. There are already signs that the automobile industry will be particularly badly hit by the global slowdown. In addition, the credit crisis will affect the economy directly as the foreign-owned banks are likely to tighten their lending standards given the downturn in the global credit cycle. These developments may end the upswing in house prices, which have almost doubled since 2005.

 

Car manufacturing in the Slovak Republic and international car sales

Source: OECD, National accounts database and Datastream.

 

The main policy challenge is to sustain high trend growth …

Looking beyond this cyclical downturn, sustaining the high trend growth rates of past years is the main policy challenge. Although the gap in GDP per capita relative to the pre-2004-accession EU countries is still around 40%, strong growth has reduced it by about 16 percentage points since 1999, more than in many other central and eastern European economies. This strong performance is mainly due to substantial growth in labour productivity, notably in manufacturing, also helped by significant FDI inflows. In contrast, labour utilisation has not contributed to the catch up since 1999. This reflects a smaller increase in participation rates compared to other countries which more than offset the fall in unemployment and the more favourable demographic development in the Slovak Republic. In addition, the relative number of hours worked per employee declined somewhat.


A key to sustaining rapid catch up will be measures to foster further increases in productivity, notably in service sectors and network industries as well as in public administration. Regarding labour utilisation, the priorities are to raise participation, in particular of women and older workers, and to reduce further the large share of long-term unemployment. Overall, these challenges require more flexibility of both product and labour markets, which should also strengthen the potential of the economy to adjust to shocks. In addition, improving education outcomes is a key determinant of long-term growth prospects, as argued in the previous Survey.

 

… while adjusting to life in the euro area

With euro adoption the economic environment will change substantially. On the one hand, the absence of exchange rate risk lowers transaction costs, leading to more trade integration, and enhances access to the large and liquid euro area financial markets, which will foster financial development. On the other hand, the Slovak Republic will face the same constraints as other members in a monetary union, namely the absence of an independent monetary policy and the lack of exchange rate adjustment. This situation poses macroeconomic policy challenges in the event of asymmetric shocks, such as the global downturn in the automobile industry affecting in particular Slovak car production, or asymmetric economic responses to common shocks.


Being a catch-up country adds to the challenge of euro area membership, above all because income differentials are larger for the Slovak Republic than for any other country that has adopted the euro. Further changes in the economic structure from the industrial sector to services will occur in the course of the convergence process. In addition, experience from other catch-up countries that entered the euro area suggests that financial deepening evolves rapidly, raising risks of asset cycles. Closer financial integration with the euro financial markets will contribute to this, as more cross-border competition in financial services will broaden the supply and likely lower the level of retail interest rates for borrowers. Easier financial conditions are also likely to be induced by a decline in risk premia embedded in real interest rates as exchange rate uncertainty is removed. Furthermore, euro area membership may reduce liquidity premia and possibly also sovereign risk premia.

 

Outstanding loans to the private sector
As a share of GDP

 

1. 2008 data includes data up to August.
Source: ECB.

 

Equilibrium inflation will likely be higher than in the euro area as convergence proceeds. The appreciation of the real exchange rate, which had previously mainly occurred through nominal appreciation, will now show up in higher inflation as the Slovak price level converges towards that of the euro area. In part this is due to the Balassa Samuelson effect, which reflects differences in productivity growth between the traded and the non-traded sectors. The nominal convergence process is likely to continue for several years to come and therefore real interest rates will tend to be lower in the Slovak Republic than the euro area.


Experience from other countries suggests that this catch-up process of rapid increases in income, strong financial development, and relatively higher transitional inflation can lead to overconsumption and overinvestment. This may be due to speculative capital inflows as the real exchange rate appreciates or as households seek to consume presumed future income gains via an increasingly sophisticated financial sector. Policies should strive to ensure, to the degree possible, that the transition takes place smoothly. The best contribution that structural reforms can make in such an environment is to ensure flexibility in product and labour markets. In more flexible markets, prices and wages adjust more quickly to shocks and thus minimize the real output losses. In addition, a strong fiscal policy framework is essential in order to allow for an appropriate cyclical variation of the policy stance.

 

How to obtain this publication

 

The complete edition of the Economic Survey of the Slovak Republic 2009 is available from:

The Policy Brief (pdf format) can be downloaded in English or in Slovak language. It contains the OECD assessment and recommendations.

 

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 Felix Hüfner and Isabell Koske under the supervision of Andreas Wörgötter. Research assistance was provided by Béatrice Guerard.

 

 

 

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