Public Information Notice No. 10/129

Public Information Notice: IMF Executive Board Concludes 2010 Article IV Consultation with the Slovak Republic

September 14, 2010

On September 3, 2010, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Slovak Republic.¹

Background

The Slovak economy is quickly recovering from a deep recession caused by the global economic downturn. After contracting sharply in the first quarter of 2009, real gross domestic product (GDP) has grown robustly over the past five quarters, along with the recovery in external demand. It is estimated that real GDP growth will exceed 4 percent in 2010—among the highest in the European Union. Inflation has fallen significantly below the euro area average.

Solid fundamentals and appropriate policies curbed the impact of the external shock. A relatively strong fiscal position with low public debt and modest deficits prior to the downturn, low debt ratios of households and companies, and a sound financial sector with internal market focus limited domestic second-round effects following the substantial external shock. Furthermore, automatic stabilizers and a discretionary fiscal stimulus provided appropriate demand support. Euro area membership helped maintain confidence and facilitated low interest rates.

Nevertheless, the unemployment rate has increased to about 15 percent. Although the continued economic recovery will help bring down conjunctural unemployment, the downturn has worsened long term structural unemployment among low skill workers, particularly in economically-lagging regions.

The general government deficit widened to 7.3 percent of GDP in 2009, and developments in the first half of 2010 indicate a further deterioration. While expenditure continued to grow at pre-crisis rates, revenue declined in tandem with output, and the structural deficit is projected to reach about 7 percent of GDP in 2010. Nevertheless, market confidence has remained broadly intact even during the recent turmoil in peripheral euro area countries, reflecting the still relatively low public debt and expectations that the new government will tackle fiscal deterioration through a credible consolidation

Executive Board Assessment

Executive Directors welcomed the ongoing recovery of the Slovak economy, supported by relatively strong fundamentals, while noting that the outlook is subject to high uncertainty. Directors stressed that the immediate priorities are to restore fiscal sustainability and address the high unemployment, while over the medium term maintaining external competitiveness within the monetary union should be a key objective.

Directors were concerned by the sharp deterioration in the fiscal position, which largely reflects structural weaknesses. They welcomed the authorities’ strong commitment to bring the fiscal deficit down to below the Maastricht norm in 2013 and supported their plan to undertake a front-loaded fiscal adjustment of about 2½ percentage points of GDP in 2011. In view of the robust recovery, a number of Directors encouraged the authorities to use any additional fiscal space this year to pursue their fiscal targets.

Directors agreed that the planned adjustment properly balances the dual objectives of ensuring fiscal sustainability and allowing the recovery to continue. To spread the burden over time and enhance market confidence, they recommended anchoring the 2011 adjustment within a clear medium-term fiscal consolidation strategy. This could be facilitated by adopting a real expenditure growth ceiling consistent with deficit targets and expenditure policy priorities, including reforming health care and pensions. Directors noted that, in addition to containing expenditure, revenue measures, including raising indirect taxes and eliminating exemptions, will also be necessary.

Directors were encouraged by the resilience of the banking sector in the face of the global crisis. They welcomed the supervisory authority’s proactive response to the crisis, and the confirmation by stress test results of the ability of the sector to absorb a variety of severe shocks. Continued close monitoring of banking sector developments, in particular lending to corporate and real estate sectors, will nevertheless remain essential. In light of the large share of foreign ownership in Slovak banks, Directors underscored the importance of enhancing cross-border supervisory coordination.

Directors regretted the increase in long-term unemployment, particularly among low skill workers. They encouraged the authorities to remove structural impediments to employment, including by strengthening higher education and vocational programs and enhancing active labor market policies. Directors welcomed the authorities’ initiative to improve the labor market prospects of low skill workers through a combination of reduced social security contributions and in-job benefits.

Directors noted that external competitiveness has been preserved in recent years, with wages growing in line with productivity and Slovakia’s market share in global exports continuing to expand. They considered, however, that maintaining competitiveness in the monetary union will require sustained structural reforms. In addition to labor market and educational reforms, they encouraged the authorities to enhance the business environment, and strengthen public sector governance, with a special emphasis on public procurement and the absorption of EU funds.