Slovak Republic

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Country assessments

Highlights

• Economic growth is at its weakest since the 2009 recession. The current downturn underlines the Slovak Republic’s continued exposure to international trade shocks for a small set of cyclical industries, and weak domestic demand.
• The Slovak Republic has persisted with a demanding programme of fiscal consolidation, which is driven, in part, by domestic debt limits. This was supported by new tax revenues, including a doubling of the bank levy.
• There have been sizeable divestments by foreign investors in the energy sector. These have been taken over by investors that are partly domestically owned. Also, foreign investment in the health insurance sector is to be transferred into state ownership, which has led to protracted disputes with a number of investors.

Key priorities for 2014

• Private pension funds can provide a stable source of long-term investment finance. Stability in investment conditions for the private pension industry will be crucial for maintaining public confidence in these funds as a vehicle for long-term saving.
• The ongoing process of re-privatisation in the energy sector should be conducted based on high standards of transparency. It is important that all further sales remain open to foreign investors in order to attract much-needed capital and expertise.
• Long-term youth and regional unemployment problems need to be addressed. Recent legislative changes have slightly reduced flexibility in employment contracts, highlighting the urgency for improved and active labour market policies, a long-term programme of vocational training, and reform of the education system.

Macroeconomic performance

Growth has slowed sharply. The Slovak Republic demonstrated one of the most rapid recoveries from the 2008-09 financial crisis of all European Union (EU) countries, fuelled, in particular, by the rapid recovery in exports and related industrial production. However, growth of 4.4 and 3.2 per cent, in 2010 and 2011, respectively, slowed to 2.0 per cent in 2012, and further to 0.8 per cent in annual terms in the first half of 2013. As domestic demand declined by 4.0 per cent in the first half of 2013, net exports have become the sole driver of growth, as was the case in 2012.

The country’s growth continues to depend on a narrow set of export-oriented industries. Export volume growth declined to only 3.5 per cent in annual terms in May 2013, with exports to Germany remaining at nearly 80 per cent of total exports. Nearly all growth in industrial production in 2012 was attributable to the car industry, where capacity was increased in line with earlier plans. Indicators recently compiled by the Organisation for Economic Co-operation and Development demonstrate that the Slovak Republic’s exports exhibit the second-highest degree of integration in global value chains among the 34 members of that organisation. The use of foreign intermediate products in the exports of electrical goods and transport equipment is especially pronounced.

The government is strongly committed to further fiscal consolidation. The new government reduced the deficit to 4.5 per cent of GDP in 2012, improving on earlier commitments to the EU. This was accomplished through a number of tax measures, including an increase in the bank levy, a special tax on highly profitable regulated enterprises, and a lower utilisation of EU funds and associated co-financing by local and central budgets. While the latter measure temporarily lowered the utilisation of EU funds, the ability to use these funds was extended by the European Commission.

The government also allowed a return of funds saved in the private pension system back into the state system. The government’s budget has also benefitted from an earlier reduction in contributions to private pension funds. Entitlements under the state pension system were also reformed, under which the retirement age will be linked to life expectancy, from 2017, which is a crucial measure, given the rapidly ageing workforce. Public debt of 52 per cent of GDP in mid-2013 remains relatively high, compared to 28 per cent in 2008. The transparency of fiscal accounts and medium-term stability are much improved, following the establishment of a fiscal council in late 2012. The government is keen to avoid triggering automatic expenditure reductions, which come into effect under the Fiscal Responsibility Act once certain debt thresholds are crossed.

Major structural reform developments

The government is intent on reviving investment and reversing the decline in fixed capital formation. Efforts to improve fixed capital formation – which dropped by more than 7 per cent in the year to mid-2013 – are proceeding, despite the government’s adherence to the ongoing fiscal consolidation programme and binding debt limits. Amendments to the Investment Law were adopted in June 2013. These aim to reduce administrative procedures and enhance incentives for large projects. The legislation also gives the central government greater powers to intervene in the investment approval process within municipalities. The rapid processing of these amendments – in particular, laws providing for greater powers of the central government to enforce land use for such projects – has been controversial.

The government is also considering a state investment holding, which will be partially funded by EU structural funds. This fund would be leveraged by outside investors, which would enable a large number of commercially structured projects, in particular in the infrastructure sector.

There has been no progress in selling the remaining state stakes in certain public utilities and infrastructure companies. However, the government is in discussions about selling its remaining minority stake in the state-controlled telecommunications company, Slovak Telekom, to the existing foreign investor. Foreign investors in the gas utility (Slovensky Plynarensky Priemysel, or SPP) and electricity utility (Stredoslovenska energetika, or SSE) divested their interests to a holding company that is partially Czech- and partially Slovak-owned, citing lack of profitability in the energy sector. In September 2013 the government announced the purchase of the remaining minority stake in SPP, with the intention of regaining control over domestic energy prices.

Plans for a unitary state health insurance scheme are still being implemented. This scheme is likely to result in the state taking over two private health insurance companies, one of which has initiated arbitration proceedings. The Slovak Republic lost an earlier international arbitration case against that same investor over limitations on profit distributions imposed in 2008. The Slovak government is contesting this ruling in a German court, and has dismissed its bilateral investment agreement with the Netherlands of 1992, as invalid for not conforming to EU law, and for not giving rise to rights for investor-state arbitration. Such international agreements provide crucial protection to foreign investors, in particular in light of the persistent inefficiencies and long delays within the Slovak judiciary.

Amendments to the Labour Law have strengthened workers’ rights. In October 2012 revisions to the Labour Law strengthened the rights of employees, and aligned the status of temporary workers more closely with those of permanent staff. At the same time, the government has been active in developing policy initiatives on inclusion in the labour market, improving workers’ skills and education. Barriers to mobility within the country – for instance, inadequate infrastructure and the lack of a functioning rental market – still militate against a levelling in regional disparities in unemployment.

Credit to the corporate sector began to contract last year. A guarantee scheme, operated by two major banks in the country and the Slovak Guarantee and Development Bank, is designed to reduce interest rates for loans to small and medium-sized enterprises (SMEs). The predominantly foreign-owned banking system remains highly liquid and well capitalised, and seems well-prepared to enter the Single Supervisory Mechanism under the EU’s Banking Union, to which all principal banks in the country would be subject. The regulator continues to enforce limitations on funding and capital transactions with parent banks. The bank levy on balance sheets was doubled in 2012, acting as a further disincentive to lending.

Important changes have been made to the pension system. Measures that came into effect in October 2012 to reduce workers’ contributions to private pension funds have redressed the financial shortfall in the state pension system, underpinning changes to entitlements under the state system. In the five months to January 2013, those insured in the private system were also allowed to opt back into the state system; almost 90,000 workers took up this option. Total assets under management in the industry (approximately 7.7 per cent of GDP) were reduced only marginally, although the vast majority of insured parties did not explicitly confirm their intention to remain in the non-guaranteed funds, and were hence moved into guaranteed funds. For the latter type of funds the guarantee period has been lengthened significantly to 10 years (from the previous six months), which now allows a number of fund managers to seek investment in longer-maturity assets. Given the profound need for further infrastructure investment, these funds could become a crucial source of long-term investment in the Slovak Republic.

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