IMF Concludes 2022 Article IV Consultation with Slovak Republic

Washington, DC: The Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation[1]with Slovak Republic on Wednesday, June 29, 2022, and endorsed the staff appraisal without a meeting.

Growth rebounded to 3.0 percent in 2021, but a stronger recovery was impeded by resurgent infection waves and supply chain disruptions. As a result, the shock of the war in Ukraine is hitting Slovakia before it had fully recovered from the pandemic, with output and employment still slightly below pre-crisis levels as of end 2021.

The war in Ukraine will dampen the recovery given Slovakia’s geographical proximity, heavy reliance on energy imports from Russia, and high integration into global value chains. Growth in 2022 is projected to slow to 2.2 percent, with inflation averaging 10 percent in 2022–23. Growth is expected to rebound to 3.5 percent in 2023, supported by large EU funds inflows. Uncertainty is exceptionally high, with key risks tilted to the downside.

Executive Board Assessment[2]

The war in Ukraine has clouded the outlook for the Slovak economy while it was still recovering from the pandemic. The effects of the war are already felt through surging commodity prices, input shortages, subdued confidence, weaker global demand, and heightened energy security risks, given Slovakia’s heavy reliance on Russian energy imports. Slovakia is also feeling acutely the humanitarian toll of the war with more than 440,000 Ukrainian refugees having crossed the Slovak border. Against this backdrop, growth is projected to decline to 2.2 percent in 2022, with inflation averaging close to 10 percent during 2022−23. Uncertainty is exceptionally high. Key risks stem from stronger spillovers from the war, especially disruptions in energy supply, and protracted supply chain breakdowns. Slovakia’s external position in 2021 is assessed to be moderately weaker than fundamentals and desirable policies.

Fiscal policy needs to be flexible and ready to adjust, while avoiding adding to inflationary pressures. The immediate policy priority is to mitigate the economic fallout of the war and minimize the humanitarian crisis. As risks may materialize and new spending priorities emerge, automatic stabilizers should be allowed to operate fully. Also, the budget could be revised to reprioritize spending and accommodate possibly higher spending, such as on refugees, energy security, and targeted support. Targeted and time-bound transfers to vulnerable households could cushion the effect of rising commodity prices. Such transfers provide cost effective relief to those who need it most without adding to inflationary pressures, and are preferable to large, permanent, and less targeted increases in benefits. If needed, the authorities could also consider temporary support to viable companies hit hard by rising commodity prices.

Rebuilding fiscal buffers should begin once the economy is on a solid growth path, to create room for maneuver and accommodate rising ageing-related spending. The 0.5 percent of GDP annual consolidation over 2023−25 envisaged in the stability program appears appropriate as high EU fund inflows would help offset the consolidation’s drag on growth. A credible medium-term consolidation path would require spelling out concrete measures. The significant progress in reducing the VAT gap is welcome and should be sustained. Raising real estate and environmental taxation could yield sizable revenue. On the expenditure side, stepped-up implementation of value for money measures will help realize the saving potential identified in spending reviews.

Recent reforms to the fiscal framework and the pension system could significantly strengthen public finances. The multiyear spending ceilings should strengthen fiscal discipline, while the link between retirement age and life expectancy will improve fiscal sustainability. These reforms could be enshrined in constitutional acts to help prevent their reversal. Some of the other elements of the ongoing fiscal reforms require further consideration. Constraints on the overall tax burden limit the ability of fiscal policy to respond to shocks. The parental bonus would also entail fiscal costs before savings from other elements of the pension reforms are realized.

The banking sector has weathered the pandemic well, but close monitoring, enhanced supervision, and careful calibration of financial sector policies are warranted. Financial sector supervision (including AML/CFT supervision) should continue to closely monitor asset quality, assess risks related to the war and its spillovers and calibrate stress tests accordingly. Adjusting the CCyB may be warranted if there are clear signals that the strong credit cycle continues, but the authorities should stand ready to change course if downside risks materialize. The authorities should continue exploring additional measures to address housing market vulnerabilities, such as capital-based measures on mortgage exposures, including minimum risk weights and targeted use of a sectoral systemic risk buffer. To address specific pockets of vulnerability, such as the rise in mortgages with maturities beyond borrowers’ retirement age, adjusting borrower-based measures would be appropriate.

Ensuring energy security, while also advancing Slovakia’s climate mitigation goals, is a key policy priority. The immediate focus should be on mitigating the effects of a potential Russian gas shut-off through securing alternative energy sources, accelerating inventory buildup, collaborating at the EU level, and contingency planning. The authorities’ plans for higher investment in renewables and improved energy efficiency are welcome and should be accelerated to the extent possible, as they will help simultaneously improve energy security and reduce greenhouse gas emissions. To accelerate the green transition, Slovakia could consider introducing explicit carbon taxation once energy prices have subsided.

Structural reforms and investments to accelerate the green and digital transformation will set the stage for resilient, inclusive, and sustainable growth in a more shock-prone world. These should be coupled with human capital investments, education reforms and effective labor market policies to strengthen labor supply in a rapidly aging society, ease the adjustment to structural changes and ensure the benefits of growth accrue to all. Reforms to improve institutional quality, strengthen governance, and innovation would raise efficiency and productivity and amplify gains from other reforms. Slovakia’s Recovery and Resilience Plan outlines sizable investments and reforms in these areas. Their successful execution would go a long way in raising living standards and lifting the economy’s potential.

Table 1. Slovak Republic: Summary of Economic Indicators, 2020 − 23

2020

2021

2022

2023

Projections

Output/Demand

Real GDP

-4.4

3.0

2.2

3.5

Domestic demand

-5.3

3.6

2.8

2.8

Public consumption

0.9

1.9

3.4

3.8

Private consumption

-1.5

1.4

1.6

0.9

Gross fixed capital formation

-11.6

0.6

8.4

7.3

Exports of goods and services

-7.4

10.2

2.1

4.9

Imports of goods and services

-8.4

11.1

2.8

4.3

Potential Growth

0.8

1.0

1.8

2.2

Output gap

-4.1

-2.2

-1.8

-0.5

Contribution to Growth

Domestic demand

-5.1

3.6

2.9

2.8

Public consumption

0.2

0.4

0.6

0.7

Private consumption

-0.9

0.8

0.9

0.5

Gross fixed capital formation

-2.5

0.1

1.6

1.5

Inventories

-1.9

2.3

-0.3

0.1

Net exports

0.8

-0.5

-0.7

0.7

Prices

Inflation (HICP)

2.0

2.8

10.6

9.8

Inflation (HICP, end of period)

1.6

5.0

11.2

8.0

Core inflation

2.4

3.4

8.0

5.7

GDP deflator

2.4

2.4

7.5

9.9

Employment and Wages

Employment

-1.9

-0.6

1.1

1.3

Unemployment rate (Percent)

6.6

6.8

6.4

6.2

Nominal wages

3.7

6.8

7.5

8.8

Public Finance, General Government

Revenue

39.9

40.7

40.1

40.2

Expenditure

45.3

46.8

45.3

43.4

Overall balance

-5.5

-6.1

-5.2

-3.1

Primary balance

-4.4

-5.2

-4.3

-2.3

Structural balance (Percent of potential GDP)

-1.8

-1.7

-3.4

-2.9

General government debt

59.7

63.1

61.5

56.3

Monetary and Financial Indicators

(Percent)

Credit to private sector (Growth rate)

4.8

7.6

8.9

11.8

Mortgage lending rates 1/

1.1

1.0

Government 10-year bond yield 1/

-0.1

-0.04

Balance of Payments

(Percent of GDP)

Trade balance (goods)

1.1

-0.1

-2.7

-1.4

Current account balance

0.3

-2.0

-4.5

-3.2

Gross external debt

120.5

137.0

133.5

124.7

Saving and Investment Balance

(Percent of GDP)

Gross national savings

19.2

19.4

18.3

20.1

Private sector

21.2

22.3

18.7

18.7

Public sector

-1.9

-2.9

-0.4

1.3

Gross capital formation

18.9

21.4

22.8

23.2

Memo Item

Nominal GDP (Millions of euros)

92,079

97,123

106,746

121,428

Sources: National Authorities; and IMF staff estimates and projections.

1/ Latest data available for 2022 (average).

[1]Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.

[2]Management has determined it meets the established criteria as set out in Board Decision No. 15207 (12/74); (i) there are no acute or significant risks, or general policy issues requiring a Board discussion; (ii) policies or circumstances are unlikely to have significant regional or global impact in the near term; and (iii) the use of Fund resources is not under discussion or anticipated.

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