Economy

Economic policy outlook

In May 2008 the European Commission gave Slovakia permission to adopt the euro from January 2009.

In July the EU officially ratified Slovakia´s entry into the euro area.

The government will focus on preserving Slovakia´s external competitiveness, which will include measures to restrain inflationary pressures. The government will strive to limit the growth of regulated prices, and will attempt to curb the pricing power of utilities and retailers.

In contrast with the previous administration, the current government´s overall policy stance is oriented towards greater state intervention in the economy.

• Fiscal policy

The accruals-based consolidated budget deficit, using European System of Accounts (ESA 95) methodology, fell to 2.2% of GDP in 2007, from 3.6% in 2006.

The 2007 outcome was the result of revenue being considerably stronger than expected, and allowed Slovakia to meet the Maastricht criterion of a deficit no greater than 3% of GDP.

The government will probably slightly overshoot its deficit targets of 2% and 1.7% of GDP in 2008 and 2009, respectively, as it strives to fulfil at least some of its promises to increase welfare spending now that permission to adopt the euro has been received.

• Monetary policy

The monetary policy of the National Bank of Slovakia (NBS, the central bank) is based on a framework of targeting inflation, but has occasionally been complicated by exchange-rate management within the EU´s exchange-rate mechanism (ERM2).

From 2009 monetary policy will be managed by the European Central Bank (ECB). The NBS will bring its policy rate, which is currently 4.25%, into line with the ECB´s ahead of euro adoption in 2009.

The Slovak economy has adjusted relatively well to lower interest rates in recent years, although there is a risk that ECB policy will prove too loose, causing the economy to overheat.

The decision by utility companies to leave household prices broadly unchanged in 2007 helped to keep inflation low. However, utility prices are set to rise in 2008, and concerns over high global energy and food prices have led the NBS to raise its inflation projections for 2008-09. From January 2009 the NBS will focus on financial markets and institutions, of which it has been sole supervisor since January 2006.

The NBS will also lobby the government to run a sound fiscal policy, as this will be the main macroeconomic tool to restrain inflationary pressures after euro adoption.

Economic forecast

The forecast is that average GDP growth in Slovakia´s main export markets in the EU will slow in 2008-09, owing to the sharply weaker outlook for the US economy.

It is expected  food, feedstuff and beverage prices to rise markedly further in 2008, owing to drought in important production areas, in the context of surging demand. In 2009 food prices will edge lower as supply recovers.

• Economic growth

Real GDP growth averaged 10.4% in 2007, owing to both strong domestic demand and net exports, but slowed to 8.7% year on year in the first quarter of 2008.

The forecast is that slower domestic demand growth and a smaller contribution from net exports will cause average GDP growth to ease to 7.5% in 2008, and to 5.2% in 2009.

It is expected that private consumption growth will slow compared with 2007, mainly owing to reduced growth in real wages.

Public consumption will grow more quickly than in 2007, as the government increases social spending, while at the same time striving to continue to satisfy the EU´s budget deficit criterion.

Capital spending in 2008 will continue to grow at around the same pace as in 2006-07, as new greenfield and infrastructure projects offset a slowdown in the rate of growth in investment in car assembly plants.

In 2009 fixed investment growth will slow, and will be driven primarily by infrastructure building.

Exports are forecast to rise strongly in 2008-09, as the automotive and electronic goods sectors gain importance.

• Inflation

It is expected  average inflation, as measured by the EU-compatible harmonised index of consumer prices (HICP), to rise to 3.6% in 2008 (compared with our previous forecast of 3.2%), up from 1.9% in 2007, as a result of excise tax and utility price increases, higher global food prices, and buoyant economic activity.

The forecast is that inflation will rise slightly further in 2009, to 3.8%, as Slovakia will no longer be able to rely on a strengthening currency to restrain inflation. Robust economic activity also poses a risk of higher inflation, and the

high energy intensity of the Slovak economy relative to that of its EU partners suggests that it is more vulnerable to soaring global energy prices.

• External sector

The current-account deficit narrowed in 2007, to 5.3% of GDP, from 7% of GDP in 2006, as the trade deficit diminished. However, the balances on the other components of the current account all deteriorated. Additional export capacity will contribute to improving the trade balance, which will further reduce the current-account deficit as a share of GDP in 2008-09. Nevertheless, higher earnings by foreign-owned companies will widen the income deficit further. It is expected  that foreign direct investment (FDI) will cover most of the current-account deficit during the forecast period, with the rest coming from foreign borrowing.

(Source:The Economist Intelligence Unit Limited 2008)