Slovak Republic country assessment

• An education policy focused on addressing skills shortages and efforts to facilitate investment in the country’s eastern regions are needed. Despite a relatively strong recovery since the 2009 recession, there has not been a significant dent in long term unemployment and social exclusion.
• The framework for private pension funds should be made more predictable. European Monetary Union (EMU) membership does not obviate the need to build local sources of funding for longer-term assets, of which pension funds could be a valuable source. While the banking sector remains well capitalised, taxation of the sector could be a risk and should hence be limited to the revenue target announced.
• Private finance of road infrastructure should play a stronger role. While EU structural funds will remain the principal source of such finance, the private sector’s capacity to design and partially complement such funding is as yet under-utilised.

The Slovak Republic has shown a very rapid recovery from the severe 2009 recession. Growth in 2010 stood at over 4 per cent and at 3.3 per cent in 2011, well above the regional average. Growth remains closely correlated with, and hence vulnerable to, the cycle in German industrial production. Exports account for 80 per cent of gross domestic product (GDP) and value added in manufacturing for about 35 per cent of GDP, and this sector is in turn concentrated in a few products, mainly vehicles and electrical equipment. After a brief weakening, indicators for exports and industrial production in early 2012 again showed signs of a surprisingly strong revival, primarily driven by automotive related industrial production, confirming this pattern. However, unemployment rates have increased notably over the last few years, peaking at just under 15 per cent in early 2010 and still at 14 per cent in mid-2012, with youth unemployment at 32 per cent, the highest in the CEB region.

Banks have been comparatively unaffected by problems of its peers elsewhere in the euro area. Capital ratios are generally sound with aggregate non-performing loans (NPLs) at 5.5 per cent of total loans. Prudent funding practices are evident in the very low loan-to-deposit ratio of about 90 per cent. The stock of domestic credit to the private sector remains relatively low (at about 46 per cent of GDP at end-2011), and both corporate and household credit have shown some increases.

The new government has strongly committed itself to further fiscal consolidation. As the budget deficit and public debt had risen sharply following the 2009 recession the previous government already implemented a significant consolidation, reducing the deficit from 7.7 per cent of GDP in 2010 to 4.8 per cent in 2011. Public sector pay cuts and an increase in the VAT rate over the course of 2011 led to a renewed fall in net disposable income. The new government adopted a mixture of further expenditure cuts and a wide-ranging reform of the tax system. Through these new measures the budget balance could reach the EU-mandated target of 3 per cent by 2013. In December 2011 the then outgoing government adopted a Fiscal Responsibility Law under which public debt will be limited and gradually brought down to 50 per cent of GDP. Fiscal performance will now be monitored by an independent fiscal council.

Deficit reduction remains a key guiding principle in the programme of the new government. Strengthened tax collection and administration is a central theme of the government’s efforts in this area. In a significant departure from the long-standing model of a flat personal tax (which has been at 19 per cent since 2004) the new government announced that a second tax band for high earners will be introduced.

The new government announced major revisions to the corporate tax system. The corporate income tax is to be raised from 19 to 23 per cent, and a one-off levy on regulated enterprises (telecommunications, utilities and banks) may be introduced. A bank tax was introduced in 2011 at a relatively high rate of 0.4 per cent of liabilities net of insured deposits and equity, which was particularly burdensome for banks relying on corporate deposits. This tax is to be broadened from 2013 to include retail deposits, though discounting the insurance premium paid to the deposit guarantee fund. The government has also indicated that the tax will be time-bound, and be phased out once a certain revenue target has been reached.

The direction on the outstanding privatisations remains unclear. The previous government’s privatisation programme remained controversial and did not make progress. The new government’s manifesto envisages a review of this programme (which was, in particular, aimed at heating companies).

The government will seek to primarily use EU structural funds to finance infrastructure projects, importantly for the unfinished parts of the highway to the eastern part of the country, though it remains open to the use of public-private partnerships (PPP) schemes, possibly in combination with structural funds.

The banking sector is well regulated, though the central bank announced some prudential tightening in inter-bank exposures. The central bank in January 2012 announced new measures to raise mandatory capital standards, limit dividend payments within a certain range of capital ratios, and enforce a cap on loan-to-deposit ratios. While these prudential measures are not binding on most banks, they have underlined the central bank’s determination to resist any deleveraging pressures through banking linkages to the rest of the euro area.

The regulation of private pension funds has again been revisited. A reduction of the employer contributions into the funds from nine to around four per cent of gross salaries became effective in September 2012. The industry is particularly opposed to the guarantee requirements, which have skewed portfolios into defensive allocations, though some more growth-oriented fund allocations with long-term guarantee requirements may now emerge. The European Commission’s 2012 Ageing Report suggests that over the next 50 years the total population is foreseen to decrease by 6.1 per cent with a parallel drop in the total workforce of almost 30 per cent. As a result of these trends the dependency ratio (population aged 65 and over relative to the workforce 15-64) is expected to increase from 19 to 68 per cent between 2010 and 2060. This will considerably heighten pressure on the sustainability of the public pension system.

Stimulating the knowledge economy remains a key objective for the new government. The new administration will seek to encourage the growth of technology-intensive local enterprises and other SMEs, in particular those focused on job creation in the more remote parts of the country. A strategy for the knowledge economy (‘Minerva 2.0’) was drawn up by the previous government and listed 26 measures in the areas of human resources, support of scientific and innovative research and the reform of the institutional and legal framework. A close collaboration in this area was envisaged between government, educational institutions and business.