Country Report Slovakia
The Slovak economy is expected to grow modestly by roughly 2.5% in 2014. Unfortunately, this does not significantly aid the structurally weak labour market, since unemployment is expected to remain persistently high. Meanwhile, the election of a new president bodes well for the business environment and the checks and balances of the political system.
Strengths (+) and weaknesses (-)
(+) A stable banking sector
Slovakia has a solid banking sector, which has a high average capital adequacy ratio (17% in 2013) and a strong domestic funding base, which supports a manageable loan-to-deposit ratio of 82%.
(+) Eurozone membership
Slovakia benefits from its membership of the eurozone, as the latter supports the institutional framework, expands Slovakia’s export possibilities and increases its attractiveness as a destination of foreign investment. EMU membership also limits exchange rate risks.
(-) Fiscal sustainability is questionable
Over reliance on one-off measures, mainly on the revenue side, raises concern about the durability of fiscal consolidation over the medium term.
(-) Weak labour market
The country’s unemployment rate is persistently high, as long-term unemployment levels are high and recent government policies pose a barrier to job creation.
1. Economic growth improves modestly
Slovakia's GDP growth will strengthen modestly in 2014 to around 2.5% from 0.9% in 2013. GDP rose by 1.5% year on year (yoy) in 4Q13, after four straight quarters of growth below 1% yoy. External demand is likely to remain the largest growth driver in 2014, with new industrial orders jumping 9.2% yoy in January following three straight months of double-digit growth. Domestic demand is also strengthening. After five straight years of weak or negative growth, household consumption appears to be recovering on the back of low inflation, expected at only 0.7% in 2014, and an end to fiscal austerity measures. Construction activity is also beginning to experience a revival, signalling improved prospects for fixed investment after declines in 2012 and 2013. Looking forward, confidence indicators showed strong yoy gains in early 2014, with an especially sharp increase in construction and consumer sentiment. Also, the economic recovery in the euro area will support Slovak economic growth in 2014. Especially encouraging is the fact that the German economy (Germany is a key trading partner) is expected to do relatively well. A downside risk could be the Russia-Ukraine crisis, but this is expected to have a relatively minor impact on growth in 2014, as the two countries combined account for less than 4% of Slovakia’s exports. Still, the Slovak economy could feel the effects if energy prices rise or if the energy supply is interrupted, which is a risk since its gas is supplied by Russia via Ukraine, or if supplies of key raw materials such as iron ore are interrupted.
2. Labour market remains weak
Despite the recovery in economic growth, the labour market remains weak, as unemployment remained persistently high at an average of 14.1% in 2013 and is expected to average 14% in 2014. Furthermore, the latest data of January 2014 show that the number of registered unemployed declined by 8% yoy, which suggests that large numbers of unemployed have given up on looking for a job. One factor that caused the unemployment rate to remain high was the significant slowdown in economic growth during 2013. The introduction of several new government initiatives, in order to boost government revenue, has also played a part, notably the introduction of high payroll levies in January 2013. Recent surveys suggest that some businesses consider this measure a barrier to job creation, as two-thirds of payroll levies are paid by employers and employees pick up the remainder. The high level of long-term unemployment, especially in the 25-30 age group, also plays a role. On average, half of all jobless people have been registered with unemployment offices for over two years, as their skill and education levels are largely insufficient to allow them to quickly find a new job. To lower structural unemployment, labour market policies should be geared towards improving the quality of education in Slovakia, which is very low and results in a poor transition from school to work. Also, the efficiency and scale of the public employment service should be improved. Therefore, even a robust return to economic growth in the near term is unlikely to alleviate problematic labour market conditions.
3. New president, but political stability highly likely
The independent candidate Andrej Kiska has become the new Slovak head of state by defeating runner-up and incumbent Slovak prime minister (PM) Robert Fico, leader of the ruling Direction-Social Democracy Party (SMER-SD) in the presidential elections of 29 March 2014. Kiska’s presidency begins in June. The election of an independent candidate is likely to be a positive development. Firstly, Kiska, as a former entrepreneur, has stated that he will scrutinise legislation affecting Slovakia's business and investment environment and call for improvements in this sphere, mainly regarding administrative red tape. Second, Kiska's presidency is likely to maintain, if not strengthen, the democratic system of checks and balances. A Fico presidency would have provided his SMER-SD with dominance over Slovak political scene and the country's major institutions. SMER-SD already dominates the government, national parliament, and regional administrations; meanwhile, the president appoints top judges and the head of the prosecutor general office, ratifies international treaties, approves cabinet ministers and has the right of veto over parliament's legislation. PM Fico is likely unlikely to resign after his defeat, as Kiska's victory does not by itself signal a lack of public support for Fico or his government. SMER-SD frequently dominates public opinion polls in Slovakia, with Fico being among the most trusted Slovak politicians. Kiska's victory mostly represents general public disillusionment with the Slovak political scene and lack of trust in mainstream political parties, mainly among the centre-right, young, and first-time voters. We expect some strain between the new president and the PM, since direct criticism of the current business regime implies criticism of Fico's SMER-SD party, although the extent of Kiska's influence on business- and investment-related regulation is difficult to assess.
Slovakia has thoroughly reformed its economy since its separation from the Czech Republic in 1993. After a period of relative stagnation in the early and mid-1990s, reforms to the taxation, healthcare, pension, and social welfare systems helped Slovakia consolidate its budget, get on track to join the EU in 2004, and adopt the euro in January 2009. Slovakia became a NATO member in 2004. Economic growth was impressive before the global financial crisis of 2008-2009, as it averaged 6.2% in 2001-2007, mostly on the back of large FDI inflows in the automotive and electronics sector. However, the small economy of Slovakia is relatively open and highly dependent on economic developments in the European Union. The Slovak economy is dominated by the automotive sector, which indirectly contributed about 26% of national income in 2013. That makes economic growth highly sensitive to changes on the European auto market. Besides cars, vehicle parts and electronic appliances, the country also produces significant amounts of aluminium and steel. The country’s exports reflect its industrial structure, with machinery and transport equipment accounting for more than half of all exports in 2013, followed by intermediary manufactured products. In line with the large extent of intra-industry trade, imports are dominated by the same goods. Most of Slovakia’s foreign trade is conducted with Germany and the Czech Republic. The political scene is stable, since Slovakia enjoys a democratic system and its eurozone membership since 2009 promotes the development of a more robust institutional policy framework, although corruption remains an issue and the labour market remains structurally weak.