May 20, 2022
A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF’s Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.
The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.
Bratislava, Slovak Republic: An International Monetary Fund (IMF) mission, led by Ms. Petia Topalova, visited Slovakia from May 9-20 to conduct discussions on the 2022 Article IV Consultation with the Slovak Republic. The mission has issued the following statement:
The war in Ukraine is expected to have a significant economic impact on the Slovak Republic, given its geographical proximity, heavy reliance on energy imports from Russia, and high integration into global value chains . The immediate policy priority is to mitigate the economic fallout of the war and minimize the humanitarian hardships of the Ukrainians seeking refuge in Slovakia. Well-designed, targeted, timely and temporary support to vulnerable households could mitigate the impact of surging commodity prices. Financial sector policies should carefully balance enabling the flow of credit and ensuring continued banking sector soundness. Structural reforms that strengthen energy security, accelerate the green and digital transition and boost productivity will set the stage for resilient growth in a more shock-prone world. These should be coupled with investments in human capital 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. The efficient use of the sizable NGEU resources and the effective implementation of reforms outlined in Slovakia’s Recovery and Resilience Plan could go a long way in this regard.
The Slovak economy was poised for a strong rebound in mid-2021 as the effective policy response to the COVID pandemic had shielded households and corporate balance sheets, limited the rise in unemployment and ensured continued credit flow. But resurgent infection waves and supply chain disruptions hampered the recovery, leaving GDP and employment around 1.5 percent short of pre-crisis levels at the end of 2021. The war in Ukraine poses new headwinds and risks. Its effects are already felt through surging commodity prices, fueling high inflation, input shortages, subdued confidence, and weaker global demand. Energy security risks have risen sharply, given Slovakia’s heavy reliance on oil and natural gas imports from Russia. Slovakia is also feeling acutely the humanitarian toll of the war with more than 400,000 Ukrainian refugees having crossed the Slovak border.
Economic activity in the near term will be shaped by the fallout from the war in Ukraine. Assuming there is no further escalation to the war and no significant disruptions to natural gas imports, growth is projected to decline to around 2 percent in 2022 and recover to approximately 3½ percent in 2023. Annual inflation is expected to average almost 11 percent in 2022 and persist at near 10 percent in 2023 as high global energy and food prices continue to feed into domestic prices.
The uncertainty surrounding this forecast is exceptionally high with risks tilted to the downside. The greatest threat is a persistent shut-off of Russian gas exports to Slovakia and Europe more broadly, which could lead to significant natural gas shortages with sizable output losses. But other risks could also worsen the outlook: protracted supply chain disruptions to which Slovakia is particularly exposed given its large auto sector and high integration in global value chains, persistently high inflation which could trigger faster-than-anticipated tightening of financial conditions and correction in asset prices, and new virus variants, which may necessitate new containment measures given Slovakia’s low vaccination rate. On the upside, faster implementation of RRP reforms, and successful integration of refugees could lift growth above the baseline.
An immediate policy priority is to address the humanitarian crisis. In this regard, the swift actions by the Slovak authorities and citizens are commendable, with Slovakia welcoming and caring for hundreds of thousands of Ukrainian refugees and already integrating thousands into the local labor market. An equally urgent challenge is mitigating the economic fallout of the war including by securing new energy supplies. Faced with a new shock of uncertain duration and severity, heightened vigilance, policy flexibility and clear communication will be essential.
Providing Fiscal Support Without Adding Inflationary Pressures
Fiscal policy needs to remain nimble and ready to adjust. The Stability Program appropriately aims for a reduction in the fiscal deficit in 2022 as COVID-related measures are phased out, and a significant boost to public investment, facilitated by EU grants. As risks may materialize and new spending needs and priorities may emerge in the rapidly changing environment, automatic stabilizers should be allowed to operate fully and the budget could be revised to reprioritize spending, and accommodate possibly higher spending, such as on refugees, energy investments, and targeted support.
Targeted and time-bound transfers to vulnerable households could mitigate the economic and social costs of rising commodity prices. The surge in inflation is eroding purchasing power especially among lower income households and raising input prices of businesses. The authorities are taking measures, including by freezing electricity prices for households until 2024 and advancing the 13th pension payment to July. They also plan to provide targeted one-off transfers to selected vulnerable groups. Such transfers could be expanded if additional support is deemed necessary as they provide temporary and cost-effective relief to those who need it most without adding to inflationary pressures, and are preferrable to large, permanent, and less targeted increases in benefits. If downside risks materialize, the government could consider temporary support to viable firms, as outlined in the EC Energy Prices Toolbox and the Temporary Crisis Framework, to prevent unnecessary bankruptcies and smooth the transition to a new normal. However, policies should aim to preserve price signals to encourage energy savings and efficiency.
Once the economy is on a solid growth path, fiscal buffers will need to be rebuilt to accommodate rising aging-related spending and restore room for maneuver. The Stability Program envisages a 0.5 percent of GDP annual consolidation over 2023−25, in line with the new multiannual expenditure ceilings. Under the baseline, this adjustment appears appropriate as high EU fund inflows would help offset the consolidation’s drag on growth. As argued in the past, a credible medium-term consolidation path would require spelling out concrete measures. On the revenue side, the mission sees scope for higher real estate and environmental taxation. Important progress has been made in strengthening tax efficiency, as evidenced by the large decline in the VAT gap, and these improvements should be sustained. Stepped-up implementation of value for money measures will be important to materialize the sizable savings identified in spending reviews.
Reforms to the fiscal framework and pension system could significantly strengthen public finances, and the mission welcomes the recent progress in this area. The multiannual expenditure ceilings linked to long-term sustainability indicators, approved in March, should strengthen fiscal discipline and improve medium-term budget performance. Relinking retirement age to life expectancy as envisioned in the Social Insurance Law amendment currently under review by Parliament will improve fiscal sustainability. The mission recommends enshrining the multiyear spending ceilings and the link between retirement age and life expectancy 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 without strengthening fiscal sustainability . The parental bonus would also entail fiscal costs before savings from other elements of the pension reforms are realized.
Maintaining Vigilance and Ensuring Continued Financial Sector Soundness
The banking sector has weathered the pandemic well, but heightened risks warrant close monitoring, enhanced supervision, and careful calibration of financial sector policies. Banks have adequate capital and liquidity buffers, NPLs have fallen to historical lows, credit growth remains strong and stress tests and sensitivity analyses indicate that the banking sector can withstand a range of shocks, a testament to the proactive and successful use of micro- and macroprudential measures during a prolonged period of financial deepening. However, the surge in inflation could erode corporate profits and is already depressing household disposable income, which could impair the quality of the credit portfolio. Risks in the housing market, to which the Slovak financial sector is increasingly exposed, have clearly risen with the acceleration in house prices and higher mortgage rates. Moreover, while the banking sector’s direct exposure to Russia and Ukraine is limited, the global threat of cyber-attacks has risen.
- Financial sector supervision should continue to closely monitor asset quality, assess risks related to the war and its spillovers, especially surging commodity prices, and calibrate stress tests accordingly. While effective policy support has prevented a surge in bankruptcies during the pandemic, the authorities should continue to pay close attention to the rise in NPLs among loans that were previously under moratoria.
- The macroprudential policy stance should continue to carefully balance supporting adequate credit supply and ensuring banking sector resilience. This task is very challenging at the current juncture as large downside risks related to the war in Ukraine have emerged in the midst of a strong credit cycle. If there are clear signals that the strong credit cycle continues, raising the countercyclical capital buffer (CCyB) from its current level of 1 percent may be warranted. However, should downside risks materialize, the authorities should stand ready to pause or even release buffers to ensure adequate credit supply.
- The authorities could continue exploring additional measures to address rising household debt and housing market vulnerabilities. As argued previously, these could include 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 extending beyond borrowers’ retirement age, adjusting borrower-based measures would be appropriate.
Securing Energy Supplies and Accelerating the Green Transition
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 the build-up of inventories, collaborating at the EU level, and contingency planning. The authorities’ plans for higher investment in renewables and improved energy efficiency, including through building renovations, 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. Staff analysis suggests that a carbon tax could significantly decrease energy consumption and emissions, with adverse growth and distributional consequences mitigated by the use of tax revenue for lower labor taxation and efficient transfers to vulnerable households.
Structural reforms for sustainable and inclusive growth
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:
- Reforms of the education system to reduce long-standing education gaps and skills mismatches and prepare the workforce for the future, including through greater emphasis on digital skills, vocational training and lifelong learning.
- Effective labor market policies to (i) bolster labor supply in an aging society and (ii) help the transition of workers across sectors and firms that the green transition and technological changes would likely trigger.
- Increasing labor supply would require greater focus on strengthening female labor force participation by improving the availability of childcare and elderly care, improving the labor force attachment of disadvantaged groups, integrating refugees in local labor markets and attracting more foreign talent.
- Supporting labor reallocation calls for stronger active labor market policies, such as retraining, reskilling and participation in lifelong learning, areas in which Slovakia lags other advanced European countries.
- Reforms to improve institutional quality, strengthen governance, and innovation, which would raise efficiency and productivity and amplify gains from other structural reforms.
Slovakia’s Recovery and Resilience Plan outlines sizable investments and reforms in these areas. The mission welcomes the impressive progress made so far, with Slovakia completing all 14 milestones necessary to request the first RRP payment and more than half of the milestones necessary for the second payment request, including passing reforms of the judicial system, higher education, fiscal framework, and public procurement, among others. The timely and decisive implementation of these reforms, along with effective execution of the planned investments, would go a long way in raising living standards and lifting the economy’s potential.
The mission would like to thank the authorities and other counterparts for the candid, constructive and insightful dialogue and productive collaboration.