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Is the economy too strong?

FOLLOWING record growth in GDP and industrial production, the trade deficit became the latest macro-economic indicator to outperform expectations on March 14.

FOLLOWING record growth in GDP and industrial production, the trade deficit became the latest macro-economic indicator to outperform expectations on March 14.

The Statistics Bureau announced that exports in January were Sk4 billion higher than imports, and grew 36.5 percent from the same month last year on the back of new production at the KIA and PSA Peugeot-Citroen auto plants. It's the first time since February 2004 that Slovakia's trade balance has been in positive figures.

Last week, the Statistics Bureau said Slovakia's GDP grew by 8.3 percent in 2006, the second-fastest rate in the EU behind Latvia and Lithuania, while industrial production was up 17.4 percent in January against a year ago.

Despite the huge growth, inflation fell in February to 2.7 percent year-on-year from three percent in January.

These figures are not just impressive in themselves, but have left Slovakia as the regional front-runner for adopting the euro on schedule in 2009.

"Slovakia will most probably meet the criteria for euro adoption so as to be able to adopt the single European currency in January 2009 as planned," Biswajit Banerjee, the head of the IMF mission for Slovakia, said at the end of a visit last week.

If there is anything that can trip Slovakia on its charge to the eurozone, beyond a massive rise in global oil prices, it will be a decision by Brussels that Slovakia cannot sustain its euro-friendly macro figures.

Estonia paid dearly for missing the inflation criterion by 0.1 percentage points in 2005, but Slovakia should not be in danger of missing the cut, and it has had ample forewarning that the EU will not make any exceptions.

However, the danger is that Brussels will decide that the Fico government has done too much to massage inflation - such as forcing down energy prices through administrative action and proposing wage caps - and that once it makes the eurozone, its inflation will leap upwards as the artificial controls are taken off.

The same thing applies to the central bank, which first intervened mightily to prevent the crown from spiralling down following the accession of the Fico government in June 2006, and since then has intervened to prevent the crown from getting too strong.

Currently, at around 34 SKK-EUR, the Slovak currency is about four percent above the lower end of the +/- 15 percent fluctuation band it is allowed around the central parity at 38.455 against the euro. The currency didn't respond dramatically to the trade balance figures, because the improvement had been expected, but if the GDP figures for the first quarter come in at double digits, as local analysts are now predicting, the crown could reach 33 far more quickly than by the end of the year, as was expected.

The central bank and the Finance Ministry should consider moving the parity, rather than spending another year struggling against a strong domestic currency. Such struggles are unseemly, and thus attract the attention of Brussels, which seems to be in an anti-expansionist mood these days. In the past, Ireland moved its parity, so there is a precedent for it.

With full production at the new auto plants and the new Samsung factory still to come, Slovakia's economy may still be some distance from peaking. Luck and hard work have helped the country to manage the high-wire act of strong growth and low inflation so far. Hedging a few bets by moving the parity and laying off the inflation manipulation could pay dividends in the future.

By Tom Nicholson

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