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MACRO NOTES

Macro Notes: Fiscal deficit - why is it a problem?

Since the Velvet Revolution in 1989, Slovakia has faced two main economic problems: the highest unemployment rate in the region and recurrent problems in external economic imbalances. The high level of state interference in the economy could be the main source of both problems.
High state interference in the economy absorbs much of the value created in the private sector. Through bureaucracy and high taxation, the state discourages private investment. Subsequently, the private sector does not produce enough jobs and the country faces high unemployment - the employment problem.
Economic theory suggests that a huge fiscal deficit creates a trade deficit, and calls both deficits 'twin deficits'.


Ján Tóth

Since the Velvet Revolution in 1989, Slovakia has faced two main economic problems: the highest unemployment rate in the region and recurrent problems in external economic imbalances. The high level of state interference in the economy could be the main source of both problems.

High state interference in the economy absorbs much of the value created in the private sector. Through bureaucracy and high taxation, the state discourages private investment. Subsequently, the private sector does not produce enough jobs and the country faces high unemployment - the employment problem.

Economic theory suggests that a huge fiscal deficit creates a trade deficit, and calls both deficits 'twin deficits'. To put it simply, a heightened demand for more and more goods above a certain level is mostly satisfied by rising imports from abroad. Hence, a fiscal deficit puts pressures, via a trade deficit, on the currency and the value of people's savings.

As the table below suggests, the government has drafted a fiscal deficit that is 5% as a percentage of GDP, much the same as the previous government did in 1997-1998, and way above the 3% Maastricht target. This is a consequence of the fact that the government has not succeeded in addressing its expenditures in a more systematic way during its first term. Instead, it has resorted to short-term fixes such as a wage freeze and a cut in investment spending. True, some of the deficit will be absorbed by lower growth and therefore will not fully translate into domestic demand and a trade imbalance. However, the rest will have an impact on the economy, and overall the draft sets an unsustainable path for fiscal policy. / see table 1./

The table above suggests that after a fiscal tightening in late 1998 and throughout 2000, the government will settle again on a spending spree in 2001. Adjusted for lower growth the next deficit is drafted to increase by 0.7% of GDP year-on-year, a rate too high to be sustainable. Elections in 2002 will probably not alter this trend. / see table 2./

Table 1: Fiscal Policy

 1995199619971998199920002001
      Eplan
Fiscal deficit target/ official declarations (%)    -2.0-3.0-4.0
Fiscal deficit/GDP (%)0.4-1.3-5.1-4.8-3.7-4.0-4.9
Structural fiscal deficit/ GDP (%)0.6-1.6-6.1-5.8-3.7-3.1-3.8
Impact on agg. demand (+ = expansionary) (%) 2.204.50-0.30-2.10-0.600.70

Note: The impact on aggregate demand is approximated by the change in the structural deficit. Structural deficit takes into account growth dynamics.

Source: Capital and Money Markets Report, August-October 2000, ING Barings


Table 2: 2001 Budget Draft

(Skbn, excludes one-off expenditures)

 2001Plan
State budget-37.2
Hidden additional deficit 
in state budget*-8.9
Extrabudgetary deficit-0.7
Total (Skbn)-46.7
% of GDP-4.9%


Note: (*) Sk8.9bn deficit (mostly spending on highway construction) is hidden in paragraph 12 of the state budget draft. The deficit calculation excludes bank restructuring costs as well as the maturing of old debts in social security and privatisation bond repayment.

Source: FinMin, ING Barings


Ján Tóth is Chief Economist at Dutch investment bank ING Barings in Bratislava.

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