Sighs of relief from financial institutions and analysts greeted the Slovak government's new package of economic austerity measures announced on May 31. The measures, which include an import surcharge, a hike in the basic tax rate and price deregulation, were designed mainly to raise an additional 18 to 20 billion Slovak crowns in revenue for the state budget.
"It's the best news that Slovak crown assets have received all year," said Ján Tóth, a senior analyst at ING Barings investment bank. "The package includes some pretty bold measures to cut the fiscal deficit, and although I don't like the import surcharge and I think they might have done more to cut expenditures, I'm very relieved to see the contents of the measures."
The austerity package, or "revival programme" as it is termed by the government, was approved unanimously by cabinet in the evening of May 31. The centre piece of the package is an increase in the basic Value Added Tax (VAT) rate from 6% to 10% as of July 1. Other measures include a 7% import surcharge which took effect on June 1, and price deregulation which will raise household electricity prices by 35%, natural gas by 50% and housing rents by 70% (see chart, page 2).
Tackling the fiscal deficit
On the same day that the austerity measures were announced, the Finance Ministry released figures showing that Slovakia's state budget deficit as of May 31 stood at 8.66 billion crowns ($200 million), well over three times higher than in the same period of 1998 and over half of the 16 billion crown deficit approved for the whole of 1999. The results were particularly worrying, said analysts, in light of the government's vow to cut this year's public sector deficit to 2% of GDP from last year's 6%.
However, Deputy Prime Minister for Economy Ivan Mikloš told a news conference on June 1 that the government's latest revenue-raising measures would bring an additional 18.2 to 18.5 billion crowns into the budget, resulting in a 1999 fiscal deficit of around 19-20 billion crowns and keeping Slovakia on track to meet its target of 2% of GDP. "Without these measures, the fiscal deficit could have reached 40 billion Slovak crowns [$920 million]," Mikloš said.
Ivan Chodák, an economic analyst with CA IB Securities in Bratislava, called Mikloš' new estimate of the 1999 fiscal deficit "quite optimistic," given the fact that spending of state funds outside the purview of the state budget - the Road Fund, the FNM privatisation agency, state pension and health insurance schemes - were likely to inflate the fiscal deficit this year.
Tóth agreed, saying he expected the 1999 fiscal deficit to be around 23 billion crowns. "Going from 6% of GDP last year to 2% is a big drop," he said. "We'll probably end up somewhere in the middle."
The new package also expected to save the state between 1.8 and 2 billion crowns this year from cuts to social welfare payouts and lower funding for regional state administration.
Current account balance deficit
Although the new package was mostly geared towards increasing state revenues, it also offered a short-term solution to Slovakia's trade balance deficit - a 7% import surcharge affecting around 80% of Slovak imports. The surcharge is to fall to 5% on January 1, 2000, to 3% next July and to be phased out entirely on New Year's Day 2001. All imports will be affected except shipments of staple items such as coal and iron, raw materials, rice, medical technology etc.
Slovakia's current account balance deficit in 1998 was over 10% of GDP, and one of the government's most important promises for 1999 was to cut this figure to between 5 and 6% of GDP. Trade figures for the first quarter of 1999 showed a slight improvement over the previous year, and CA IB's Chodák calculated that the current account balance deficit was slightly over 7% of GDP during the first two months of 1999.
According to ING's Tóth, however, improvements in the 1999 current account balance deficit were offset by a crisis in the capital and financial account balance. Slovakia's capital account, Tóth said, was in deficit in March and April this year, meaning that the country received "no new net money" in this period and was unable to revolve maturing state debts - making an import surcharge almost inevitable.
"This [capital account deficit] put the government under enormous pressure, because if this trend had continued, the country would have been forced to run a trade surplus to compensate, resulting in huge exchange rate losses," said Tóth. Facing a choice between an import surcharge and a further 20% fall in the value of the Slovak currency in addition to May's precipitous decline, the government chose the tax on imports.
In an interview with The Slovak Spectator on June 1, Mikloš said that the surcharge had been negotiated with international trade bodies like the World Trade Organisation and the OECD, who had been satisfied that the surcharge was part of a larger complex of restraints. "Their response [to the surcharge] was absolutely positive," Mikloš said.
While the new taxes, charges and price hikes will put a little more money in the state's pocket, it will also put consumers in a bind. Mikloš told Twist Radio in an interview on June 1 that headline inflation could reach 13-14% this year, in contrast to the government's earlier year-end inflation target of around 10%.
"Predictions until now... were around 10%, of which 6-7% was core inflation. If we add on the effect of these measures...we can expect [headline] inflation at around 13-14%," he said.
Chodák said that the Slovak government's reluctance to approve the painful measures before had not lessened their negative impact on consumers, but had diluted their positive effect on the economy, since most of them would not take effect until the fiscal year was half over.
"If the package had been approved earlier, we could have avoided our troubles with the crown, for example," he said. "Really, this package just puts out the fire - it was an overnight decision, and the question is not why it wasn't harsher, but why it didn't come sooner."