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Twin deficits draw heavy fire

DESPITE repeated warnings from international bodies, the Slovak government has done little to assuage fears of deepening trade and fiscal deficits, say analysts.
Slovakia's official fiscal deficit target of 3.5 per cent of GDP has been abandoned, and even the cabinet's revised target of 4.5 per cent of GDP has been challenged by foreign experts.
The expanding fiscal deficit is also seen as deepening the country's worrying trade deficit, which reached a record Sk103.2 billion last year, and recorded a year-on-year widening of Sk800 million for the first quarter of 2002.

DESPITE repeated warnings from international bodies, the Slovak government has done little to assuage fears of deepening trade and fiscal deficits, say analysts.

Slovakia's official fiscal deficit target of 3.5 per cent of GDP has been abandoned, and even the cabinet's revised target of 4.5 per cent of GDP has been challenged by foreign experts.

The expanding fiscal deficit is also seen as deepening the country's worrying trade deficit, which reached a record Sk103.2 billion last year, and recorded a year-on-year widening of Sk800 million for the first quarter of 2002.

"The government must return to the path of fiscal consolidation," said Juan José Fernández-Ansola, head of the Slovak Mission for the International Monetary Fund (IMF).

In the past few months similar warnings have been issued by the Organisation for Economic Cooperation and Development (OECD), the European Union, the National Bank of Slovakia (NBS), and an umbrella group of Slovak economists.

Due to what NBS governor Marián Jusko called the government's failure to curb spending, the central bank raised its key interest rate in late April by 50 basis points, a move greeted by the IMF as a positive step.

"The recent 50 basis point increase in interest rates by the central bank is an appropriate signal in response to external imbalances and insufficient action on the fiscal front," said IMF officials in a written report.

However, the IMF also pointed out: "There is no doubt that monetary policy is not the best instrument to address the large external current account deficit.

"While further increases in interest rates would dampen domestic demand, they might also strengthen the crown excessively, weakening competitiveness at a time when exports have been stagnant for a while."

Analysts warn that while such measures may be an effective stopgap, the key problem of overspending remains, and with September elections fast approaching, it is unlikely that spending will decrease.

According to Eva Limanska, a fixed income analyst for Merrill Lynch, the central bank's action stems from its desire "to perform through monetary policy the job [reducing domestic demand] the government is avoiding in fiscal policy".

She added that "the government is in a very difficult position in an election year."

Government spending, which includes higher pension and social welfare payments, has fuelled consumer demand, leading to a rise in imports while Slovakia's export market has not kept pace, widening the huge trade deficit.

Over 2001, imports climbed by 20.9 percent year-on-year to Sk713.9 billion while exports increased by only 11.3 percent to Sk610.7 billion.

In early May, NBS figures indicated that although the monthly trade deficit for March showed a Sk1 billion improvement over the previous year, the first quarter trade deficit had reached Sk19.6 billion, exceeding the 1Q01 deficit by Sk800 million.

According to the Slovak Ratings Agency, the trade deficit stemmed primarily from a general European economic malaise.

"The primary reasons for decreasing growth in exports are the slowing dynamics of economic growth in our most important business partners - exports to the EU this year account for about 60% of total exports - and the restructuring of some industrial sectors.

"But the problem is also the structure of our exports, which is insufficiently diversified, with products of the automobile and steel industries accounting for almost one third of exported commodities," said the agency.

With no sign of a slowdown either in government spending or in the growth of the trade deficit, warnings to Slovakia have become steadily more insistent.

"While there are certain temporary factors in the background of the current account deficit, there is also a risk that it will get to an unsustainable level, because it is affected by excessive domestic demand related to a significant growth in public sector spending," said Ansola.

"The authorities should also move ahead with planned reforms to streamline social assistance, improve public finance management, and restructure the civil service.

"In the end, fiscal sustainability will depend on the concerted and sustained implementation of key reforms," he added.

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