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FUND OPTIMISTIC ABOUT SLOVAKIA; ADOPTION OF EURO BY 2009 AMBITIOUS BUT FEASIBLE

IMF gives report without question marks

ECONOMIC reforms are on the right track and the Slovak business environment is improving, the International Monetary Fund said in its concluding statement to a staff visit, published at the end of May.
The IMF commended Slovakia on its economic development and fiscal management, predicting four percent economic growth and a three percent increase of real disposable income for this year. Maintaining the trend of a gradually decreasing public finance deficit, and creating favourable conditions for entry into the European Monetary Union and the adoption of the euro will be the main challenges in the years to come, according to the IMF's report.

ECONOMIC reforms are on the right track and the Slovak business environment is improving, the International Monetary Fund said in its concluding statement to a staff visit, published at the end of May.

The IMF commended Slovakia on its economic development and fiscal management, predicting four percent economic growth and a three percent increase of real disposable income for this year. Maintaining the trend of a gradually decreasing public finance deficit, and creating favourable conditions for entry into the European Monetary Union and the adoption of the euro will be the main challenges in the years to come, according to the IMF's report.

Slovak Finance Ministry officials agree that this last IMF report was the most optimistic in the history of the fund's missions in Slovakia.

"The previous IMF report issued six months ago was also positive. However, in the latest report there are no question marks. In the previous one, the question marks concerned tax revenues and the impacts of reforms. I think that the positive signal is very clear and the report is the most optimistic ever," Vladimír Tvaroška, the state secretary of the Finance Ministry told press.

According to the IMF report, Slovakia's accession to the EU took place amidst promising economic prospects. Despite an adverse external environment, output has continued to expand strongly and exports have shown remarkable recovery.

"These positive developments reflect a number of factors - a strong competitive position vis-á-vis western Europe and neighbouring countries, the influx of past (mainly foreign) direct investments, skillful macroeconomic management, improvements in the business climate reflecting the privatisation of public enterprises, a strengthened legal framework, and labour market reform. Building on these successes to sustain growth will be essential to necessary job creation," the IMF report stated.

The IMF foresees strong macroeconomic performance in 2004, with growth shifting gradually to domestic sources.

The GDP growth of 4.2 percent in 2003 was driven by good performance of the export sector, which offset a significant decline in domestic demand. Fiscal tightening such as hikes in indirect taxes and administered prices, alongside the associated fall in real wages, dampened private sector consumption. Fixed investment, which had grown strongly in the past, declined modestly.

Signs of a turnaround in domestic demand have emerged in the first few months of this year, and with an improving outlook for the EU as well, the fund projects GDP growth of about 4 percent in 2004.

Consumption, supported by higher disposable income is expected to recover, and investment should also pick up in an increasingly favourable business environment. On the other hand, a more restrained recovery in the EU coupled with delays in large export-oriented investment projects would dampen growth through their effect on exports.

Economists from the IMF project core inflation at just under 3 percent this year. Inflationary pressures have been mostly absent, and should remain so considering present expectations of restraint in wage settlements as well as continued high unemployment. The current account deficit is expected to widen slightly to just over 2 percent of the GDP this year.

Recent foreign direct investments (FDI) decisions and a sustained favourable business environment should provide the basis for further increases in productivity and rates of growth of over 5 percent in the medium term. Continued fiscal consolidation is needed in the coming years to provide for higher private investment and maintain the external current account deficit.

According to the IMF, the 2004 budget target is well within reach, with favourable prospects for over-performance. The budgeted deficit (4 percent of GDP) would represent some expansion of last year's outcome of 3.5 percent of GDP, which was justifiable in light of the observed cyclical weakness of domestic demand and the stronger than expected external current account performance in 2003.

"The IMF does not see any problems in reaching the planned budget results for 2004. It even sees the possibility to improve the results. However, at the same time it emphasises that the possible better budget performance should be used to decrease the public finance deficit rather than to increase budget expenditures," added Tvaroška.

The mission believes that the Slovak government goal to adopt the euro by 2009 is ambitious but feasible. The government needs to keep fiscal discipline and monitor budget expenditures to fulfill the Maastricht criteria.

"The Finance Ministry suggests 2008 - 2009 as the year of entry in the European Monetary Union. We suppose that it will be August this year when we submit material with more concrete terms of euro adoption to the government," Tvaroška said.

He continued: "I am confident that if Slovakia is prepared and can ably fulfill the Maastricht criteria, which will not be easy, it will be advantageous for Slovakia to adopt the euro as soon as possible. So far, I cannot answer the question as to when the criteria will be fulfilled. We will know more after our talks with the National Bank of Slovakia with whom we will co-operate in preparing the aforementioned material."

The mission also praised the Finance Ministry for continued efforts to improve fiscal management and transparency. Besides the introduction of a three-year fiscal framework, they also welcomed the strengthening of the analytical capabilities at the ministry, and the enhanced reporting of public debt information.

The IMF thinks that Slovakia can only benefit from staying the course of reforms. According to the fund, the main challenge now is to pursue a policy mix that will lead to a sustainable fiscal position and stave off inflation.

"Such a policy, together with the completion of the unfinished structural reform agenda, particularly in the areas of healthcare, education, legal framework, and fiscal responsibility, would reinforce good economic prospects and confirm Slovakia as one of the most promising new members of the EU," stated the IMF.

Slovak Finance Minister Ivan Mikloš pointed to the inevitability of further reforms at the seventh round table of The Economist conference in Bratislava on June 3.

"We still have to accomplish important reforms in education, healthcare and fiscal decentralisation," the finance minister said. "Structural reforms are inevitable. They may be hard sometimes, but they are necessary."

However, some economists pointed out that that the competitive advantages of Slovakia mentioned in the IMF statement are mainly based on factors that can disappear quickly.

"We often forget that the competitive advantage of Slovakia in comparison to other countries often stands on the country's geographic location and its cheap labour," Miroslav Šmál, analyst with Poštová banka, told the Hospodárske noviny daily. He said that cheap labour is not sustainable if the living standard of inhabitants is supposed to be increasing.

Jean-Michel Giovannetti, the president of the French-Slovak chamber of commerce and general manager of Credit Lyonnais Bank Slovakia, recently told The Slovak Spectator that the quality of human resources and its low price make Slovakia an attractive environment for investments, especially for an export-oriented business. But he added: "For the future, you would definitely need to find something else. You cannot base the whole strategy on labour costs".

It seems that the Finance Ministry is aware of such an issue. Mikloš admitted that some investors might leave Slovakia as the living standard and labour costs increase, and he stressed the necessity to alter the country's strategy of attracting investment.

"I have to say that we will lose some investors. It is natural that salaries will grow in the future, and thus it is important to build the economy with that in mind," Mikloš said.

The finance minister said that Slovakia will need to attract investors with more sophisticated production. Regarding such modes of production, Mikloš pointed to the recently expanding Slovak industry. "I do not think that the automotive industry is a branch of the economy that necessarily allows only low wages," he said.

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