Reforms key to business health

THE SLOVAK Spectator asked several bank analysts to share their prognosis for 2005 in terms of the business environment and the economy. The best medicine for Slovakia in the coming year, according to them, is keeping the reformist mood alive, achieving education reform, and making room for payroll tax cuts.

EDUCATION reform should the priority in 2005..
photo: TASR

THE SLOVAK Spectator asked several bank analysts to share their prognosis for 2005 in terms of the business environment and the economy. The best medicine for Slovakia in the coming year, according to them, is keeping the reformist mood alive, achieving education reform, and making room for payroll tax cuts.

Reforms must stay on track to ensure a healthy Slovak business environment going forwards. Analysts warn against “spoilage” of the new systems by diluting them with additional proposals, such as tax exemptions, especially as the parliamentary elections approach in 2006.

Despite the Education Ministry’s fondness for churning out education reform packages that will not float politically, analysts say that the country’s future economic growth depends upon quality higher education. Slovakia, they insist, will gradually lose its low-cost advantage to countries farther east, such as Ukraine, so education reform is paramount.

Analysts also see cuts in payroll taxes as a key to improving the 2005 business climate. Introducing lower payroll taxes would drag labour costs even lower, thus helping to strengthen Slovakia’s comparative business advantages. However, analysts doubt the government will further cut payroll taxes in 2005, although a political party could potentially take it on as a pre-election agenda item.

Furthermore, economists say foreign direct investment will continue to pour in, and an influx of EU structural funds will not only help balance the budget but also boost the economies in Central and Eastern Slovakia, mainly in Prešov, Košice, and Banská Bystrica.

Together, these factors will create a strong base for the appreciation of the crown. In addition, analysts expect inflation to stay low, resulting in higher real wages. Analysts, however, do not expect a significant rise in living standards - but they do think unemployment will shrink.

Here’s a closer look at what some analysts had to tell The Slovak Spectator:

The Slovak Spectator (TSS): Which economic events of 2004 do you consider the most important and why?

Mário Blaščák, Ľudová banka: The most important fundamental change was the introduction of the 19-percent flat income tax rate. International ratings agencies appreciated it as well, raising Slovakia’s rating in 2004 to the A- level.

The state budget recorded favourable results. In March and April it even ended with surpluses - the first time since 1995. The influx of foreign direct investments was very significant in 2004 as well.

Pension reform was important in light of the current situation in which the current pay-as-you-go system would not be sustainable. The adoption of health reforms will also bring savings to the state budget.

Accession in the European Union is a political issue, but it definitely has a favourable impact on public finances. Membership will also help Slovakia smooth regional disparities.

Juraj Kotian, Slovenská sporiteľňa: Slovakia’s tax reform won lots of attention from foreign investors. Adoption of health reform laws was also a great event, as it should curtail debt increases and bring about important changes in the quality of healthcare.

Silvia Čechovičová, ČSOB: I consider tax, pension and healthcare reform the most positive events of 2004. The last two should help stabilize the budget while the first continues to draw foreign investments to Slovakia.

Ján Tóth, ING Bank: Tax reform has significantly changed the image of Slovakia and supported the influx of foreign direct investments.

Mária Valachyová, VÚB bank: The tax reform is the most important. It introduced a flat tax, unified value-added tax, and made the whole tax system more transparent and simple. Other important events are EU accession and pension and health reforms.

Elizej Macho, Tatra banka:Tax and pension reforms are the most important. These are responsible for the continued influx of foreign direct investment, which speeds up economic growth and decreases unemployment. Additionally, they encourage the process of catching up to more developed countries.

TSS: What important reforms remain to be adopted going forward?

Mário Blaščák: It is definitely education reform. Additionally, I would like to emphasize the need to make the state administration more effective. The cost and consumption of the state administration is enormous. Although the public administration, through its policies, is increasing personal freedom and making people behave with greater responsibility, it is not doing so itself.

Juraj Kotian: The issue of education reform has not been solved at the expense of society. The quality of education will be the most decisive for maintaining the economic growth in Slovakia, since the low-cost labour advantage will move farther east as time goes by. Our share of people with university education is one of the lowest in the EU and this must change.

Silvia Čechovičová: Education reform is the last important reform that remains.

Ján Tóth: University reform.

Mária Valachyová: Education reform.

Elizej Macho: Education reform did not find sufficient support. I consider its adoption essential because our economy is tied to an educated workforce. I think the adopted version of the healthcare reform carries potential risks, too.

TSS: What is the biggest challenge facing Slovakia in 2005?

Mário Blaščák: Payroll tax cuts. Despite that the Finance Ministry says Slovakia has one of the lowest tax burdens, payroll taxes make labour costs high. I doubt that the ministry will lower payroll taxes in 2005, but perhaps it might become a pre-election agenda for certain political parties.

Juraj Kotian: Keeping on the reformist trend is the biggest challenge. Upcoming parliamentary elections [in 2006] will make it even more difficult.

Ján Tóth: Defending the tax and pension reforms from various “spoiling” proposals, such as tax exemptions or pension reform changes, and accomplishing university reforms will be the biggest challenges.

Mária Valachyová: The technical launch of the pension reforms will be the toughest challenge facing Slovakia. This year, future pensioners that want to save in newly established pension administration companies must register before their payments are transferred to appropriate companies. Payroll taxes and joining the euro zone will dominate political discussions as well.

Elizej Macho: Getting the pension reform system off the ground is the biggest challenge. From the long-term point of view, it is inevitable to teach people to be responsible for their pensions and lower the importance of the pay-as-you-go pension system that is not sustainable.

Maintaining the public deficit on the planned levels might be difficult since the ruling coalition lacks a majority. One year before elections, some political parties or politicians might tend to adopt “popular” measures that will harm reforms.

TSS: Do you think the Slovak crown will continue to appreciate in 2005? If so, to what level?

Mário Blaščák: The central bank has recently issued its new monetary programme, according to which its monetary policy will be dependent on inflation. Inflation will be the main factor that determines the level of the central bank key interest rates, which influences the currency.

The crown exchange rate significantly strengthened in 2004. The foreign exchange rate at the beginning of the year stood at Sk41.10 for €1, and at the end of the year it reached its historical maximum: Sk38.54 for €1. Its appreciation was more than 3.5 percent on average on a year-to-year basis. The trend will continue in 2005. It will be supported by economic growth and an influx of foreign direct investment. In 2005, the foreign exchange rate could reach Sk37.50 for €1, or even Sk37.00 for €1.

Juraj Kotian: This year, the crown should break Sk38.00 for €1, but we do not suppose that it will drop far below this. The reason is that much of last year’s appreciation referred to a positive economic outlook, and thus the strengthening of the crown occurred in advance.

Silvia Čechovičová: We expect the gradual appreciation of the crown towards the euro to prevail in 2005. Our expectations are based on the favourable development of economic fundamentals, a sustainable, strong economic growth and influx of foreign direct investments. The growth of gross domestic product should reach 5 percent, which will be more than in the euro zone [EU countries that have adopted euro] and more than in other central European countries. Slovakia’s lead in labour productivity compared to old EU countries will play an important role as well. High labour productivity supports competitiveness of domestic exporters and improves the results of foreign trade. Although we expect deepening foreign trade deficits, we do not consider them threats to the crown foreign exchange rate. Deficits will occur due to technology imports and know-how, which will bring increased exporting effectiveness in the future.

Even though the Slovak central bank decreased the key interest rates four times in 2004, the differential between the rates for deposits kept in Slovak crowns and deposits in euros are still advantageous for crown, and will play an important role in the further appreciation of the Slovak currency. Our estimate for the Slovak crown to the euro stands at Sk37.90 at the end of 2005.

Ján Tóth: The appreciation will continue, similarly as this year. We expect the foreign exchange rate to be around Sk37.5 per €1.

Mária Valachyová: We expect the crown to appreciate based on higher production productivity in Slovakia than in the euro zone and foreign direct investment. Our estimate for the end of 2005 stands at Sk38.00 for €1.

Elizej Macho: Strong economic fundamentals and an influx of foreign direct investment will continue to appreciate the crown. We estimate that the crown will reach Sk38.00 for €1 by the end of 2005.

TSS: How will prices develop? Where do you estimate inflation for 2004 and 2005?

Mário Blaščák: In 2003 and 2004, the government had to adopt massive price deregulations, which was reflected in higher inflation rates. In 2003 it was 8.5 percent, and in 2004 it will be about 7.5 percent on average. Since price deregulations have been accomplished, we estimate 2005 inflation at only 3.5 percent.

Juraj Kotian: Last year’s inflation should range from 6 to 6.5 percent. For 2005, inflation should be 3.5 percent.

Silvia Čechovičová: In 2005, prices should drop significantly. In January 2005 alone, the consumer price index should decrease year-on-year under 4 percent. The reason is that regulated prices will grow only slightly compared to previous years. We expect that the overall inflation will reach 6.2 percent in 2004, and 3.4 percent at the end of 2005.

Ján Tóth: We estimate a drop of end-year inflation from 6 percent in 2004 to 3.4 percent in 2005, as Slovakia has finished price deregulations.

Mária Valachyová: We estimate 2004 end-year inflation at 6.1 percent. It should gradually fall to less than 4 percent in 2005. Average inflation in 2005 should reach 3.5 percent. However, prices of food and fuel bring a risk to the estimate as they are much dependent on this year‘s harvest and international oil prices respectively.

Elizej Macho: No deregulation measures will bring a disinflation in 2005. According to our prognosis, inflation should reach at the end of 2004 the level of 6.2 percent and 3.1 percent at the end of 2005.

TSS: Do you think reforms and European Union membership will help improve living standards in 2005?

Mário Blaščák: GDP per capita in purchasing power parity is one of the most frequently used indicators in international comparisons of the living standards of inhabitants. Despite a dynamic economic growth rate in the last few years, I do not think there will be any major hikes in Slovakia in terms of living standards. But, for sure, people will feel that prices will not increase as they did in previous years. Thanks to low inflation, their real wages will grow by about 3.5 percent.

Juraj Kotian: The drop in inflation will improve purchasing power of inhabitants. EU membership will help the balance of payments of Slovakia through financial transfers.

Silvia Čechovičová: Measuring living standards by economic indicators like real wages growth, we can say that citizens will be better off. We estimate that real wages will grow in 2005 by 3.5 percent and this will support household consumption. This factor will be one of the most important engines of economic growth.

Ján Tóth: I do think so, yes. Real wages could increase by 4.8 percent. Foreign direct investments will push up wages in 2006 as well.

Mária Valachyová: Definitely. We think real wages will grow by 4.3 percent and household consumption by 5 percent. At the same time, the number of job vacancies should grow and unemployment should go down.

Elizej Macho: Even 2004 showed a mild increase in real wages. This development will be stronger in 2005. Thanks to EU membership, investors will trust Slovakia more and EU structural funds will help build infrastructure and reduce regional disparities. This will encourage even greater FDI influx, creating jobs and raising living standards.

TSS: Where do you see the biggest risks for the Slovak and EU economies in 2005?

Mário Blaščák: The Slovak economy is small and open [dependent on imports and exports]. Turbulence on international markets will necessarily impact Slovakia. However, we do not expect any major turbulence.

Juraj Kotian: Relaxing efforts to lower the public finance deficit is a threat to the whole EU.

Silvia Čechovičová: Slovakia has a small and open economy, while the European and global economy has a significant impact. Economic growth in our major business partner countries will play an important role in the Slovak economy. Weaker than expected growth in these countries could lead to deepening Slovak trade deficits, slowing down GDP growth and leading to a weaker crown. Oil price hikes could be reflected in high inflation and increased production costs; they also could deteriorate economic growth.

Ján Tóth: The biggest risks can be found in a slowed down economic growth in Germany and Western Europe.

Mária Valachyová: Turbulences in global demand, the weakening dollar and rising oil prices are risks for the EU economy.

Elizej Macho: Slovakia needs to continue its economic reforms. From this point of view, shifts in political power are a threat. Additionally, if the EU wants to maintain its competitiveness, it will need to reform the EU system itself.

TSS: What levels of GDP growth do you expect for 2004 and 2005? What will be the main engines for growth?

Mário Blaščák: We estimate that 2004 GDP growth will stand at 5.3 percent. In 2005 it should be at 5.4 to 5.5 percent. Investments and household consumption will be the most dynamic part of the GDP growth. Exports that were the main engine of economic growth in 2004 will not be that strong, as investment will temporarily lower the trade balance.

Juraj Kotian: According to our estimates, economic growth should slow down a bit, from 5.5 percent at 5.2 percent. Strong economic growth should be backed by household consumption and investments. On the other hand, exports should deteriorate [the deficit will grow] because of increased imports.

Silvia Čechovičová: Our estimate of GDP growth in 2005 is 5 percent. Domestic demand, especially household consumption and investment, will be the main engines of growth.

Ján Tóth: The GDP growth should stay strong above 5 percent - 5.4 percent in 2004 and 5.1 percent in 2005. An increase in exports and gradually growing consumer and investment demand will be the main engines.

Mária Valachyová: The GDP growth in 2004 should reach 5.2 percent compared to 4.6 percent in 2003. In 2005 the economy should grow by 5.0 percent. The main engines for will be domestic demand.

Elizej Macho: The economy should grow by 5.4 percent in 2004 and 4.9 percent in 2005. The engine for GDP growth in both years will be domestic demand.

TSS: What is your prognosis for unemployment in 2004 and 2005? What developments do you expect?

Mário Blaščák: Slovakia should be an interesting target for investors in 2005. This means a growth of production capacities and drop in unemployment. However, the decrease in unemployment will not be very significant. The unemployment rate measured by the Slovak Statistical Office will reach about 17 percent in 2004; we can expect a 0.5-percent drop in 2005.

Juraj Kotian: We expect the unemployment rate, as measured by the National Labour Office, to remain approximately the same - at 13.6 percent. The rate measured by the Statistical Office should decrease from 17.5 percent in 2004 to 16.2 percent in 2005.

Silvia Čechovičová:Strong economic growth should support a mild lowering of the unemployment rate. However, there will be two opposite trends in employment: On one hand, investment and GDP growth will create new job opportunities; on the other hand, retirement ages will increase and there will be lay-offs in education and healthcare.

The Statistical Office unemployment rate should reach 18.1 percent in 2004 and 17 percent in 2005.

Ján Tóth: According to the Statistical Office, the unemployment rate should reach 17.5 percent in 2004 and 16.4 percent in 2005. Based on the methodology of the National Labour Office, the unemployment rate could stand at 13.6 percent in 2004 and 12.6 percent in 2005. The reality is somewhere between those numbers.

Mária Valachyová: We expect a drop in unemployment measured by both the Statistical Office and the National Labour Office. Our estimate for unemployment by the Statistical Office stands at 17 percent in 2004 and 15.9 percent in 2005. According to Labour Office methodology, we expect it to be 15 percent in 2004 and 15 percent in 2005.

Elizej Macho: We expect a mild drop in unemployment in 2005. The creation of new jobs will continue, but on the other hand, lay-offs will occur in some industries as a result of restructuring. Labour Office unemployment will reach 14.1 percent in 2005.

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