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SLOVAKIA MUST SUSTAIN ECONOMIC GROWTH TO ADVANCE TO EURO ZONE

OECD heaps praise on Slovak economy

THE ILLUSTRIOUS club of 30 market democracies credited Slovakia for walking down the path of ambitious reform.

THE ILLUSTRIOUS club of 30 market democracies credited Slovakia for walking down the path of ambitious reform.

The Organization of Economic Cooperation and Development (OECD) particularly saluted Slovakia's sound macroeconomic policies, the liberalization of its capital and labour markets along with its fundamental tax and welfare reforms.

"Foreign direct investment has responded particularly well, becoming the prime engine of capacity and productivity growth helping to put the economy on a strong and well-balanced growth path," the OECD states in its 2005 economic survey on Slovakia.

According to the OECD, the recent fiscal and inflation outcomes have been positive, making the government's goal of meeting the Maastricht convergence criteria by 2007 more credible.

Val Koromzay, the author of the report, told the press that the effects of Slovakia's reforms are already visible, thus enabling the country to maintain sustainable growth.

"We estimate that Slovakia's potential economic growth is between 5 and 6 percent a year. Now we are speaking about sustainable growth, not about cyclical growth that could be caused by artificial stimuli," Koromzay told the TASR news wire.

He said that after Ireland, Slovakia is enjoying the highest economic growth among OECD-member countries.

According to the OECD, however, Slovakia must fine-tune its reforms and sustain growth in order to advance smoothly into the euro zone.

Slovakia faces four major challenges. It must: 1) preserve macroeconomic stability and prevent pitfalls on the road to EMU; 2) stimulate labour demands for low-skilled workers; 3) improve conditions for innovation and growth; and 4) modernize the public sector without increasing the fiscal costs.

Analysts agree that the run up to euro adoption will be challenging. The Slovak Spectator spoke with research analyst Mária Valachyová at the VÚB bank. "Among the most important tasks the Slovak economy faces ahead of euro adoption is to anchor inflation and inflationary expectations.

This could be a problem for a fast-growing country, since fast economic growth is usually accompanied with rising inflationary pressures. Also important will be to continue in a mode of fiscal consolidation ahead of looming elections as well as continue in that mode after a new government takes over in 2006," Valachyová told the Spectator.

"The risk connected to euro adoption is the timing of the entry into the ERM II [European Exchange Rate Mechanism] and the value of the exchange rate at the time we enter the ERM II. Speculation could lead to excessive crown strengthening and thus fix the crown at an overvalued level, which is negative for Slovak exporters.

To avoid this, the central bank could enter the ERM II before the planned time period of mid-2006," Valachyová added.

Other hurdles await. Although Slovakia's Labour Minister Ľudovít Kaník happily reported that the unemployment rate in Slovakia dropped below 11 percent, the lowest in eight years, the OECD is still concerned about the country's jobless rate.

According to the OECD, the country's relatively low employment rate is one of the factors that push the levels of gross domestic product per capita lower than in other OECD countries.

"With respect to the demand for low-skilled workers who are the most abundant among the unemployed, this chapter argues that the cost of low-paid labour should be significantly reduced, either by significantly cutting employers' social security contribution rates for low-wage workers or by reducing the minimum wage," the OECD says.

The OECD also identified the Slovak housing market as a major obstacle to regional mobility of labour supply, and recommended significant policy changes for this sector.

Analysts agree that unemployment could be further reduced if the government lowered the amount of contributions that an employer has to pay for a worker, which would affectively lower the cost of labour.

"Labour market mobility (and reducing labour market rigidities) is a critical precondition for an economy to be able to absorb shocks (as with EMU entry the economy loses its independent monetary policy and exchange rate tool)," Valachyová said.

Finance Minister Ivan Mikloš welcomed the OECD report, which he said confirms the correctness of the economic reforms. "Our view on the state of the economy and on the challenges which stand in front of us is not in contradiction with the OECD's view," Mikloš said.

As for what steps the government should take to improve the conditions for innovation and growth as requested by the OECD, Valachyová mentioned reforms in education.

"Continuing to improve the business environment (i.e. through a more effective judiciary system) could attract more innovation-oriented FDI projects," she added.

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