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OECD advises caution

AMONG the members of a club comprising the world’s most developed economies, many are staring down the wrong end of a protracted recession, the likes of which they have not experienced since the early 1980s.

AMONG the members of a club comprising the world’s most developed economies, many are staring down the wrong end of a protracted recession, the likes of which they have not experienced since the early 1980s.

Over the next two years, 8 million people could join the ranks of the unemployed in the member states of the Organisation for Economic Cooperation and Development (OECD); at the same time, inflation is abating in all of them and some even face the risk of mild deflation, according to the OECD in its latest economic forecast.

Though Slovakia is forecast to remain the OECD’s top performer for the next two years, the organisation expects economic activity to decelerate significantly in 2009, before picking up in the following years.

“In particular, investment spending and trade growth are likely to be adversely affected by the effects of the financial crisis,” said the OECD in its economic outlook, which is published twice a year, analysing major trends and the economic policies required to foster high sustainable growth.
According to the OECD, Slovak growth is expected to return to close to its potential rate towards 2010. Inflation rates should decline from their currently high levels, but stay above euro-area levels, the organisation said. The OECD predicts economic growth in Slovakia to be 4.0 percent at most next year.

“Among the recently published prognoses, the OECD’s is the most pessimistic for Slovakia,” Zuzana Holeščáková, an analyst with Poštová Banka, told The Slovak Spectator. “The autumn estimate of the European Commission stood at 4.9 percent and the recently revised prediction of the Finance Ministry stands at 4.6 percent.”

Radovan Ďurana of the Institute of Economic and Social Studies (INESS), a think tank, said that Slovakia owes its ability to keep economic growth at the highest level among OECD members to foreign investments encouraged by the reforms adopted by the previous government.

“Currently there are no measures taken which would fundamentally influence the interest of investors in increasing their production in Slovakia,” Ďurana told The Slovak Spectator.

The relatively high economic growth should be still driven by domestic production; specifically household consumption, but also by the public administration and thanks to the creation of gross fixed capital, according to Holeščáková.

However, analysts also say that the slower growth of GDP will be reflected in slower growth in domestic consumption.

“The slowdown in economic growth due to the financial crisis should contribute to growing unemployment, a slower growth of salaries and a slowdown in inflation,” senior analyst with the VÚB bank Martin Lenko told The Slovak Spectator.

Holeščáková agrees that unemployment will now fall more slowly in Slovakia, which currently has one of the highest unemployment rates in the European Union.

In terms of foreign trade, the eurozone is Slovakia’s most significant market, but like other world economies it faces a slowdown in consumption and this fact will be reflected in the falling demand by foreign countries for Slovak products and services, which will mean a drop in exports,
Holeščáková explained.

“Declining consumption might result in a slowdown of production and related limitations or even the closure of some operations,” Holeščáková said. “However, Slovakia should remain an attractive destination for foreign investors due to its lower costs, including cheaper labour.”

The OECD has also appealed to its member governments to support their economies with stimuli. As for which kind of stimuli these should be in Slovakia, Ďurana listed the “reduction of costs by which the government burdens the creation of jobs by businesses, and maintaining the volume of production”.

According to Ďurana, it should not be a policy of financial stimuli for selected sectors and companies but a flat reduction of the costs which the government itself has helped to cause.
“I am an advocate of revision of tax and payroll tax policies, which in a period of economic slowdown is one of the basic tools of the state to support investment and consumption, since it has a flat rather than just a selective impact,” Lenko told The Slovak Spectator.

Ďurana said that in Slovakia’s case the reduction of the tax and payroll tax burden and reduction of the administrative and regulatory burden would help.

According to Holeščáková, Slovakia should not be affected by the crisis to the same extent as some EU or other developed economies, while the Slovak government does not yet have to support the economy with different stimuli.

The OECD also asked member governments to be more watchful, which is very important in Holeščáková’s view.

“Mainly in the area of fiscal stimuli and due to excessive spending in the economy the public finance deficits could deepen but also the state debts could swell, which in some circumstances might result in Slovakia not fulfilling the [eurozone] stability pact,” Holeščáková said.

Handling the adoption of the euro, which is scheduled for January 1, 2009, will determine policy priorities.

Although the expected slowdown will dampen the danger of a boom-bust cycle induced by low real interest rates, fiscal policy should be used cautiously, the OECD said.

As for the role the euro will play next year in defining the government’s economic policies, Lenko said that the loss of the monetary lever, which in the past took the form of a strengthening Slovak crown, would create greater pressure to follow considerate fiscal policies, which should be targeted on achieving sustainable long-term development of the economy.

“Whether it happens this way all depends on the government,” Lenko said.

Ďurana said that the government should consider the monetary policy of the European Central Bank next year to be beyond its reach and it will be left with only fiscal policies to fight eventual inflationary pressures.

“Thanks to the euro, the Slovak currency, compared to the currencies of neighbouring countries, has significantly strengthened, which has increased wage expenses for foreign investors in Slovakia,” Ďurana said. “The government should compensate for this negative effect by cutting taxes and payroll taxes.”

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