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Right time to rationalise public spending

IT WILL be the private sector, not the public sector, which plays the most crucial role in the stabilisation of the economy and its subsequent revival: so believes Vladimír Masár, the chairman of the accountancy and consultancy firm Deloitte in Slovakia. He is also convinced that this is the right time to rationalise public spending and redirect some funds from public administration budgets to investment, for example in infrastructure or energy projects.

Vladimír Masár (Source: Sme - Peter Žákovič)

IT WILL be the private sector, not the public sector, which plays the most crucial role in the stabilisation of the economy and its subsequent revival: so believes Vladimír Masár, the chairman of the accountancy and consultancy firm Deloitte in Slovakia. He is also convinced that this is the right time to rationalise public spending and redirect some funds from public administration budgets to investment, for example in infrastructure or energy projects.

The Slovak Spectator spoke to Masár, who had his finger on the pulse of Slovakia’s banking sector as the governor of the country’s central bank between 1993 and 1999, about the growing influence of the public sector in a time of economic downturn; tax issues; information security; how the crisis is affecting professional services organisations; and the challenges Slovakia faces in order to remain an attractive destination for investors.

The Slovak Spectator (TSS): The current financial crisis will further strengthen the public administration’s role in national economies, according to a recent Deloitte release. Could you specify the areas in which the role of governments will grow stronger?
Vladimír Masár (VM): What we have observed is not only a stronger role for the public administration but also a greater synergy among central banks and particular governments in their efforts to ease the impacts of the global economic downturn. We are witnessing large-scale global coordination. Even countries which had been developing unambiguously as market economies have taken this path and therefore the phenomenon of a stronger role for the public administration is not something we necessarily observe only in central Europe. Times of global economic downturns give something of an advantage to the public sector, in which public trust is growing compared to the private sector. Investors will thus be more inclined to cooperate with the public sector, for example through investments in infrastructure projects or public-private partnership projects.

TSS: What are the main challenges that governments face during such times of economic downturn? In your opinion, are governments responding to the economic downturn in the same way that they have responded to past crises?
VM: Governments do have experience tackling the previous economic crises and they are reaching for some of the methods that have been used to ease the impacts of previous downturns, many of which have been perhaps softer than the current economic crisis. The question is, however, how effective these measures are, mainly in the light of our assumption that the role of the public administration is likely to grow stronger. We also must not get too optimistic about this role: governments first of all redistribute resources but do not create them. If any government decides to help someone, it necessarily will have to take the funds away from someone else’s coffer. Yet, in times of crisis both the public and private sectors have more difficult functional conditions. In Slovakia’s economy, the private sector still plays a key role in creation of GDP so it is very important that the public sector does not use its growing influence to maintain its spending at the expense of the private sector. Despite all the measures that have been taken, it would be unfortunate if the private sector is disadvantaged in any way. It will be the private sector, not the public administration, which will play the most crucial role in the stabilisation of the economy and its subsequent revival. This is really the right time to rationalise public spending and redirect some funds from administration budgets to investments, for example into infrastructure or energy projects.

TSS: The Slovak government has produced three packages of measures to ease the impacts of the global economic downturn on Slovakia. How do you assess these measures?

VM: It is quite natural that the government is trying to ease the impacts of the crisis on the economically most vulnerable groups in society such as the unemployed, the self-employed and small and medium-sized businesses. It is a standard behaviour of the government which makes the situation more bearable for the groups most exposed to the crisis; it eases social tensions and thus maintains a certain social stability. But we must realise that we are still talking about easing the impacts of the crisis and not about solving the problems that have been causing it.

As for the risks of the measures taken, I see them as potentially disadvantaging the private sector in the area of spending and also deepening the public finance deficit. How the support systems are distributed is crucial and the government needs to maintain transparency and fairness, bearing in mind that the crisis equally affects both the successful and the unsuccessful.

If you take too much from the successful they will also start producing losses.

TSS: Economists and businesses have been calling on the government to cut taxes and ease the payroll tax burden, suggesting that this is a solution which might benefit more participants in the market in a transparent way. Is there room for further tax cuts?
VM: Tax cuts come as a more systematic and transparent way of redistributing finances for the private sector. Generally, the fewer resources applied to different redistribution mechanisms, the higher their effectiveness is. However, in times of crisis it might not be the best time to experiment with taxes. Besides, we really are talking about 1 to 3 percentage points tax cuts here, which would not be such a decisive change. Cutting taxes from about 40 percent to 19 percent was a different story. Today the space for cutting taxes is not as wide. There are also concerns about government spending since the expenditures will be under strong pressure due to the growing unemployment and financing the various support packages.

The payroll tax burden is a different issue. We rather frequently brag about our low taxes but we do not talk about the total expenses of businesses towards the state. Our situation is not that attractive in this area compared to other countries. So definitely, there is room for cuts here.

TSS: What have been the impacts so far of the global economic crisis on global tax, audit and consulting companies such as Deloitte? Have the recent developments changed the composition of the clients for these companies, and how have they changed the tasks they face?
VM: It is quite natural that the crisis increases competitive pressures in our market segment. The firms are trying to face these pressures by making cuts, reducing their expenses or making their operations more effective. No segment of the economy can escape these pressures, including the segment in which Deloitte operates. But the scale of the products that we are providing is strongly connected with the actual problems that our clients affected by the crisis have. Innovation in products is, of course, unavoidable since it is an adjustment to the changing character of the market: we are no longer talking about tools for expansion but rather are preparing firms to operate in a stagnating environment; to stabilise their market share; and to develop strategies for crisis survival.

One of the most intensively discussed questions is the length of the downturn since answers to this question are a key to defining an optimal strategy for firms to survive without severe wounds while preserving their strongest possible position in the market.

The portfolio of our clients remains very similar due to the size of Slovakia’s economy and it is more so the portfolio of products that are changing. Audit remains an important part of our activities. Since the financial crisis has been linked to a loss of confidence, an audit serves as a certain guarantee of quality and credibility.

TSS: A recent Deloitte survey suggests that the global economic crisis is also fuelling a growing risk of information security. Could you share some thoughts about the survey?
VM: Most firms are struggling to manage their costs more effectively, which of course has not left the area of information technologies untouched and this study does point at some trends. Based on this study, 60 percent of the respondents confirmed that their budgets for information security increased by 1 to 5 percent in 2008; however, they expect these budgets to be reduced in 2009. More than half of the respondents said that budget cuts will be the main obstacle to ensuring safety of information while a third of them said that budget cuts will prevent their firms from carrying out their information safety projects.

We observe that businesses and companies have grown less cautious and have invested less in the area of information safety systems due of a falling rate in attacks against their systems in the past or smaller problems in this area. The firms intend to save costs by cutting investments in this area.

The other interesting phenomenon we observed is that the firms tend to be more concerned about potential attacks from their internal environment than from external sources. More than a third of the respondents said they were concerned with improper conduct by their employees while only 13 percent were concerned with external exploits. Six in 10 respondents were concerned about their ability to protect their organisation from attacks by internal cyber–attacks. On one hand people are the greatest assets of firms, but on the other hand, managers see human failings, not technical ones, as being a very high risk. It also is linked to the difficult economic situation which impacts all the players on the market.

TSS: Businesses often reach for layoffs as their first instinct to cut costs. Aren’t layoffs one of those mechanical reactions to a critical situation? What are the downsides?
VM: I would not generalise. It depends on the situation of the firm and it is quite natural that cuts do heavily affect the human capital because in many firms these costs represent a significant share of their expenses. Cuts in human capital, however, are far more sensitive than cuts in other area and require more careful consideration since these decisions often have quite dramatic human and economic effects. Firms need to have certain alternative behaviours in times of crises so that they are able to determine for how long they can afford to keep various parts of their portfolio and when the breaking point arrives to restructure their assets or to simply cut them off. It is important to have assessed all these alternatives professionally and to make these assessments based on sophisticated data.

TSS: As a former governor of Slovakia’s central bank, how do you assess the process of adopting the euro in Slovakia? In the light of the economic downturn, how do you view the timing of the adoption and the benefits of the EU currency?
VM: Since we are all paying with euro now, it means that we handled the switch well. What is now discussed is the impact of the euro on our economy and comparisons of the stability of our currency with the currencies of our neighbours, which have not yet switched to the euro. As far as the crisis is concerned, the eurozone represents the more stable part of the EU while countries outside the eurozone are affected by stronger currency turbulence. On the other hand, the government and the central bank no longer have the power of certain interventions that they were capable of when Slovakia had its own currency, which sometimes could be even beneficial, if these decisions are not that effective.

Another aspect of the euro is the question of purchasing power and the price levels in Slovakia when compared to other European Union countries where their currencies are weakening. Prices in Slovakia are higher, mainly due to the strong conversion rate at which Slovakia switched to the euro and the weakening of neighbouring currencies and we have seen many advantages of the strong currency or exchange rate. Nevertheless, it also has the opposite side, because the euro is naturally strong also when we consume it. The strong euro is also a considerable problem for many Slovak exporters since it weakens their ability to remain competitive in terms of prices.

TSS: In one of its analyses Deloitte suggested that infrastructure investments will be the area which can most benefit from the involvement of the public sector during the crisis. Could you explain the reasons for this?
VM: The study assumes a more intense interest from investors in infrastructure and PPP projects which involve the public sector. The advantages of these projects are that they are long-term undertakings and that their profitability can be fairly reliably calculated while the potential risks can be assessed as well. Also, Slovakia is in a real need of having its infrastructure projects completed since it is a precondition for keeping Slovakia attractive to foreign investors. Along with the direct investments of funds, I also see the multiplying economic effects that can directly help to revive Slovakia’s economy. These projects are also a way to narrow regional disparities in Slovakia. Even though the government has declared the completion of a cross-country highway by 2010, the truth is that the tempo of building highways in Slovakia is one of the slowest. Besides, times of crisis do have the potential to put pressure on making public spending effective and push the government towards projects that during times of prosperity do not seem as urgent.

As for the PPP projects, the advantage is that the public sector does not need to go too deeply into debt while with the involvement of the private sector in these projects makes them more effectively managed than they would be if they were managed entirely by the public sector. The disadvantages are similar to those attached to any large project, such as the tendency of overpricing, regardless of their method of financing.

TSS: You have also suggested that central Europe will continue to attract direct foreign investment only if there are urgent changes made to its educational systems, which would bring new skills, especially in harmony with the demands of the market.
VM: Slovakia and the surrounding countries are still attractive for foreign investors. We also have to realise that despite the GDP growth that has been achieved during the past years that our productivity is still under the European Union average just as is the saturation by investments. Our tax system is still attractive and we still have relatively low labour costs, but on the other hand we must not make a fetish of only taxes: they are important for foreign investors but investors also look at other things such as political stability, transparency of the economy and issues of corruption and the enforceability of the law.

Since Slovakia was struggling with both short-term and long-term unemployment which led the EU jobless charts, any jobs were desirable for the country. Later we started witnessing the lack of qualified labour which has shown that the education sector must more intensively reflect the real needs of businesses. There has been an imbalance between what the economy needed and what the schools produced. We also need to be cautious not to become just an assembly hall of Europe and to attract more investments with higher added-value so that more know-how is transferred to Slovakia. These are the tasks that we face whether there is a crisis or not; however, their importance increases in the times of crisis. If we are successful in solving these problems we have a greater chance to overcome the crisis without larger losses.

Topic: Finances and Advisory

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