A year of change in 2010

2010 will undoubtedly be recorded in Slovakia’s modern history as the year of multiple elections, significant political change at the level of state government and the beginning of a national belt-tightening programme to bring the country’s finances into better balance.

The new government of Iveta Radičová faces some tough tasks over the next four years. The new government of Iveta Radičová faces some tough tasks over the next four years. (Source: SME)

2010 will undoubtedly be recorded
in Slovakia’s modern history as the year of multiple elections, significant political change at the level of state government and the beginning
of a national belt-tightening programme to bring the country’s finances into better balance.

After June’s parliamentary election it was clear that four centre-right parties would take the driver’s seat in Slovakia for the next four years, and that these parties envisioned taking a different route to what the country had experienced during the past four years, under the helm of former prime minister Robert Fico and his coalition partners.

After the polls closed on June 12, the four centre-right parties, the Slovak Democratic and Christian Union (SDKÚ), the Freedom and Solidarity party (SaS), the Christian Democratic Movement (KDH), and the Most-Híd party, together gained eight seats more in the national parliament than those won by the Smer party and the Slovak National Party (SNS).

Even though the party of Robert Fico, Smer, won the highest number of votes by a large margin, the former prime minister was unable to find a coalition partner or partners with which to form a government because Vladimír Mečiar and his Movement for a Democratic Slovakia (HZDS), which had been a member of the previous coalition, had disappeared literally and symbolically after the election by failing to attract the 5 percent needed to enter parliament. The SNS, the other coalition party in the past government, cleared the threshold by only a whisker.

Shortly after the four centre-right parties signed a coalition agreement to govern in early July, Prime Minister Iveta Radičová stated that her government was throwing itself into the gargantuan task of cleaning up after the Fico government and mending the damages caused by the global economic downturn.

Radičová’s government has declared a crusade against corruption and cronyism, an intention to overcome problems that it perceives in the business environment and the country’s judiciary, and pursuit of thorough reform in the country’s education system, all the while promising a better political culture.

But the Radičová government did not have an easy takeoff: her government had to deal with the aftermath of devastating summer floods across large parts of Slovakia, defuse controversy over Slovakia’s decision to not participate in an EU loan to Greece, and also handle questionable ethical decisions made by several newly-appointed ministry officials.

In November 2010 it is still too early to assess whether the declarations of the new government are merely the usual post-election rhetoric or an agenda that the coalition partners will genuinely try to achieve over the upcoming four years.

Dealing with the budget deficit

The Slovak government’s budget deficit in 2009 was 7.9 percent of GDP and the country’s total public debt reached 35.4 percent of GDP according to calculations made by Eurostat, the EU Statistics Office, the SITA newswire reported.

Slovakia ended up among the less responsible EU states in 2009 as only seven of the 26 countries that provided data to the EU reported a deeper budget deficit than Slovakia’s. However, in terms of total public debt the country still has one of the lowest ratios of indebtedness in the EU, according to Slovakia’s Finance Ministry.

After concluding a ten-day mission to Slovakia on July 19, the International Monetary Fund (IMF) estimated the country’s deficit could be as high as 7 or 8 percent of GDP in 2010 and stated that consolidation of public finances will be one of the greatest challenges facing the new Slovak government. The Radičová cabinet must also face the medium-term task of squeezing the government’s deficit under 3 percent of GDP by 2013, the target set by the EU’s Maastricht Treaty.

Slovakia’s new Finance Minister, Ivan Mikloš, and his predecessor Ján Počiatek have described the condition of the country’s public finances during the transition of power in starkly different terms.

Mikloš, a nominee of the SDKÚ who is in the finance minister’s post for a second time, used words synonymous with catastrophic to describe the situation. Počiatek, who was a nominee of the Smer party, said the outgoing government’s goal of squeezing the deficit down to 5.5 percent of GDP in 2010 was still realistic if the new government “practices what they preach”.

In mid 2010, market watchers scrapped deficit predictions to below 6 percent and suggested that the deficit would reach nearly 7 percent of GDP for 2010. They also said that the new government would face a gigantic challenge in bringing the rapidly-growing public debt under control.

Despite the rapid growth in public debt in recent years, Slovakia’s total public debt as a percent of GDP was the seventh lowest within the European Union at the end of 2009 according to a Finance Policy Institute report released by the Finance Ministry on June 30. At the end of 2009 public debt was 35.7 percent of GDP.

“The relative level of the public debt, as such, is not as alarming as the pace of its growth in recent years,” Vladimír Vaňo, chief analyst with Volksbank, told The Slovak Spectator. “Hence the 2009 deficit level is unsustainable not only due to EMU [European Monetary Union] obligations, the limits of the EU [Maastricht] Stability and Growth Pact, but also due to risks it poses for Slovakia’s sovereign rating.”

Radovan Ďurana of the INESS economic think tank said that the best way to illustrate the condition of the state budget is to compare its conditions for the first six months of 2010 with the pre-crisis year of 2008 in Slovak crowns: this year’s [2010] tax revenues are lower by Sk17 billion while the spending is Sk60 billion higher than 2008, a development which unavoidably leads to a higher deficit.

At the same time Ďurana said the comparison illustrates that a takeoff in the economy and tax revenues returning to the levels of 2008 will alone be insufficient to reach a balanced budget.
“The negative or stagnating development of tax revenues has been predictable and unfortunately the high deficit does not come as any surprise either since the outgoing government has ignored the need for fundamental cuts in public administration spending,” Ďurana told The Slovak Spectator earlier in 2010.

Mikloš announced his goal of decreasing the deficit by 2.5 percent of GDP in 2011, which given a deficit of 7 percent or more in 2010 will require a significant reduction in expenditures and a corollary increase in revenues. Ďurana of INESS believes that if the deficit for 2010 ends at 7.5 percent of GDP, or €4.9 billion, it might then be reduced to about 5 percent of GDP in 2011, or €3.5 billion.

Austerity package shocks many

The €1.7-billion austerity package announced by the government shortly after it took office will affect citizens across all segments of society, including state employees, pensioners, the self-employed, consumers and businesses, among others.

One of the most debated parts of the package was an increase in the value added tax by one percentage point to 20 percent as of January 2011. The government said VAT would return to the 19-percent level when the general government deficit falls below 3 percent of GDP, estimating that the country should reach this point as early as 2013. A lower VAT rate of 10 percent for books, medicines and some health-care products will be continued in 2011, though a reduced 6-percent VAT rate for farm-gate sales of agricultural products was abolished and such sales will be taxed at the full 20-percent rate.

The Finance Ministry estimated the higher VAT rate will increase the state’s revenue by €185.5 million in 2011, €196.3 million in 2012 and €209.3 million in 2013.

Radičová admitted that the VAT increase, which she labelled ‘Fico’s tax’ in reference to the past government under which the budget deficit ballooned, could increase some prices for final consumers but said she believes this action is the lesser evil.

Fico called the VAT hike “the worst right-wing solution” and claimed that the new ruling parties violated what he said was their pre-election promise to not increase taxes.

The government also asked for parliament’s approval to increase excise taxes levied on beer, tobacco and other goods. The excise tax on beer is proposed to change next March with the basic levy going up from €1.65 per hectolitre to €2.45, while the reduced rate for certain breweries would go up from €1.22 to €1.832 per hectolitre.

An increase in the excise tax on tobacco products is scheduled to occur in two phases. The first increase will take effect on February 1, 2011 while the second rise is scheduled for March 1, 2013.

These tax increases will bring the Slovak government into compliance with EU requirements to gradually increase the excise tax rate on tobacco to at least 60 percent of the weighted average price of cigarettes by 2014. The minimum rate should not be below €90 per 1000 cigarettes. Higher excise tax on tobacco products should contribute €15.9 million to revenues of the state in 2011 and €21.2 million in 2012, the TASR newswire wrote.

The Radičová cabinet also cancelled excise tax exemptions on coal and natural gas used by central heating companies for the generation of heat for households because this was at odds with a European directive on taxing energy products and electricity. Simultaneously, the cabinet cancelled the tax exemption on Compressed Natural Gas (CNG) used as a motor fuel.

The revision to these laws, to be effective on January 1, 2011, will generate additional revenue of €8.6 million in 2011 and €14.2 million in following years. The cabinet further decided to cancel excise tax exemptions for so-called red diesel used by farmers and for liquefied petroleum gas (LPG).

The government’s consolidation measures will also affect personal income taxes in 2011. A cabinet-approved change in lump-sum tax allowances for self-employed people will also have an impact on the income taxes these individuals pay in future. The cabinet approved unification of the three current levels of lump-sum tax allowances – 25 percent, 40 percent and 60 percent – at 40 percent.

The government has also imposed cuts on its own operations in order to reduce spending by €986 million in 2011: €154 million of the total was supposed to come from reduced public-sector wages. However, parliamentary deputies have shown some unwillingness to cut deeply into their own pockets.

Radičová’s first budget

The cabinet approved a bill outlining its first state budget on October 6, projecting a state deficit of just over €3.8 billion in 2011, based on total revenue of €13.092 billion and expenditure of €16.916 billion.

The deficit of the entire general government, which also includes the budgets of the state-owned health insurance company, universities, self-governing regions and the social security provider Sociálna Poisťovňa, is set at 4.9 percent of gross domestic product.

Though the parliamentary opposition is already grinding its teeth over the draft and Slovakia’s trade unions have shown little enthusiasm for the plan, political and economic observers believe that the draft would easily sail through parliament, opening up new chapters of belt-tightening in state administration, as well as of higher taxes on citizens.

Pensioners to feel the squeeze

The government did not spare Slovakia’s senior citizens as the cabinet approved a draft amendment to the law on social insurance on September 22 which will change the method by which annual increases in pensions will be calculated in the future. The government has argued that the changes are needed to plug a budget gap in the accounts of the country’s social insurer, Sociálna Poisťovňa.
Beginning in 2012 pensions provided by Sociálna Poisťovňa will be increased by a flat sum, rather than by a percentage increase. The annual increase will be based on the annual inflation rate calculated by Slovakia’s Statistics Office for the first six months of the previous year applied to the average old-age pension on June 30 of the past year. Currently, the annual increase in old-age pensions is calculated based on the inflation rate and the average rate of growth of wages in the national economy.

The proposed new calculation method will be used to determine a flat annual increase in all old-age, early retirement and disability pension benefits. Survivor pensions would be increased by only 60 percent of the fixed sum and orphan pensions by 40 percent of the calculated flat amount.
Using the current calculation method, pensioners will receive a monthly increase of 1.8 percent in 2011 based on the amount of their own individual pension rather than a fixed sum based on the average pension.

The government has also proposed a ban on people earning wages at the same time they draw an early retirement pension. Slovakia’s Pensioners’ Association has called on the government to preserve the current model for calculating annual pension increases, and said that one of the country’s most vulnerable groups is being targeted.

Unions reject measures and employers are cautious

Slovakia’s Confederation of Trade Unions (KOZ) has demanded that the state not tighten the country’s belt solely at the expense of employees and the most vulnerable groups in society. The unions opposed the 1 percentage point hike in VAT and instead demanded differentiated VAT rates, for example, lower ones for food products and a higher one for luxury goods.

The unions said the state should be more aggressive about curbing its own administrative expenses and changing some employment rules, KOZ spokesman Otto Ewiak told The Slovak Spectator.

KOZ also stated its opposition to the increase in the excise tax rate on coal and natural gas, farmers’ loss of a tax bonus through their use of so-called red diesel, and the government’s proposed pension reforms. The unions expressed disagreement with all the tax increases except those on tobacco products.

The Federation of Employers’ Associations (AZZZ) noted that the measures, specifically the hike in payroll tax deductions, will affect everyone: the self-employed, entrepreneurs and employees. The employers association also called for changes to the structure of the austerity package.

“We understand the need to consolidate the public finances but we are convinced that it should be done in a different way,” AZZZ said in a statement. “If the government wants to improve the business environment and increase employment and the quality of life of its citizens, it should avoid measures which will negatively impact not only business people but also regular citizens.”
AZZZ is worried, for example, that the higher excise tax on beer might harm the competitiveness of Slovak breweries and thus endanger hundreds of jobs.

During the first two weeks of October, trade union members rallied against the austerity package in Žilina and Košice and the protests culminated in a demonstration in Bratislava on October 12 which attracted more than 3,000 supporters.

Thus far, during the debate over the austerity package in parliament several changes have been suggested to the proposals which, in the end, might extract some of its teeth.

Tug-of-war over the Labour Code

The government has several times declared its intention of making the country’s labour law more flexible in order to support job creation in Slovakia – which has an unemployment rate over 12 percent. Making these changes promises to be a laborious undertaking. The trade unions are happy with the law’s current form; employers are demanding that it be made simpler, more flexible and more easily understandable; and foreign investors are saying the labour law should reflect the specifics of the country’s economy and social system while preserving Slovakia’s competitiveness.

Labour Minister Jozef Mihál (SaS) stated in late October that the trade unions and employers had already tabled some opposing proposals in their first discussion: trade union leaders called for a reduction in overtime hours and shortening of regular working hours while employers wanted more flexible working hours and asked that requirements for pay during a layoff notice period as well as severance pay be eliminated.

Employers also proposed that the notice period for layoffs should be shortened and that there should be a longer probationary or trial period for newly-hired employees.

The American Chamber of Commerce in Slovakia (AmCham), which groups over 300 companies doing business in the country, on October 26 suggested making the legal definition of ‘dependent work’ more specific, and that termination of work contracts be made more flexible, as ways to improve the labour market. Slovakia’s Labour Code generally only covers those employees with ‘dependent work’ established through an employment relationship and the code does not apply to business or trade activity based on contractual civil-law or commercial-law relationships.

More flexibility for employers to regulate working hours, including overtime or night shifts, along with the removal of what the chamber called unjustified powers of representatives of trade unions also appeared on AmCham’s list of suggestions. The chamber also proposed expanding the possibility for employers to use temporary employees.

Mihál said at that time that he was positive about AmCham’s suggestions and that he too is bothered by the current definition of dependent work, which he said needs to be more precise and dynamic.

One of KOZ’s priorities is also to unambiguously define dependent work. KOZ says doing so is
important because during the economic crisis a huge number of self-employed people emerged after employers “directed” their employees and job applicants into “forced self-employment” if they wanted to secure a job or continue in a work position. The union confederation charged that by doing so these employers eliminated their obligation to pay compulsory social insurance contributions because self-employed persons are not considered employees.

In early November it was nearly impossible to predict what form a modified Labour Code might take.

Privatisation and highways

One of the criticisms that former prime minister Robert Fico (Smer) has been directing towards the new government is that the Radičová team would start selling state-owned property and businesses. The new government has reopened the issue of privatisation of several state-owned companies operating in the transportation sector but has rejected the criticism that there will be any mass privatisation.

The Ministry of Transport said, that it has identified a compelling need to seek a strategic partner for ZSSK Cargo, Slovakia’s non-passenger rail transport company, as well as for the state-owned Bratislava Airport.

Fico also stated that he expected the government to kill some of the highway construction initiatives launched by his government to fulfil Slovakia’s goal of having a cross-country highway linking Bratislava in the west with Košice in the east. In mid September, Transport Minister Ján Figeľ did scrap a public-private partnership (PPP) package to build a 75-kilometre section of highway between Martin and Prešov using a consortium involving the construction giants Doprastav and Váhostav-SK, Slovak companies that are now set to lay off hundreds of employees by the end of the year.

Figeľ said it is possible to reopen this PPP package and to find a way to build the highway sections based on new tenders.

The Radičová government has been critical from its first days in office of building a highway via the so-called northern route to connect Bratislava and Košice. While the new cabinet has not totally rejected the idea of undertaking highway projects via PPPs, it has stated its vision to finance highway construction more from the state budget, EU funds, and other resources. Figeľ said he wants highway construction in Slovakia to continue but in a more responsible and transparent way.

Greece and the euro safety net

In the midst of trying to mend the growing hole in its own government accounts, Slovakia also had some explaining to do for its European partners over its refusal to participate in the EU’s emergency aid loan to Greece.

At the recommendation of the Radičová government, parliament in August agreed that Slovakia would not bear any share of the cost of the EU’s rescue loan to Greece and rejected the additional codicils to an agreement signed by the previous government that were necessary if Slovakia were to contribute any cash to the Greek loan. The bilateral loan would have required Slovakia to contribute up to €816 million over the next three years. The total amount that the EU has tabled to prop up the troubled Greek economy now exceeds €100 billion.

Parliament did agree that Slovakia would participate in the European Financial Stability Facility, a broader plan to assure stability within the eurozone.

The Reuters newswire quoted a memo describing the September meeting of eurozone finance ministers which suggested that Slovakia’s decision had upset Jean-Claude Trichet, the president of the European Central Bank (ECB) who expressed “outrage” at Slovakia’s defiance of European solidarity.
Trichet allegedly said that in hindsight the ECB should have blocked Slovakia’s eurozone membership. Slovakia adopted the euro in January 2009. Slovak government officials have responded to this criticism by saying they are simply protecting the country’s legitimate interests.

More information about Slovak business environment you can find in our Investment Advisory Guide.

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