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OPTIMISTIC GDP FIGURES ARE NO REASON FOR COMPLACENCY

Looking beyond Slovakia’s statistical miracle

REAL GDP growth as high as 2.7 percent for Slovakia in the second quarter appears rather impressive at first sight. This is especially so when placed alongside comparable regional peers, who are already mired in recession, as is the eurozone – a crucial export market for Slovak manufacturers. Hence, rather than indulging in an easy explanation of an ‘island of positive deviation’, a more detailed analysis of Slovakia’s performance is needed.

Household consumption, illustrative stock photo(Source: SME)

REAL GDP growth as high as 2.7 percent for Slovakia in the second quarter appears rather impressive at first sight. This is especially so when placed alongside comparable regional peers, who are already mired in recession, as is the eurozone – a crucial export market for Slovak manufacturers. Hence, rather than indulging in an easy explanation of an ‘island of positive deviation’, a more detailed analysis of Slovakia’s performance is needed.

After the Czech Republic’s rate of real GDP growth fell from -0.7 percent in the first quarter to -1.2 percent in the second quarter, Slovakia’s neighbour is now heading for its second full-year recession in the past four years. An identical sequence of declines in real GDP (-0.7 percent and -1.2 percent respectively) has been recorded by Hungary, which also slipped into recession this year.

These two bigger neighbours share with Slovakia both their high extent of openness to foreign trade, but also a similar composition of export markets, dominated by eurozone countries. After stagnating in the first quarter, the real GDP of the eurozone declined by an annualised 0.4 percent in the second quarter and a negative development is set to unfold in the second half too, as signalled by forward-looking indicators. The purchasing managers’ index of activity in manufacturing in the eurozone in July dropped to its worst level since June 2009 – i.e. during the previous recession.

A glimpse at Slovak aggregate industrial activity might at first sight prompt optimism. Slovak industrial activity expanded by double digits in the first half of 2012 (+10.1 percent year-on-year), compared with a decline of 0.75 percent in Hungary and a slowdown to +1.1 percent in the Czech Republic. However, a closer look reveals that eight out of 15 industries in Slovakia reported a year-on-year decline in production in the first half of this year.

The overall growth can be credited to a handful of major Slovak industrial sectors, such as production of transport vehicles (+42 percent year-on-year) and production of electrical equipment (+10.3 percent year-on-year). Even these figures appear almost too good to be true, given the development in these sectors across Europe.

But this paradox is easy to explain by recalling the experience from a few years ago, when Slovakia first experienced the more favourable side of the process that could be labelled geographic optimisation of production capacities by multinational corporations. Within this, even industries facing sluggish or declining demand try to streamline their costs by making higher use of their facilities in cheaper CEE countries, while downsizing more radically those with a higher cost base, usually in western Europe.

As we have seen in the automotive sector, this process can take the form of higher utilisation of CEE facilities, or even new investments. Several of these large scale investments, including over €1-billion worth of new manufacturing lines kicked into operation at the turn of the year and explain the huge annual growth in the Slovak automotive sector.

Although the breakdown of second-quarter Slovak GDP has not yet been published, we can reasonably expect it to be rather similar to the composition from the beginning of the year.

In the first quarter of 2012, final household consumption (C) declined by 0.1 percent year-on-year, a picture that is unlikely to turn around abruptly as real retail sales turned negative (-0.73 percent) in the second quarter. Final government consumption (G) was almost stagnant at the beginning of the year (+0.4 percent), but the inevitable fiscal restraint after the elections will keep this item subdued for the rest of the year.

With the outlook for Slovakia’s export markets heading south rapidly (German new industrial orders declined by 4.8 percent year-on-year in the first half of 2012), Slovak companies are reconsidering their expansion and modernisation plans as well. Hence after a 5.7-percent increase in gross fixed capital (I) in 2011, real investments declined by 3.9 percent in the first quarter. The worst readings of German business expectations since June 2009 are unlikely to change this picture in the second quarter: Germany alone accounts for one fifth of Slovak exports.

Therefore, through a process of gradual elimination, we are left with the item which has been the backbone of Slovakia’s real GDP performance ever since the end of the 2009 recession: the improvement in net exports (NX). In 2011, Slovakia recorded its best foreign trade surplus on record, to the tune of €2.4 billion (3.5 percent of GDP). With imports slowing faster than exports, the trade surplus jumped to an identical amount during just the first half of 2012 (€2.5 billion). That means a staggering 161-percent increase from the same period last year, and a more than four-fold jump in the second quarter alone.

However, in the third and forth quarter, the current year’s figures will begin to be compared with the notably higher base from last year and hence the annual change can be expected to subside gradually. And along with it, the aggregate reading of Slovakia’s real GDP growth will subside too.
In light of the necessary consolidation of Slovakia’s public finances, the optimistic aggregate macroeconomic figures from the first half of 2012 are definitely no reason for complacency about the risks posed by the unfolding eurozone recession.

As the first draft of the 2013 state budget has already been introduced it is worth recalling that the Prudent Man Principle calls for planning for the worst, while hoping for the best. A rough patch for the Slovak economy and employment in Slovakia lies ahead.

Vladimír Vaňo is chief analyst at Volksbank Slovensko

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