While global growth has already peaked, Slovakia is likely to gear up its real GDP growth in 2019 as the Jaguar Land Rover plant in Nitra will start producing at full capacity. Potential US car tariffs and a no-deal Brexit, nevertheless, are particularly big concerns for Slovakia, given its intensive trade links with the US and UK.
The ongoing expansion of the Slovak economy, meanwhile, is accompanied by intensifying capacity constraints, especially on the labour market. As a result, wage costs will increase yet further and companies, especially in the automotive sector, will have to rely ever more on the import of foreign labour.
After rapid growth in 2017, the global economy has moderated its growth in the first half of 2018. As world trade volumes and industrial production have slowed, growth downshifted in all major countries in Europe. Slovakia, in contrast, has actually seen its pace of economic growth pick up. Indeed, the real GDP grew 4.2 percent year-on-year in the second quarter of 2018, up from 3.6 percent in the first quarter and 3.4 percent in 2017 as a whole.
A detailed GDP composition, however, reveals that growth was pushed mainly by the automotive industry, which in the second quarter posted both extraordinary exports and investments. While the rise in exports was due to shipments of already established car manufacturers in the country, especially Volkswagen, the investment boost came primarily from the newcomer, the Jaguar Land Rover (JLR). JLR has now completed its factory in Nitra and thus booked a large part of its intended €1.4 billion overall investment spending. Growth outside the automotive linked sectors, has slowed, alongside the developments elsewhere in Europe.
Mind the car tariffs…
As JLR gradually rolls out its production to full capacity, the real GDP of Slovakia may well exceed 4 percent in 2019. After all, the overall contribution of the JLR investment and production plans has the potential to boost the GDP by a cumulative 1.5 percentage points by 2021.
Yet, 2019 growth projections are subject to several downside risks, mostly emanating from outside Slovakia. Increased US trade protectionism and potential car tariffs are one particular risk, given the importance of the automotive industry for the Slovak GDP.
Indeed, Slovakia is the EU’s most exposed country to the US car market, to which it exports cars worth an equivalent of 1.7 percent of GDP. On current production plans, a potential 25 percent car tariff would hit GDP growth in 2019-20 by 0.1 percentage point per annum. Moreover, an indirect hit from spoiled confidence (e.g. postponed investments) could be two to three times as big as the direct hit.
Although some consolation may be provided by less price sensitivity to the luxury car segment that dominates Slovak car exports to the US (e.g. Audi Q7, Porsche Cayenne, VW Touareg), the projected GDP trajectory surely will have to be revised should the car tariff scenario materialise.
Another downside to the GDP projection outside Slovakia’s control is the ill-prepared exit of the UK from the EU in March 2019. A no-deal Brexit will hit Slovakia hard. Slovakia has a positive trade balance with the UK, which in absolute terms is superseded only by Germany and France. Nearly 100,000 Slovaks work and live in the UK and there are also substantial business relationships between the two countries.
The hits to exports and imports from increased trade frictions, as well as the hits to consumer spending and business investment in the case of a no-deal would therefore be significant.
On Oxford Economics modelling, a no-deal Brexit would result in the level of Slovakia’s GDP being 0.6 percent below the baseline forecast at the end of 2020. Only four other EU countries, including the UK, would be hit harder.
To be sure, rising trade barriers and a no-deal Brexit are sizeable and not exhaustive risks to the European and global economic outlook. Rising oil prices, higher political risks and the reversal of capital inflows to emerging markets are other global risks that recently became more pronounced.
In the baseline scenario, though, global growth is slowing, but not stalling completely. In the latest October 2018 World Economic Outlook, the International Monetary Fund (IMF) lowered global growth projections for 2018-2019 by 0.2 percentage points for both years compared to the forecast six months ago. The revised growth level, however, is the same as that in 2017, at 3.7 percent.
Growth in the eurozone in 2019 is forecast by the IMF at 1.9 percent, only a 10th below the pace in 2018. Analysts in Intesa Sanpaolo Research see growth in the eurozone moderating a bit more, towards 1.7 percent, but should still remain above trend (1.5 percent), which they believe will be achieved in 2020. While prospects for global trade have clearly deteriorated compared to the outlook a year ago, foreign demand for Slovak exports should remain reasonably supported in 2019.
The outlook for domestic demand, the other leg of GDP growth, remains encouraging. Household consumption, in particular, should remain well supported as jobs are plentiful and wage incomes are increasing – a scenario that is likely to prevail in the year ahead. Namely, the demand for labour will remain hot as the economy fires on all cylinders. The supply of labour, however, is becoming increasingly short as population ageing and other adverse demographic trends set in.
Already now, labour shortages are common across manufacturing and service sectors. Employers can no longer find an available labour force on the local market and therefore increasingly resort to a foreign one. Over a year ago, through August 2018, the number of foreign employees increased by 18,000, or 42 percent. More are expected to come. Slovaks working temporarily abroad are now returning home. From the peak two years ago, some 25,000 moved back (to 140,000).
Clearly, it is employees who are gaining the upper hand on the labour market. And wage growth, unsurprisingly, is gearing up. The average nominal gross wage reached €1,004 in the second quarter and was 6.4 percent higher than a year ago. Expect even faster wage growth in the year ahead. This will clearly support household spending, but on the other hand may cool the production and investment plans of some companies.
On investments, the government will come to the rescue. In 2018, local governments are spending money as they repair road infrastructure ahead of the municipal election in November 2018. Next year, the central government will take over fiscal electioneering and pump up infrastructure spending ahead of parliamentary elections in early 2020.
Luckily for public finances, the strong economy delivers fiscal leeway that leaves room for extra spending and a declining public deficit. In 2019, the deficit should amount to a mere 0.1 percent of GDP. And in 2020, the public finance budget should be balanced for the first time ever. The overall public debt is heading below 50 percent of GDP in the current year and predicted to fall below 45 percent by 2021. Slovakia thus continues to enjoy investor confidence and government bonds remain tightly priced, just 50 base points above German benchmarks in 10-year maturity.
With a prospective termination of European Central Bank’s asset purchases by the end of 2018 and start of the oficial rate normalisation after summer 2019, bond yields in the eurozone will likely gradually increase. Still, given the projected decline in public debt, Slovak bonds will remain in short supply and thus well bid by potential investors. The prospective increase in Slovak bond yields will thus remain limited to those of core eurozone markets, Germany in particular.
31. Dec 2018 at 15:00 | Zdenko Štefanides, chief economist at VÚB bank