Via IMF (Den Internationale Valutafond)

On July 11, 2019, the Executive Board of the International Monetary
Fund (IMF) concluded the Article IV consultation

[1]

with the Slovak Republic and considered and endorsed the staff
appraisal without a meeting.

[2]

Following consecutive years of favorable performance, the Slovak
economy is facing deceleration. Strong domestic demand fueled by
double-digit household credit growth, robust job creation, and rising
wages as well as capacity expansions in the automotive industry has
lifted growth to 4.1 percent in 2018. With a positive output gap and
unemployment at record lows, rapid wage growth has been outpacing
productivity. Strong growth, together with past reforms in health and
social spending, has helped lower the fiscal deficit to below 1 percent
of GDP in 2018 and public debt below the lowest limit prescribed by the
national Fiscal Responsibility Act. Meanwhile, the banking system
remains stable and well-capitalized, although profitability is under
pressure.

Signs of deceleration in growth are becoming apparent owing to softer
external demand and weaker sentiment. As one-off effects of investment
in the automotive industry taper off, real GDP growth is projected to
slow to 3.5 percent this year and 3.1 percent in 2020 before converging
to its potential over the medium term. Private consumption is expected
to remain the main propeller of economic activity supported by
continued credit and wage growth. Higher exports on the back of
capacity expansions in the automotive sector are expected to contribute
to growth and narrow the current account deficit toward a balanced
position in the medium term.

The softer economic outlook faces significant uncertainties. A turning
economic cycle is unmasking several structural vulnerabilities.
Slovakia’s heavy dependence on exports and a concentrated export
structure makes the economy highly sensitive to ongoing global trade
tensions and risks of a no-deal Brexit. Meanwhile, the country’s
comparative advantages arising from the availability of low-cost skilled workers are being tested by
rising automation of assembly jobs. Structural challenges are
compounded by lingering weakness in public institutions and gaps in the
quality of education and infrastructure relative to EU peers. In
addition, a decade of strong credit growth has significantly raised
household indebtedness and made banks vulnerable to economic downturns.

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Executive Board Assessment

In concluding the 2019 Article IV Consultation with the Slovak
Republic, Executive Directors endorsed staff’s appraisal as follows:

With one-off effects of investment in the automotive industry tapering
off, growth is projected to decelerate and gradually converge to its
potential. Domestic demand, supported by robust wage and credit growth,
is expected to propel economic activities, while contributions from net
exports are also expected to improve on the back of recent capacity
expansion in the automotive sector. Continued international trade
tensions and a hard Brexit pose major downside risks to Slovakia’s
export-led economy. With still-high credit growth, households and banks
are vulnerable to possible labor and property market downturns.

Slovakia’s continued success in export-led growth strategy hinges on
capturing higher-value activities. Recent policy efforts to ensure an
adequate supply of qualified teachers and strengthen dual-track
vocational training should be complemented by improving the quality of
tertiary education and aligning higher education with technical skills
needs. Improving the coordination of public research system,
strengthening linkages between businesses and universities, and
ensuring full use of EU funds for R&D would help enhance innovative
capacity, which are important to move beyond assembly activities in
exports. To increase the role of domestic firms, reforms should target
a more predictable and enabling business environment, competitive and
transparent public procurement system, independent judiciary, and
well-developed infrastructure and logistics networks.

With the population set to experience fast ageing, efforts to ensure
optimal use of the domestic labor force are appropriate. An
insufficiently inclusive education system combined with a lack of
affordable early childcare facilities is contributing to the still-high
gender gap and regional disparities in labor market participation.
Legislative proposal to make schooling mandatory starting at age 5,
efforts to reintegrate the long-term unemployed into the labor market
and increasing availability of affordable childcare are welcome. This
should be complemented by active labor market policies to invest in
skills and increase employability of the marginalized groups, including
through better absorption of EU funds.

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With above-potential growth, a balanced budget target for 2019 and 2020
is appropriate but will require additional efforts. Recent fiscal
consolidation, driven by strong growth and policy efforts, has created
some fiscal space under the SGP. However, the public debt trajectory is
vulnerable to sizable economic downturns given strict escape clauses
and debt brakes prescribed under the national FRA. Sustained fiscal
consolidation will require fending off pressures to increase
discretionary stimulus, which has absorbed a good part of the revenue
windfall in recent years. The proposal to introduce multi-year
expenditure ceilings to anchor budget planning and execution, while
being consistent with the FRA and the SGP, would serve as an important
step to instill durable fiscal discipline. Overly strict escape clauses
may need to be revisited to avoid pro-cyclical fiscal tightening.

Higher revenue and spending efficiency are needed to create resources
for growth-enhancing social and infrastructure investment. Planned
measures to improve tax compliance through online electronic cashiers
and electronic taxpayer services should be sustained through further
strengthening of audit capacity in all core tax areas. Strong political
will and better
inter-ministerial coordination are needed to push through reforms
outlined in the spending reviews. Strengthening the mandate of the
implementation unit and incorporating actionable measures in the
medium-term budget would help actualize savings. Additionally, a more
robust public investment framework can improve the efficiency of public
investment and absorption of EU funds, including through better project
selection and prioritization at a national level.

The banking sector is stable and well-capitalized, but profitability is
under pressure and segments of vulnerability exist. A prolonged period
of low interest rates, a too benign credit risk assessments by banks,
the regulatory cap on mortgage refinancing fees, and the strong market
intermediation role of mortgage brokers result in the compression of
the lending margin. A sustained period of high credit expansion by
banks, especially to low income segments, has nearly doubled household
debt relative to disposable income. Moreover, rapidly rising flat
prices in urban areas and appreciating house price-to-income ratio
indicate growing vulnerabilities of households and banks, in
particular, smaller banks with less capital buffers.

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Proactive macro-prudential measures have moderated credit growth and
reduced credit risks of new loans. The incremental use of CCyB and
supervisory capital requirements have been appropriate in ensuring
adequate capital buffers for banks. Strong vigilance of smaller banks,
including through reduction of NPLs, is important and further increase
in capital buffers may be needed given their higher vulnerability.
Allowing the bank levy to expire as scheduled in 2021 should help the
smaller banks build more capital buffers. Given historically low
default rates, considerations should be given to impose add-on risk
weight on mortgages loans to ensure better internalization of credit
risks. To complement macro- and micro-prudential policies,
consideration should be given to reducing preferential tax treatments
for housing investment and removing obstacles to develop the rental
housing market.