2021 Article IV final statement from mission staff
Slovakia – 2021 Article IV Mission Staff Final Statement
May 18, 2021
A final statement describes staff’s preliminary findings at the end of an official staff visit (or “mission”), in most cases to a member country. Missions are undertaken within the framework of regular consultations (generally annual) under Article IV of the IMF Articles of Agreement, within the framework of a request for the use of IMF resources (borrowing from the IMF), within the framework of discussions of programs followed by IMF staff, or part of other staff monitoring economic developments.
The authorities have consented to the publication of this statement. The views expressed in this statement are those of the staff of the IMF and do not necessarily represent the views of the Executive Board of the IMF. Based on the preliminary findings of this mission, staff will prepare a report which, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.
Slovakia faced the COVID-19 pandemic from a position of strength, and effective political support limited the economic fallout. As the second wave of infections recedes, the economy appears to be heading for a strong recovery this year and next, although uncertainty remains very high. Continued fiscal support is warranted, until the recovery is firmly entrenched, but policies should be increasingly targeted and focused on facilitating the reallocation of resources and enhancing the potential of the economy. The rebuilding of fiscal cushions should begin once the recovery is on a solid footing to create policy space and increased aging-related spending. Financial sector policies should continue to allow the granting of credit, while protecting against the build-up of risk. Structural reforms that strengthen human and physical capital and boost productivity will be essential to support robust and inclusive growth in the aftermath of the pandemic. The timely and efficient use of EU funds and the implementation of the reforms outlined in the Recovery and Resilience Plan can play a key role in supporting the recovery, expanding the potential of the economy and accelerating green and digital transformations.
The COVID-19 pandemic has taken a heavy toll on the Slovak economy, but policies have helped cushion the negative impact on households, businesses and banks. The 4.8% output contraction in 2020 was more moderate than the euro area average, reflecting a strong and timely policy response and resilient external demand. A range of measures taken by the authorities have saved tens of thousands of jobs and businesses.
The outlook for this year is for a strong economic recovery, although uncertainty remains very high. As the second wave of infections recedes and political support continues, real GDP growth could reach 4.7% this year and accelerate further in 2022. The pace of the recovery depends on the race between the virus and vaccination. New waves or variants of the virus could slow activity, while a successful containment and sweeping stimulus packages in the US and EU could push growth above our expectations. In this highly uncertain environment, there is a premium in getting the right mix of policies.
Fiscal policy must balance livelihood support with incentives for reallocation of labor and capital, bearing in mind the need to rebuild fiscal space when economic recovery is entrenched. Given the increased uncertainty, it must remain nimble, adjusting and clearly communicating overall fiscal targets and the mix of policy measures in response to changing conditions.
For 2021, the stability program envisages an appropriate fiscal stance, with a higher allocation for health spending, the first aid program, support for certain sectors and buffers for contingencies linked to the pandemic. As the recovery gains momentum, the mission encourages the authorities to shift the policy mix from broad-based emergency aid to targeted measures that prevent the crisis from eroding the potential for the economy. For example, the rise in long-term unemployment could be constrained by active labor market policies, such as well-targeted hiring subsidies, training and retraining, which would help workers reorient themselves towards the lesser parties. more dynamic of the economy. Targeted solvency support to viable businesses, especially SMEs in hard-hit sectors, could prevent excessive bankruptcies. If activity surprises on the rise, it would be desirable to keep unspent reserves for contingencies linked to the pandemic.
When robust expansion is firmly in place, fiscal buffers will need to be replenished to create policy space and cope with rising aging-related spending. If the timing of consolidation is to depend on the economic situation, it will be important to start the planning process now in order to provide a credible medium-term fiscal path by defining concrete measures. Strengthening tax efficiency and increasing property and environmental taxation could generate significant tax revenues. On the expenditure side, the full implementation of cost saving measures identified in the expenditure reviews should free up resources without compromising the quality of public services. To mitigate the economic impact of consolidation, it will be essential to ensure the timely and efficient absorption of large EU funds, a challenge for Slovakia in the past.
The envisaged amendments to the constitutional law on fiscal responsibility and certain elements of the pension reform will be essential to help restore fiscal space and strengthen public finances. The introduction of multi-year expenditure ceilings will ensure that fiscal buffers are built up in times of economic strength. Linking the retirement age to life expectancy and minimizing the cost of the parental premium would be crucial for the long-term sustainability of the pension system. It is encouraging that the authorities have committed to introducing spending ceilings and re-establishing the link between retirement age and life expectancy in the recovery and resilience plan and the mission supports their rapid implementation. : this would send a strong signal of the government’s commitment to fiscal prudence and reforms.
Financial sector policies
The banking sector has weathered the COVID shock well so far, but the full impact of the pandemic remains uncertain. The banking system is profitable, liquid and well capitalized. The proactive use of micro and macroprudential measures has succeeded in limiting the build-up of systemic risk during a prolonged period of rapid financial deepening of the household sector. Repayment problems after the end of the loan moratoriums are relatively low and NPLs continue to decline. Nonetheless, the mission’s analysis suggests that the risks of insolvency in certain segments of the companies’ portfolio have increased due to the pandemic, and that there is still a risk of a wave of bankruptcies when the fiscal measures and other supportive measures. Continued rapid mortgage growth, fueled by fierce competition and falling interest rates, growing household debt and rising house prices demand continued vigilance.
Policymakers will need to strike a balance between safeguarding the soundness of the financial sector and sustaining credit growth.
- To ensure an adequate supply of credit to the corporate sector, it will be important to maintain liquidity support through secured loans. However, the authorities should assess the conditionality of the various arrangements deployed so far and adjust them appropriately to encourage adoption by banks and businesses. If downside risks materialize, authorities should stand ready to release the countercyclical capital buffer or relax regulatory requirements for retail lending to support the supply of credit. Prudential flexibility must be carefully withdrawn once the pandemic is under control, with supervisors ensuring a healthy supply.
- The macroprudential stance is broadly adequate from a financial stability perspective, and the mission’s stress tests suggest that the banking system has sufficient capital to withstand a wide range of shocks. The authorities could consider taking advantage of the new flexibility provided by the Capital Requirements Directive (CRD V) and explore a targeted use of the systemic risk buffer to address the specific risk arising from exposures to the real estate market.
Structural reforms should aim to limit the long-term effects of the crisis and prepare the ground for robust, sustainable and inclusive growth. Emphasis should be placed on facilitating the reallocation of resources, investing in human and physical capital and increasing productivity.
- The labor market has shown resilience, but the impact of the pandemic has been uneven between workers and regions. Targeted measures are needed for those disproportionately affected by the crisis. More generally, as the pandemic could accelerate structural transformation, trends in automation and digitization and reshaping global value chains, more effective labor market and education policies will be needed to facilitate the transition of workers between jobs, through lifelong learning, hiring subsidies.
- Effective restructuring mechanisms and insolvency frameworks will support the reallocation of resources and improve the business climate. The reforms and investments proposed in this area in the recovery and resilience plan (for example, the digitization of insolvency processes, early warning systems and specialization of courts) are welcome.
- The quality of education in Slovakia is lower than that of peers in the EU. Investments in research, innovation and digitization lag, while productivity is hampered by an uncertain regulatory environment and perceived gaps in governance and, more broadly, public sector efficiency. The ambitious investments and reforms included in the recovery and resilience plan address many of these challenges. The authorities are also appropriately leveraging large NGEU funds to accelerate the digital and green transformation of the economy. The swift and efficient execution of these investments and the steadfast implementation of reforms could increase the potential of the economy and revive income convergence.
The mission would like to thank the authorities and other counterparts for the frank, constructive and insightful dialogue and the productive collaboration.