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Slovakia - Staff Concluding Statement of the 2021 Article IV Mission

May 18, 2021

A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.

The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.

Washington, DC: Slovakia faced the COVID-19 pandemic from a position of strength and effective policy support has limited the economic fallout. With the second wave of infections receding, the economy seems headed for a strong recovery this year and next, though uncertainty remains very high. Continued fiscal support is warranted, until the recovery is well entrenched, but policies should be come increasingly targeted and focused on facilitating resource reallocation and strengthening the economy’s potential. Rebuilding fiscal buffers should begin once the recovery is on a firm footing to create room for policy maneuver and rising aging-related spending. Financial sector policies should continue enabling credit provision, while guarding against the buildup of risks. Structural reforms that strengthen human and physical capital, and boost productivity will be essential to sustain robust and inclusive growth in the aftermath of the pandemic. Timely and effective use of EU funds and the implementation of reforms outlined in the Recovery and Resilience plan can play a key role in supporting the recovery, expanding the economy’s potential and accelerating green and digital transformations.

The COVID-19 pandemic exacted a heavy toll on the Slovak economy, but policies helped cushion the negative impact on households, firms, and banks. The output contraction of 4.8 percent in 2020 was milder than the Euro Area average reflecting a sizable and timely policy response and resilient external demand. An array of measures deployed by the authorities helped save tens of thousands of jobs and businesses.

The outlook for this year is for a strong economic recovery though uncertainty remains very high. With the second wave of infections receding and continued policy support, real GDP growth could reach 4.7 percent this year and accelerate further in 2022. The pace of the recovery depends on the race between the virus and vaccination. New virus waves or variants could slow activity, while successful containment, and large stimulus packages in the US and EU could lift growth above our projections. In this highly uncertain environment, there is a premium on getting the policy mix right.

Fiscal policy

Fiscal policy needs to balance support for livelihoods with incentives for reallocation of labor and capital, while not losing sight of the need to rebuild fiscal space when the economic recovery is entrenched. Given the heightened uncertainty, it needs to stay nimble, adjusting and communicating overall fiscal targets and the mix of policy measures clearly in response to changing conditions.

For 2021, the Stability Program envisages an appropriately supportive fiscal stance, with higher allocation for health spending, the First Aid scheme, support to selected sectors and buffers for pandemic-related contingencies. As the recovery gains traction, the mission encourages the authorities to shift the policy mix from broad-based emergency support to targeted measures that prevent the crisis from eroding the economy’s potential. For example, the rise in long-term unemployment could be limited by active labor market policies, such as well-targeted hiring subsidies, training, and reskilling, that would help workers reallocate to the more dynamic parts of the economy. Targeted solvency support to viable firms, especially SMEs in hard hit sectors, could prevent excessive bankruptcies. If activity surprises on the upside, it would be advisable to save the unspent reserves for pandemic-related contingencies.

When a robust expansion is firmly in place, fiscal buffers will need to be rebuilt to create room for policy maneuver and accommodate rising aging-related spending. While the timing of consolidation should depend on the economic situation, it will be important to begin the planning process now in order to provide a credible medium-term fiscal path by laying out concrete measures. Strengthening tax efficiency and raising real estate and environmental taxation could yield sizable fiscal revenues. On the expenditure side, fully implementing savings measures identified in spending reviews should free up resources without compromising the quality of public services. To alleviate the economic impact of consolidation, it will be crucial to ensure the timely and effective absorption of the sizable EU funds, a challenge for Slovakia in the past.

Envisaged amendments to the Constitutional Act on Budgetary Responsibility and some elements of the pension reform will be critical to help reestablish fiscal space and strengthen public finances. The introduction of multiannual expenditure ceilings will ensure the buildup of fiscal buffers during times of economic strength. Relinking retirement age to life expectancy and minimizing the cost of the parental bonus would be crucial to the long-term sustainability of the pension system. It is encouraging that the authorities have committed to introduce expenditure ceilings and restore the link between retirement age and life expectancy in the Recovery and Resilience Plan and the mission supports their prompt implementation: it 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 successfully limited the buildup of systemic risk during a prolonged period of rapid financial deepening of the household sector. Problems with repayment after the end of loan moratoria are relatively low and non-performing loans continue to decline. Nonetheless, the mission’s analysis suggests that insolvency risks in some segments of the corporate portfolio have increased because of the pandemic, and there is still a risk of a wave of bankruptcies when fiscal and other support measures expire. Persistently rapid mortgage growth, fueled by fierce competition and declining interest rates, growing household indebtedness, and rising real estate prices require continued vigilance.

Policymakers will need to balance safeguarding financial sector soundness and sustaining credit growth.

  • To ensure adequate credit supply to the corporate sector, it will be important to maintain liquidity support through guaranteed loans. However, the authorities should assess the conditionality of the various schemes deployed so far and adjust these appropriately to encourage take-up by banks and businesses. Should downside risks materialize, the authorities should stand ready to release the countercyclical capital buffer or relax regulatory requirements for retail lending to support credit supply. Prudential flexibility should be carefully withdrawn once the pandemic is under control, with supervisors ensuring sound provisioning.
  • The macroprudential stance is broadly adequate from a financial stability point of view 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 under Capital Requirements Directive (CRD V) and explore a targeted use of the systemic risk buffer to address the specific risk stemming from real estate market exposures.

Structural Reforms

Structural reforms should aim to limit the long-term effects of the crisis and set the stage for robust, sustainable, and inclusive growth. The focus should be on facilitating the reallocation of resources, investing in human and physical capital and boosting productivity.

  • The labor market has shown resilience, but the pandemic’s impact was uneven across workers and regions. Targeted measures are needed for those affected disproportionately by the crisis. More broadly, as the pandemic could accelerate structural transformation, automation and digitalization trends, and reshape global value chains, more effective labor market and education policies will be needed to assist the transition of workers between jobs, through lifelong learning, training, reskilling, and hiring subsidies.
  • Effective restructuring mechanisms and insolvency frameworks will support the reallocation of resources and improve the business environment. The reforms and investments proposed in this area in the Recovery and Resilience Plan (e.g. insolvency processes digitalization, early warning systems and specialization of courts) are welcome.
  • Slovakia’s education quality falls short relative to EU peers. Investments in research, innovation, and digitalization are lagging, while productivity is hindered 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 the sizable NGEU funds to accelerate the digital and green transformation of the economy. The timely and effective execution of these investments and the unwavering implementation of reforms could lift the economy’s potential and reignite income convergence.

The mission would like to thank the authorities and other counterparts for the candid, constructive and insightful dialogue and productive collaboration.

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