RFE/RL NEWSLINE
Vol 1, No. 151, 3 November 1997


IS SLOVAKIA'S ECONOMIC REPUTATION ABOUT TO TARNISH?

by Michael Wyzan

According to the Western view, Slovakia's economy is a solid
performer and only political factors have kept the country out of
European institutions and NATO. Indeed, the European Commission
said as much when it explained its decision in mid-July not to
recommend Slovakia among the five postcommunist countries to be
invited to accession negotiations.

But this year, there have been indications of looming economic
problems, especially growing foreign sector imbalances. Until now,
however, fiscal--and especially monetary--policy has been run
competently, resulting in low inflation and rapid economic growth.

Some indicators suggest 1997 is shaping up to be another
satisfactory year for the Slovak economy. Consumer prices rose by 6
percent in the 12 months to July, compared with 9.3 percent in the
Czech Republic, 18.2 percent in Hungary, and 15.0 percent in Poland.
Gross domestic product (GDP) grew by 6.2 percent in the first half,
while industrial output was up 3.7 percent in the first seven months.
Among transition economies, only Estonia and Poland are growing
more rapidly.

On a less positive note, the unemployment rate remained high at
12.8 percent in July, compared with 12.5 percent a year earlier.
Recent declines in Polish unemployment rates mean that Slovakia
now has Visegrad's highest jobless figures. Slovakia also has a large
and growing budget deficit, predicted to reach between 4.6 and 5.7
percent of GDP this year. That figure is much higher than in Poland
or the Czech Republic and is similar to Hungary's. It reflects a steady
increase from 4.4 percent last year and 1.6 percent in 1995.

But the main cause for concern is the foreign sector. The first seven
months of the year revealed a current account imbalance of $1.006
billion and a trade deficit of $986 million. Predictions for the size of
the former for all of 1997 range from 10.4 to 15 percent of GDP, the
highest among the Central European and Baltic economies. Moreover,
Slovakia is a relatively unattractive country for foreign investors. As
of mid-1996, Slovakia's per capita foreign direct investment stood at
$152, compared with $1,299 in Hungary, $586 in the Czech Republic,
and $265 in Poland.

With so little foreign investment and such large current account
deficits, it is not surprising that Slovakia's official foreign exchange
reserves declined from $3.47 billion at the end of 1996 to $3.181
billion in August. Reserves of approximately the current level would
cover 2.7 months worth of imports, while the equivalent figures for
the Czech Republic, Hungary, and Poland are 3.8, 4.4, and 5.6,
respectively.

Such low reserves mean that Slovakia is ill prepared to defend the
crown against speculative attack. Pegged to a currency basket that
includes the U.S. dollar, it has strengthened recently against the
German mark and the Czech crown. Whereas in January 1996 one
Slovak crown was worth 90 percent of a Czech one, that figure is now
99.24 percent following the economic turmoil in the Czech Republic
earlier this year

The Slovak situation resembles that in Mexico in 1994 or in Thailand
last year, when both countries were on the verge of currency crises
that turned into macroeconomic disasters. When "The Economist"
magazine examined a number of macroeconomic indicators for the
Visegrad and Baltic nations, it gave Slovakia 10 points on a scale
from 1 to 12, with 12 representing the greatest risk. Only Lithuania
was rated riskier, with 11 points (pre-crash Mexico scored 10
points). Many analysts hold that a significant weakening of the crown
is virtually inevitable, resulting in higher inflation and slower
points). Many analysts hold that a significant weakening of the crown
is virtually inevitable, resulting in higher inflation and slower
growth.

The key to Slovakia's prospects is the quality of policy-making. As in
Southeast Asia this year, inadequate responses to the first alarming
signs sharpen and prolong subsequent crises. Slovakia is especially
worrisome because policy-makers have responded to troubling
indicators by resorting to counterproductive actions.

To reduce the budget deficit, Bratislava has raised value-added tax,
slapped a 7 percent surcharge on most imports, and is discussing
levying a tax on portfolio investment. The leadership remains
opposed to following the Czech lead and devaluing the crown, which
in Slovakia is defended with high interest rates and tight money.

Pulling in the opposite direction from the fiscal standpoint, recent
"economic revitalization" measures allow firms in high-
unemployment areas to apply for debt forgiveness from the state
and to defer tax, excise duty, and social security payments. Another
source of budget revenue loss are the tax holidays for foreign
investors who meet certain conditions.

Slovakia's relatively good figures for inflation and economic growth
have obscured an important fact. Slovakia's economic policy-makers
are often as heavy-handed as the Bulgarian Socialists under Zhan
Videnov, who by February 1997 had brought the Bulgarian economy
to the verge of total collapse.

The author is a research scholar at the International Institute for
Applied Systems Analysis in Laxenburg, Austria.

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