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Martin Wolf Q&A: Is Abenomics bound to fail?
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Put your questions to Martin Wolf here on Japan’s economic outlook
9 years ago
Slovakia has swiftly recovered from a deep recession, and is facing a favorable medium-term macroeconomic outlook, with real GDP projected to grow by around 4 percent per year. The policy focus should shift from crisis response to enhancing the foundations for long-term growth and stability. The main challenges will be to correct the crisis-induced underlying deterioration in the fiscal position, prevent credit boom-bust cycles, reduce the high unemployment and maintain strong productivity growth. Following important fiscal adjustment this year, consolidation will need to continue during 2012–13 with a view to bringing the government deficit below 3 percent of GDP in 2013. Achieving this challenging target will require a careful consideration of the composition of the adjustment efforts.
Outlook: a return to steady and robust growth
1. The Slovak economy has continued to recover since early 2010. Following a deep recession in 2009, real GDP swung to a robust 4 percent growth in 2010. The upturn has been larger than in most of Slovakia’s neighbors reflecting strong fundamentals and a surge in the export-oriented manufacturing sector, which benefited from a revival in global demand. In tandem, the financial sector has regained strength, profits in the corporate sector are recovering, real estate prices have stabilized, and the fiscal position is improving.
2. The growth outlook for 2011 and the coming years is strong. While growth will still be driven mainly by the export sector, a gradual rebound in domestic demand would provide some boost and broadly offset the withdrawal of fiscal support. As spare capacity diminishes and confidence firms, employment and private consumption will start to improve, albeit gradually. Overall, real GDP is projected to grow by about 3¾ percent in 2011 and by about 4¼ percent in 2012–15, among the strongest performances in the European Union (EU) but still significantly below the pre-crisis rate of expansion.
3. Inflation is projected this year temporarily to increase to about 3½ percent. Reflecting higher international oil and food prices, and an increase in VAT and excise taxes, inflation surged in early 2011. However, as core inflation remains well-anchored, headline inflation is projected to decline to below 3 percent in 2012 and beyond.
4. Downside risks remain considerable and are both external and domestic in nature. The global economic environment continues to be challenging, including on account of possible loss of market confidence related to adverse feedback loops between sovereign and bank risks, Mideast political turmoil, and uncertain oil and other commodity prices. Domestically, a renewed decline in real estate prices and a loss of fiscal credibility, if the government fails to achieve the targeted fiscal consolidation, are the main risks.
The policy agenda: from crisis response to growth and stability
Fiscal Policy: bringing the deficit below 3 percent of GDP in 2013
5. In spite of the recovery, the general government deficit remained high in 2010, at 7¾ percent of GDP. The deficit had widened to about 8 percent of GDP in 2009, as revenue contracted sharply and spending continued to expand at a fast pre-crisis pace. Reflecting the export-led recovery, revenue growth in 2010 fell short of GDP growth. With expenditure and output growing broadly in line, the deficit was almost unchanged from its 2009 level.
6. The 2011 deficit is projected to decline to below 5 percent of GDP on the back of a welcome consolidation effort and further economic recovery. The size of the adjustment, around 2½ percentage points of GDP, and its composition are broadly appropriate. Implementing the planned expenditure cuts in full, particularly with regard to wages and municipal spending, may prove to be difficult. However, some higher-than-budgeted revenue on account of the improved economic conditions would help offset expenditure slippages.
7. The authorities’ commitment to reduce the deficit to below 3 percent of GDP by 2013 is credible and appropriate.Adhering to this anchor, in line with EU requirements, will help maintain market confidence and keep Slovakia’s interest premium low. The deficit should be further reduced to about 1 percent of GDP in the medium term. This will help prepare for aging-related expenditure pressures, and provide some room for counter-cyclical fiscal policy in case of a downturn.
8. The intention to reduce the deficit by around 1 percentage point of GDP each year in 2012–13 strikes the right balance. Pacing the adjustment will help minimize the adverse impact on growth and avoid recourse to lower-quality and possibly unsustainable measures. Nonetheless, the adjustment efforts needed to meet the 2013 deficit target will be challenging.
9. The authorities’ fiscal policy priorities should guide the composition of the 2012–13 consolidation efforts. Priorities could include supporting growth through infrastructure investment and education, reducing the high unemployment and income disparity across regions, and strengthening the efficiency of the tax system. In addition, improving the quality and ensuring the financial soundness of the health care system remains a standing priority.2
10. Simultaneously achieving these priorities and the consolidation targets will require broad-ranging revenue efforts and expenditure reallocation and cuts. Only raising some minor taxes and concentrating the expenditure efforts on cutting wages and operational costs may not be sufficient, and may erode some essential government services to unsustainably low levels. Given the large consolidation needs, there is no room for premature tax cuts or for additional spending without re-prioritization. It will also be important not to slow or postpone key public investment projects and to strengthen EU funds absorption capacity.
11. Initiatives to harmonize and simplify social security contributions and unify revenue collection are welcome.They could be complemented with efforts to broaden the tax base and improve the efficiency of VAT collection. However, net revenue gains from harmonization, unified collection and improved VAT administration could be slow to materialize and should not be expected to contribute to the 2012–13 consolidation effort. In this regard, it would be preferable for recently announced proposals to reform the social security contributions system to remain focused on the main objectives of simplification, transparency and reduced incentives to opt for self-employed status, while maintaining broad revenue neutrality.
12. The authorities’ fiscal institutional reform plans are expected to improve commitment, discipline, transparency and planning. Laudable efforts to seek a broad consensus on such important reforms as introducing debt and expenditure ceilings and establishing a fiscal council can help ensure their durability. A well-designed ceiling on overall expenditure growth could be especially useful for guiding the fiscal consolidation in the next few years and for facilitating spending reallocation in line with evolving priorities. In the context of the envisaged fiscal institutional reforms, putting in place an effective medium-term budget framework would support planning and prioritization. Further improving the timeliness and quality of fiscal information would enhance transparency. Proposals to strengthen fiscal discipline at the local level could be complemented with incentives to raise real estate taxes.
13. The plans to ensure the sustainability of the pension system are welcome. Automatic alignment of the retirement age with changes in life expectancy and in the old age dependency ratio and adjustments in the indexation formulas could help ensure the viability of the first pillar. As to the second pillar, relaxing the restrictions on investment policies would increase the range of products available to savers and better align saving and investment objectives and horizons, and is an immediate priority. In addition, maintaining a sufficient contribution rate and promoting the participation of new labor market entrants would help support this pillar.
Financial Sector: strengthening safeguards and promoting further capital market development
14. The financial sector has strengthened further. A traditional banking model with a large deposit-to-loan ratio and limited investment in risky securities helped banks withstand the global financial crisis. With the improvement in economic conditions profits have rebounded. Financial soundness indicators are solid, and recent stress tests carried out by the National Bank of Slovakia reassure that banks can cope with severe shocks to economic growth and inflation.
15. Nevertheless, risks remain and continued vigilance is needed. In particular, the commercial real estate and construction sectors remain fragile. Moreover, banks could be affected in case of renewed financial turmoil in the euro area through the impact on parent banks, even though domestic direct exposure to foreign securities is limited. To reduce these risks, the authorities should continue improving coordination and collaboration with neighboring countries and home supervisors of foreign banks. Indications of intensifying competition, relaxation of lending standards and accelerating credit growth should be carefully monitored.
16. The authorities should harmonize the different treatment of housing loans to avoid regulatory arbitrage.Banks are substituting traditional mortgages with other housing loans that are subject to weaker regulations and allow for higher loan-to-value ratios. Harmonizing the different treatment would ensure that regulation aimed at limiting excessive risk taking remains effective. To improve consumer protection, steps to increase the transparency of housing loans with regard to interest rate adjustments would be welcome.
17. The authorities should explore ways to deepen the secondary government bond market. This can lower interest rates and help develop the capital market overall. Steps taken by the debt management agency to increase issuance size and focus on benchmark instruments are welcome. Establishing an effective primary market dealer arrangement and relaxing investment restrictions on pension funds could provide additional liquidity to the market.
Labor Market and Other Structural Policies: tackling high long-term unemployment and maintaining strong productivity growth
18. In the wake of the crisis, addressing long-term unemployment and regional disparities is even more pressing. Long-term unemployment of low-skilled and young workers has risen to among the highest in the EU. Less prosperous regions are particularly affected. The economic recovery and incipient rebound in employment had little impact, so far, on prospects for the long-term unemployed.
19. Bringing down long-term unemployment will require a range of measures. Various new initiatives considered by the authorities—including linking social benefits to training and job search efforts; expanding intermediate labor market opportunities; and selectively increasing labor market flexibility—are welcome. However, they need to be complemented with steps to enhance some existing active labor market policies, and with appropriate funding to ensure implementation and program evaluation. Improving the transport infrastructure and fostering the development of a private rental market could help ease labor mobility constraints.
20. Productivity gains remain the main driver of medium-term growth potential and convergence, and the key to preserving external competitiveness. Boosting productivity will require sustained efforts to further reduce administrative burdens; to enhance the transparency of public procurement, in line with welcome recent initiatives; to strengthen legal enforcement; and to promote competition in network industries. Labor market flexibility in combination with wage growth moderation should help maintain the strong performance of Slovakia’s main export sectors.
1 The mission wants to thank the Slovak authorities for their hospitality and the open and constructive discussions.
2 Health care reforms could be guided by earlier IMF advice and recent OECD recommendations.
