Council opinion

of 12 February 2008

on the updated convergence programme of Slovakia, 2007-2010

(2008/C 49/11)

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty establishing the European Community,

Having regard to Council Regulation (EC) No 1466/97 of 7 July 1997 on the strengthening of the surveillance of budgetary positions and the surveillance and coordination of economic policies [1], and in particular Article 9(3) thereof,

Having regard to the recommendation of the Commission,

After consulting the Economic and Financial Committee,

HAS DELIVERED THIS OPINION:

(1) On 12 February 2008, the Council examined the updated convergence programme of Slovakia, which covers the period 2007 to 2010.

(2) Slovakia is currently experiencing a period of strong growth induced by wide-range structural reforms introduced in previous years combined with substantial inflows of FDI, especially into the manufacturing sector. Although consequential to growth employment picked up as well and the unemployment rate fell substantially, certain segments of the population concentrated in eastern regions do not seem to take part in this economic expansion.

Apart from constituting a drag on public finances and a social problem, the low employability of certain segments of the labour force limits the country's potential output growth and thus hampers the catching-up process. This unevenness in the distribution of economic activity across population groups and regions would call for an increase in the quality of public education and some reallocation of government expenditure to education, R&D and innovation and infrastructure development. Following a predominantly restrictive budgetary policy in previous years, the fiscal stance turned expansionary in 2006, while monetary conditions tightened on the back of increased policy rates and continued exchange rate appreciation which however, as testified by the strong growth in exports and falling current account deficit, does not seem to have affected external competitiveness of the Slovak economy. As a Member State with a derogation and an ERMII participant Slovakia should gear its macroeconomic and structural policies towards achieving sustainable convergence. Although inflation has decelerated markedly in 2007, it is expected to pick up again on the back of rising food and energy prices, strong growth, a tightening labour market and a fading effect of the strong exchange rate appreciation in 2006-2007. In order to meet the inflation targets set out in the programme — which assumes euro area membership from 2009 — and to contain possible inflationary pressures after the disinflationary effect from past substantial exchange rate appreciation fades out, further structural reforms are necessary and the government should stand ready to adopt a tighter fiscal stance than that envisaged in the programme.

(3) The macroeconomic scenario underlying the programme envisages that real GDP growth will drop from 8,8 % in 2007 to 5,0 % in 2010. Assessed against currently available information [2], this scenario appears to be based on plausible growth assumptions until 2009 and cautious ones for 2010, as the exceptional export performance recorded in 2007 induced by the launch of new production capacities in the manufacturing sector is not expected to be repeated in the coming years. The programme's projections for inflation appear to be on the low side as they are based on more favourable external assumptions than the Commission services' autumn 2007 forecast and on a different assumption on the fading out of the effect of past exchange rate appreciation.

(4) For 2007, the general government deficit is estimated at 2,7 % of GDP in the Commission services' autumn 2007 forecast, against a target of 2,9 % of GDP set in the previous update of the convergence programme and of 2,5 % of GDP in the current update. This improvement was enabled by a revenue over-performance outweighing higher-than-budgeted expenditure. Given that the estimated 2007 deficit outturn is lower (by 0,2 % of GDP) than previously targeted both in nominal and structural (i.e. cyclically-adjusted net of one-off and other temporary measures) terms, the Slovak authorities have partly responded to the invitation in the Council opinion of 27 February 2007 on the previous update of the convergence programme [3] which called for a strengthening of the structural adjustment in order to ensure the correction of the excessive deficit in 2007 with a larger margin.

(5) The main goal of the budgetary strategy is to reach the medium-term objective (MTO) for the budgetary position of a structural deficit of just below 1 % of GDP by 2010. The programme foresees the general government deficit to decrease from 2,5 % of GDP in 2007 to 0,8 % of GDP in 2010 in nominal terms, with the primary balance improving from a deficit of 1,0 % of GDP in 2007 to a surplus of 0,5 % of GDP in 2010. The adjustment in both structural and nominal terms is back-loaded towards the end of the programme period. Compared to the previous update, the new update broadly confirms the planned adjustment against a more favourable macroeconomic scenario. Fiscal consolidation is envisaged to be expenditure-based (especially cuts in social payments and compensation of public employees) as the expenditure ratio is planned to be reduced by 3 percentage points of GDP over the programme horizon while the revenue ratio would decline by half this amount.

(6) The budgetary outcomes could be better in 2008 and worse in 2009 and 2010 than projected in the programme. In particular, strong growth prospects, already adopted revenue-increasing measures (broadening of the corporate tax base and increase in the maximum ceiling for social contribution foreseen to generate additional revenue of some 0,3 % of GDP) and the likely outflow of participants from the second pension pillar [4] (positive impact estimated at about 0,2 % of GDP) should allow for a better-than-foreseen deficit outcome in 2008 if expenditure growth is kept more in check than suggested by the programme as was the case in previous years. However, apparent risks exist for the planned fiscal consolidation back-loaded to 2009 and 2010. In particular, there are no binding expenditure ceilings, there is a lack of information on the measures that underpin the adjustment and there are potentially some risks to expenditure related to planned partnerships with the private sector notably as regards construction of motorways.

(7) In view of this risk assessment, the budgetary stance in the programme seems broadly consistent with a durable correction of the excessive deficit by 2007 as recommended by the Council. A sufficient safety margin against breaching the 3 % of GDP deficit threshold with normal macroeconomic fluctuations (estimated around a structural deficit of 2 % of GDP) would only be provided from 2010 onwards if the envisaged consolidation is strictly implemented [5]. Moreover, the budgetary stance in the programme seems insufficient to ensure that the MTO is achieved by the end of the programme period, as envisaged in the programme. In 2008, only a slight improvement (0,25 % of GDP) in the structural balance can be expected when good times are foreseen to occur.

The pace of adjustment towards the MTO implied by the programme in 2008 should be therefore strengthened to be in line with the Stability and Growth Pact, which specifies that, for euro-area and ERM II Member States, the annual improvement in the structural balance should be 0,5 % of GDP as a benchmark and that the adjustment should be higher in good economic times. Moreover, budgetary room needs to be created for the expected increase in inflows of EU funds in order to maintain the restrictive fiscal stance planned for 2009-2010. The planned adjustment in the remaining years of the programme — in line with the Pact — should be strictly implemented and, if necessary, backed up with measures. Finally, should inflationary pressures emerge, a tighter fiscal stance than foreseen in the programme would be required.

(8) Slovakia appears to be at medium risk with regard to the long-term sustainability of public finances. The long-term budgetary impact of ageing is lower than the EU average, with pension expenditure showing a more limited increase than in many other countries, notably thanks to the 2005 pension reform. However, those projections hinge upon the assumption that a relatively low share of workers will leave the mixed pension system in the first half of 2008, during which they will have the opportunity to do so. The budgetary position in 2007 as estimated in the programme with a structural primary deficit constitutes a risk to sustainable public finances even before considering the long-term budgetary impact of an ageing population. Consolidating the public finances, as planned in the convergence programme, would therefore contribute to reducing risks to the sustainability of public finances.

(9) The convergence programme seems to be consistent to some extent with the October 2007 implementation report of the national reform programme. It confirms that the government's expenditure priorities (healthcare, education and agriculture) continue to partly diverge from the key challenges identified in the NRP (information society; R&D and innovation; business environment; and education and employment). Moreover, it does not specify whether the national R&D expenditure target of 0,8 % of GDP will be met by 2010 while education spending tends to increasingly rely on EU Structural Funds. The programme does not contain a qualitative assessment of the overall impact of the National Reform Programme within the medium term fiscal strategy but it provides systematic information on the direct budgetary costs associated with the main reforms envisaged in the NRP for 2008.

(10) In terms of progress in implementing its ERM II commitments, the fiscal targets in successive convergence programmes have been consistently overachieved but the targets themselves have turned out not to be particularly ambitious given the better-than-originally-assumed initial fiscal position and stronger-than-expected economic performance. As regards income policies, collective bargaining agreements in the public sector have provided an important signal of wage moderation for the whole economy. With a view to containing credit growth, the National Bank of Slovakia has closely monitored risk management practices of banks and strengthened cooperation with home country supervisors of banks operating in Slovakia.

(11) As regards the data requirements specified in the code of conduct for stability and convergence programmes, the programme provides all required and most of the optional data [6].

The overall conclusion is that the programme is consistent with a correction of the excessive deficit by 2007. Thereafter, it envisages back-loaded progress towards the MTO in a context of strong growth prospects; in 2008, the envisaged structural improvement is not in line with the Pact and should be more ambitious. Given risks to the budgetary targets from 2009 onwards, the MTO may not be achieved by 2010 as planned in the programme and therefore additional efforts might be required. Moreover, should inflationary pressures emerge, a tighter fiscal stance than foreseen in the programme would be required along with further structural reforms to improve the labour market performance. As regards the long-term sustainability of public finances, Slovakia appears to be at medium risk. With respect to medium-term challenges, the programme does not envisage any progress in reallocating expenditure towards R&D and innovation while it states that education spending should increasingly rely on EU funds.

In view of the above assessment and the recommendation under Article 104(7) of 5 July 2004 and also given the need to ensure sustainable convergence and a smooth participation in ERM II, Slovakia is invited to:

(i) exploit the strong growth conditions to strengthen the pace of structural adjustment towards the MTO in 2008 and strictly implement the envisaged structural consolidation thereafter backed up, if necessary, by additional measures as well as more binding medium-term expenditure ceilings; and

(ii) introduce further structural reforms to improve the labour market performance and stand ready to adopt a tighter fiscal stance, in particular in order to contain possible inflationary pressures, especially after the disinflationary effect of past substantial exchange rate appreciation fades out.

Comparison of key macroeconomic and budgetary projections

Notes:

[7] [8] [9]

Sources:

Convergence programme (CP); Commission services' autumn 2007 economic forecasts (COM); Commission services' calculations,

| 2006 | 2007 | 2008 | 2009 | 2010 |

Real GDP (% change) | CP Nov 2007 | 8,3 | 8,8 | 6,8 | 5,8 | 5,0 |

COM Nov 2007 | 8,3 | 8,7 | 7,0 | 6,2 | n.a. |

CP Dec 2006 | 6,6 | 7,1 | 5,5 | 5,1 | 5,0 |

HICP inflation (%) | CP Nov 2007 | 4,3 | 1,7 | 2,3 | 2,6 | 2,7 |

COM Nov 2007 | 4,3 | 1,7 | 2,5 | 3,0 | n.a. |

CP Dec 2006 | 4,4 | 3,1 | 2,0 | 2,4 | 2,6 |

Output gap [7] (% of potential GDP) | CP Nov 2007 | – 0,5 | 1,8 | 2,3 | 2,1 | 1,4 |

COM Nov 2007 [8] | – 0,8 | 1,0 | 1,3 | 0,8 | n.a. |

CP Dec 2006 | – 0,9 | 1,0 | 1,6 | 1,9 | 2,4 |

Net lending/borrowing vis-à-vis the rest of the world (% of GDP) | CP Nov 2007 | – 8,4 | – 3,4 | – 1,9 | – 1,1 | – 0,4 |

COM Nov 2007 | – 7,8 | – 4,2 | – 2,7 | – 1,6 | n.a. |

CP Dec 2006 | – 6,4 | – 3,1 | – 2,5 | – 2,0 | – 1,6 |

General government balance (% of GDP) | CP Nov 2007 | – 3,7 | – 2,5 | – 2,3 | – 1,8 | – 0,8 |

COM Nov 2007 | – 3,7 | – 2,7 | – 2,3 | – 2,4 | n.a. |

CP Dec 2006 | – 3,7 | – 2,9 | – 2,4 | – 1,9 | n.a. |

Primary balance (% of GDP) | CP Nov 2007 | – 2,2 | – 1,0 | – 0,9 | – 0,3 | 0,5 |

COM Nov 2007 | – 2,2 | – 1,2 | – 0,8 | – 0,9 | n.a. |

CP Dec 2006 | – 1,9 | – 0,9 | – 0,6 | – 0,2 | n.a. |

Cyclically-adjusted balance [7] (% of GDP) | CP Nov 2007 | – 3,5 | – 3,0 | – 3,0 | – 2,4 | – 1,2 |

COM Nov 2007 | – 3,4 | – 3,0 | – 2,7 | – 2,6 | n.a. |

CP Dec 2006 | – 3,4 | – 3,2 | – 2,9 | – 2,5 | n.a. |

Structural balance [9] (% of GDP) | CP Nov 2007 | – 3,1 | – 3,0 | – 3,1 | – 2,4 | – 1,2 |

COM Nov 2007 | – 3,4 | – 3,0 | – 2,7 | – 2,6 | n.a. |

CP Dec 2006 | – 3,5 | – 3,2 | – 2,9 | – 2,5 | n.a. |

Government gross debt (% of GDP) | CP Nov 2007 | 30,4 | 30,6 | 30,8 | 30,5 | 29,5 |

COM Nov 2007 | 30,4 | 30,8 | 30,7 | 30,6 | n.a. |

CP Dec 2006 | 33,1 | 31,8 | 31,0 | 29,7 | n.a. |

[1] OJ L 209, 2.8.1997, p. 1. Regulation as amended by Regulation (EC) No 1055/2005 (OJ L 174, 7.7.2005, p. 1). The documents referred to in this text can be found at the following website:http://ec.europa.eu/economy_finance/about/activities/sgp/main_en.htm

[2] The assessment takes notably into account the Commission services' autumn forecast and the Commission assessment of the October 2007 implementation report of the national reform programme.

[3] OJ C 72, 29.3.2007, p. 1.

[4] In the first half of 2008 the second pension pillar will be temporarily opened, allowing current participants to leave and new participants to join the scheme.

[5] The output gap estimates presented in the programme differ substantially from the Commission services estimates that are based on the information in the programme using the common agreed methodology.

[6] In particular, the data on the functional classification of government expenditure (COFOG) for 2010 are not provided.

[7] Output gaps and cyclically-adjusted balances according to the programmes as recalculated by Commission services on the basis of the information in the programmes.

[8] Based on estimated potential growth of 6,4 %, 6,7 %, 6,7 % and 6,7 % respectively in the period 2006-2009.

[9] Cyclically-adjusted balance excluding one-off and other temporary measures. One-off and other temporary measures are 0,4 % of GDP in 2006 — deficit-increasing and 0,1 % of GDP in 2008 — deficit-reducing according to the most recent update of the programme. There are no one-off measures in the Commission services' forecast.

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