TRANSITION REPORT 2014 Innovation in Transition

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Highlights

  • Economic recovery is increasingly driven by domestic demand. This contrasts with most of the post-accession period, when exports were the main engine of economic growth.
  • A successful fiscal consolidation enabled the Slovak Republic to exit the European Union’s (EU) Excessive Deficit Procedure. Given the significant improvement in the government’s fiscal position, the corporate tax was lowered from 23 to 22 per cent.
  • An official bilateral agreement was signed with Poland to construct a new cross-border gas pipeline. The pipeline, once built, will carry liquefied natural gas (LNG) from Poland’s LNG terminal in Swinoujscie to Krk in Croatia, thus diversifying the Slovak Republic’s gas supply.

Key priorities for 2015

  • Competition in the gas market should be revived. The recent state acquisition of a share in the gas utility, SPP, may further spur the withdrawal of foreign investors from the Slovak energy sector. Given the government’s promise to further reduce household gas prices, the sector’s already low profitability could be undermined, and risks to public finances could emerge.
  • The government should continue to focus on boosting innovation in domestic small and medium-sized enterprises (SMEs), including providing incentives for start-ups and accelerating reforms in the education system. A national innovation strategy has been approved and should help to enhance effective knowledge transfer between academic institutions and businesses. In addition, the authorities have introduced a concept to help revitalise the Slovak Republic’s capital market, which may help to improve market infrastructure and financing for the real economy.
  • The government should streamline administrative procedures and strengthen capacities to manage EU funds. Modernising and improving public administration, reducing red tape and decentralising responsibilities are all steps in that direction. The state announced a sovereign investment holding, which will be partially funded by the EU and leveraged by commercial financing, to invest in those sectors targeted by the operational programmes.

ECONOMIC RECOVERY IS INCREASINGLY DRIVEN BY DOMESTIC DEMAND

A SUCCESSFUL FISCAL CONSOLIDATION ENABLED THE SLOVAK REPUBLIC TO EXIT THE EU’S EXCESSIVE DEFICIT PROCEDURE

AN OFFICIAL BILATERAL AGREEMENT WAS SIGNED WITH POLAND TO CONSTRUCT A NEW CROSS-BORDER GAS PIPELINE

2014 sector transition indicators
Corporate Energy Infrastructure FI

Source: EBRD.
Note: FI – Financial institution; ICT – Information and communication technology; Water – Water and wastewater; IAOFS – Insurance and other financial services; PE – Private equity.


Main macroeconomic indicators %

  2010 2011 2012 2013 2014
          proj.
GDP growth 4.4 3.0 1.8 0.9 2.3
Inflation (average) 0.7 4.1 3.7 1.5 0.4
Government balance/GDP -7.5 -4.8 -4.5 -2.8 -2.9
Current account balance/GDP -3.7 -3.8 2.2 2.1 1.9
Net FDI/GDP 0.9 2.9 3.2 1.1 1.3
External debt/GDP 75.6 75.5 76.0 83.2 n.a.
Gross reserves/GDP n.a. n.a. n.a. n.a. n.a.
Credit to private sector/GDP 44.5 46.2 46.2 47.4 n.a.

Note:  Slovak Republic is a member of the euro area.

Macroeconomic performance

After a significant slow-down last year, GDP growth is expected to pick up gradually as domestic demand recovers. In 2013 economic growth slumped to 0.9 per cent, dragged down by domestic demand, largely due to a 5 per cent drop (in annual terms) in gross fixed capital formation. By contrast, in the first half of 2014 the economy grew by 2.3 per cent, primarily on the back of a rebound in household consumption – the strongest since the pre-crisis peak in 2008 – and a robust increase in gross investments. Due to weaker growth in some key markets, exports slowed somewhat in the first half of 2014. Domestic demand is likely to become the main growth driver in 2014-15, supported by strong credit growth, especially as corporate credit growth turned positive in annual terms in March for the first time since May 2012.

Following a significant expansion last year, export volumes began to stagnate in the second quarter of 2014. Exports to other EU countries lost momentum in the first half of the year, and exports to Russia registered a drop of 7 per cent over the same period. However, exports to Russia represent only a small portion (less than 4 per cent of GDP) of total exports and the Slovak Republic remained virtually untouched by the ban on food imports recently imposed by Russia.

Successful fiscal consolidation enabled the Slovak Republic to exit the EU’s Excessive Deficit Procedure. After reaching 8 per cent in 2009, the fiscal deficit narrowed to 2.8 per cent of GDP in 2013. The government’s fiscal position has improved in the past few years, in part due to measures such as an increase in corporate tax, the elimination of the flat tax on personal income and the earlier reduction in contributions to private pension funds. Nevertheless, public debt last year exceeded the 55 per cent threshold set under the 2011 Fiscal Responsibility Law, forcing the government to implement a partial freeze on spending.

The labour market situation has also marginally improved. The unemployment rate decreased somewhat, though at 13.8 per cent it remains high by regional standards. The labour force participation rate remains low, and at 65.1 per cent, the employment rate is well below the EU-wide average of 68.4 per cent.

Economic growth should average 2.3 per cent this year and accelerate to 3 per cent in 2015. However, there are important downside risks. As a highly open economy, the Slovak Republic will be significantly affected by weak performance in the eurozone.


Major structural reform developments

In an attempt to revive investment, the government has cut the corporate income tax rate by one percentage point. The so-called tax licences aim to further reduce tax evasion following a successful implementation of measures to improve value added tax (VAT) collection in 2012. In December 2013 parliament approved an amendment to the income tax law, which lowers the corporate income tax rate from 23 to 22 per cent in 2014. It also introduced a tax licence (or minimum tax), which will be a fixed lump-sum corporate tax payable in 2015. The rate of this minimum tax will depend on the amount of a company’s annual turnover and whether it pays VAT, regardless of whether or not it makes a profit. The new law may be perceived as positive by large profitable companies, as they can deduct the minimum tax from corporate tax liability in the subsequent three years, but it could harm less profitable SMEs.

Total research and development (R&D) expenditures averaged merely 0.56 per cent of GDP from 2003 to 2012, among the lowest in the EU. Even though the country plays a key part in global value chains of export-oriented foreign direct investment enterprises, the domestic value added content of exports is one of the lowest in the EU. The country’s growth model has traditionally been focused on know-how imports embodied in foreign direct investment. More recently, the government has sought to boost endogenous innovation in domestic SMEs and thereby target education better. There is now a strategy in place to enhance the effective knowledge transfer between academic institutions and businesses. In addition, plans to encourage innovation are under way, as is the creation of a support network for start-ups in the country. By building on areas in which the Slovak Republic has already achieved specialisation, further investments in complementary sectors could be stimulated (for example, in the car industry, cyber security and electricity production).

Introducing measures to ease administrative burdens should reduce corruption and tax fraud. In July 2014 the Slovak Ministry of Interior proposed a law aimed at reducing fraud in public procurement and the use of EU grants. The bill would also provide protection to employees reporting unlawful practices of their employers. In addition, last year the government enacted tax law amendments, effective from the beginning of 2014, targeted at a reducing administrative burdens for enterprises. The authorities also expect to increase tax collection through new VAT collection statements. These measures should help the Slovak Republic in its fight against corruption (the country scored 61st place out of 177 countries in Transparency International’s Corruption Perception Index last year).

The Slovak Republic has become a significant regional hub for gas transmission. An official bilateral agreement was signed with Poland to build a new cross-border gas pipeline, which would be part of the north-south corridor, from Poland’s LNG terminal in Swinoujscie to its Croatian counterpart at Krk. The project is expected to be completed in 2019 with capacity close to that of the gas pipeline between Hungary and the Slovak Republic, which will become operational in January 2015. The project aims to reduce vulnerabilities to supply disruptions in Central and Eastern Europe. In addition, Ukraine signed a memorandum with the Slovak Republic in May 2014 for the delivery of up to 8 billion cubic metres of natural gas per year via an upgraded, and previously unused, pipeline link. Gas transmissions from other EU member states will help to partially reduce Ukraine’s dependence on Russian gas supplies.

The state became the sole owner of SPP, the Slovak Republic’s dominant gas supplier. In June the Czech energy group, EPH, sold its 49 per cent stake in Slovensky Plynarensky Priemysel (SPP) to the government, thereby making the state the sole owner. The government’s aim is to gain full control over gas pricing in the country, with a promise to cut gas prices for households by a total of 10 per cent in 2015-16. SPP has agreed with Gazprom to lower the price of natural gas in their long-term contract, valid until 2028. The withdrawal of foreign investors from the Slovak energy sector has been under way for some time, given poor profitability.

Youth unemployment remains a key challenge for the government, amid persistently increasing long-term unemployment. The youth unemployment rate constitutes over 32 per cent of total unemployment. A final version of the Youth Guarantee implementation plan was submitted to the European Commission in May 2014. The plan includes measures to ensure that all 15 to 24-year-olds obtain either a job offer or an opportunity to continue education within four months of being registered with the Public Employment Service. The government has allocated €200 million to support youth employment in 2014-15, and young people who want to start their own business would be able to receive up to 95 per cent of the required start-up funds through the programme. Moreover, a new Act on vocational education training was announced, with the purpose of enhancing the provision of work-based learning.