Economic and Monetary Developments in Slovakia

in the past 20 yearsJán Tóth

Deputy Governor of the National Bank of Slovakia

2

Outline

Slovakia - different phases of transition

Slovak vs. Czech Experience „Looking back“ - selected economic indicators Euro adoption and Great Recession

3

Different phases of transition

Early transition - Federation Meciar’s Era Stabilization period, catch-up in integration processes Big reform push period Pre-euro Euro (on the onset of Great Recession)

4

Early transition 1990-1993

1989-1992 economic policy within the Federation the same

The early transition had much greater impact on Slovak unemployment (more heavy industry focused on ex-Soviet markets), in 1992 exceeding 10% in SR vs. 2.6% in CR

New tax system (VAT introduced) The currency fixed at 1:1 first, but the Slovak

economy less competitive (creation of Slovak central bank, 10% devaluation in summer 1993)

5

Meciar’s Era 1994-1998

Little interest to attract FDI through privatization First tight fiscal policy, later very loose (also due to

issuance of government guarantees) Twin deficits, fixed exchange rate regime protected by

very high real interest rates, deteriorating loan portfolios of state banks

No OECD, NATO membership EU membership likely to be postponed Collapse of fixed exchange rate at the end of 1998

6

Stabilisation 1999-2002

Liberalisation of markets, high inflation and unemployment

Big push towards integration OECD membership (2000) Preparation for EU and NATO membership (2004) Privatization of state banks including the cleaning up

of loan portfolios (gross costs 10.6% of GDP, net 5.5% of GDP)

Opening up for FDI, big privatization improves foreign reserves as well as net foreign debt position

7

Big reform push 2003-2006

Flat tax, labor market liberalization, pension reform Much greater visibility among investors New capacities based on FDI mainly in autos and

electronics Strong sustainable real currency appreciation,

inflation stabilization (inflation targeting regime)

8

Pre-euro period 2007-2008

Very high growth rate Continuing currency appreciation Flat tax, labor market liberalization, pension reform Much greater visibility among investors New FDI capacities expanding

9

EURO and Global Recession 2009-

Greater slump, faster recovery Ex-ante expected benefits of EURO adoption:

Direct (immediate) benefits

elimination of exchange rate risk against euro

lower costs of capital elimination of some

transaction costs better resistance to

(currency) crises higher price transparency

Indirect (long-term) benefits

trade growth increase of FDIResulting in faster

growth/increase of living standards/progress in real convergence

10

Slovak vs. Czech experience

Growth Policy (ratings, bond spreads, structural indicators) Inflation, interest rate Exchange rate

11

GDP growth and convergence

75

62

95

60

65

70

75

80

85

90

95

100

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

CZ=

100

Standard convergenceActual convergence

168

228

100

120

140

160

180

200

220

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

1993

=10

0

CZ SK

Real GDP index GDP per capita in PPP (SK/CZ)

Source: Eurostat, NBS calculation, Fischer and Stirböck (2004)

Note: Standard pace of convergence is assumed to be 2.4 % p.a.

60 bp

20 bp

12

Credit ratings of Slovakia and Czech Republic

Rating S&P

Grade 1994 1998 2004 2009 2012

AA- CZ

A+ SK

A CZ SK

A- CZ SK = CZ

BBB+ CZ

BBB

BBB-

BB+ SK

BB

BB- SK

-5 g

rades

-4 g

rades

-2

+1

Non

-Invest

ment

Gra

de

Invest

ment

Gra

de

Government bond spreads SR vs CR

13

2001Q1

2001Q2

2001Q3

2001Q4

2002Q1

2002Q2

2002Q3

2002Q4

2003Q1

2003Q2

2003Q3

2003Q4

2004Q1

2004Q2

2004Q3

2004Q4

2005Q1

2005Q2

2005Q3

2005Q4

2006Q1

2006Q2

2006Q3

2006Q4

2007Q1

2007Q2

2007Q3

2007Q4

2008Q1

2008Q2

2008Q3

2008Q4

2009Q1

2009Q2

2009Q3

2009Q4

2010Q1

2010Q2

2010Q3

2010Q4

2011Q1

2011Q2

2011Q3

2011Q4

2012Q1

2012Q2

2012Q3

2012Q4

2013Q1

2013Q2

-0.5

0

0.5

1

1.5

2

2.5

3

SK bond yield-CZ bond yields [in pp]

Slovak euro adoption

Source: ECB

14

Why are we still lagging behind Czechs?

World Competitiveness Yearbook 2013 Global Competitiveness Report 2013-2014

Domestic EconomyInternational Trade

International InvestmentEmployment

PricesPublic Finance

Fiscal PolicyInstitutional Framework

Business LegislationSocietal Framework

Productivity & EfficiencyLabor Market

FinanceManagement Practices

Attitudes and ValuesBasic InfrastructureTech. Infrastructure

Scientific InfrastructureHealth and Environment

Education

-30 -25 -20 -15 -10 -5 0 5 10 15 20

1 13

-15 -16

-2 -11

-8 -6

-7 -6

9 -16

-14 -8

-2 -19

-16

-26 -5

-7

Difference in ranking (SK-CZ)

Institutions

Infrastructure

Macroeconomic environment

Health and primary education

Higher education and training

Goods market efficiency

Labor market efficiency

Financial market development

Technological readiness

Market size

Business sophistication

Innovation

-70 -50 -30 -10 10 30

-33

-28

-7

21

-19

-28

5

16

-18

-17

-35

-58

Difference in ranking (SK-CZ)

Source: WEFSource: IMD

... significant worsening of several (mostly soft) indicators:Hiring and firing practices (-111)

Diversion of public funds (-92)

Quality of the educational system (-84)

Cooperation in labor-employer relations (-83)

Burden of government regulation (-82)

... inclusion of new (soft) indicators with low ranking:Efficiency of legal framework in settling disputes (143)

Efficiency of legal framework in challenging regs. (142)

Effect of taxation on incentives to work (131)

Country capacity to retain talent (130)

Effect of taxation on incentives to invest (122)

15

What drags Slovakia down?

Institutions

Infrastructure

Macroeconomic environment

Health and primary education

Higher education and training

Goods market efficiency

Labor market efficiency

Financial market development

Technological readiness

Market size

Business sophistication

Innovation

-80 -60 -40 -20 0 20

-69

-14

-25

26

-19

-38

-52

-15

-19

-5

-26

-53

Difference in ranking of main pillars (2013-2006)

(according to Global Competitiveness Reports)

Source: WEF

16

Inflation

Source: Eurostat, NBS calculation

36 %Start of inflation targeting in CZ

Start of inflation targeting in SK

Price level convergence driven predominantly by inflation between 1998-2004. Exchange rate becoming the main source in the pre-euro period. Inflation differential taking the main role again after the euro adoption.

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011

90

140

190

240

290

Price index

CZ SK

July

1993=

100

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011

0

5

10

15

20

25

30YoY price growth [in %]

CZ SK

Real interest rates

17

Note: 3M MM deflated by HICP excluding food and energy prices.

Source: ECB, OECD, NBS calculation

1997Q1

1997Q3

1998Q1

1998Q3

1999Q1

1999Q3

2000Q1

2000Q3

2001Q1

2001Q3

2002Q1

2002Q3

2003Q1

2003Q3

2004Q1

2004Q3

2005Q1

2005Q3

2006Q1

2006Q3

2007Q1

2007Q3

2008Q1

2008Q3

2009Q1

2009Q3

2010Q1

2010Q3

2011Q1

2011Q3

2012Q1

2012Q3

2013Q1

-4

-2

0

2

4

6

8

10

12

14

16

3M real interest rates[in %]

CZ SK

18

Exchange rate developments

Source: Eurostat, NBS calculation

20 %

I.1993

VII.1

993

I.1994

VII.1

994

I.1995

VII.1

995

I.1996

VII.1

996

I.1997

VII.1

997

I.1998

VII.1

998

I.1999

VII.1

999

I.2000

VII.2

000

I.2001

VII.2

001

I.2002

VII.2

002

I.2003

VII.2

003

I.2004

VII.2

004

I.2005

VII.2

005

I.2006

VII.2

006

I.2007

VII.2

007

I.2008

VII.2

008

I.2009

VII.2

009

I.2010

VII.2

010

I.2011

VII.2

011

I.2012

VII.2

01265

75

85

95

105

115

125

135

Exchange rate against EUR/ECU

CZK SKK

Index (

I.93=

100)

How deep was the crisis?Recession reality worse than forecasts by 10.7% in CR and 15.3%

in SR

2008 2009 2010Forecasted CZ growth 4.1 3.6 4.1

Actual GDP growth 3.1 -4.5 2.5

Difference 1.0 8.1 1.6Source: CNB forecast (7/8/2008)

Forecasted SK growth 7.6 6.6 6.4

Actual GDP growth 5.8 -4.9 4.4

Difference 1.8 11.5 2.0Source: NBS forecast (P3Q-

2008)

19

Source: Eurostat, NBS calculation

2006 2007 2008 2009 2010 2011 2012-4

-3

-2

-1

0

1

2

3

4

Change in unemployment rate [in pp]

CZ SK

How fast is the recovery?Recovery reality worse than forecasts by 3.2% in CR and 1.8% in

SR

2010 2011 2012Forecasted CZ growth 1.6 1.8 2.9

Actual GDP growth 2.5 1.8 -1.2

Difference -0.9 0 4.1Source: CNB forecast (5/8/2010)

Forecasted SK growth 4.3 3.0 4.1

Actual GDP growth 4.4 3.2 2.0

Difference -0.1 -0.2 2.1Source: NBS forecast (P3Q-

2010)

20

Source: Eurostat, NBS calculation

2006 2007 2008 2009 2010 2011 2012-3

-2

-1

0

1

2

3

Change in employment rate [in pp]

SK CZ

Slovakia needed 2 years to catch up with Czech exports after the breakup of Great

RecessionBut the export recovery is much stronger now

21

Source: ECB, Eurostat, NBS calculation

85

90

95

100

105

110

115

120

2008Q2 2009Q2 2010Q2 2011Q2 2012Q2

Market shares (exports/foreign demand)(2008Q2 = 100)

SK CZ

Equilibrium REER and market (1993M1 = 100)

22

Source: NBS calculation

19

19

19

19

19

19

19

19

19

19

20

20

20

20

20

20

20

20

20

20

20

20

20

20

20

20

20

20

20

20

90

100

110

120

130

140

150optimal range

Real effective exchange rate (PPI manuchactur-ing)

Eqiulibrium rate

REER misalignment

23

1993Q

11993Q

31994Q

11994Q

31995Q

11995Q

31996Q

11996Q

31997Q

11997Q

31998Q

11998Q

31999Q

11999Q

32000Q

12000Q

32001Q

12001Q

32002Q

12002Q

32003Q

12003Q

32004Q

12004Q

32005Q

12005Q

32006Q

12006Q

32007Q

12007Q

32008Q

12008Q

32009Q

12009Q

32010Q

12010Q

32011Q

12011Q

32012Q

12012Q

32013Q

1

-15

-10

-5

0

5

10

Deviations of REER (PPI-manufacturing based) from the equilibrium [in %]

REER misalignment

Overvalua-tion

Source: NBS calculation

Undervalued REER supports market share growth now

24

Source: ECB, Eurostat, NBS calculation

Note: REER is based on PPI – manufacturing. 5 quarters centered moving averages are presented.

1998Q

3

1999Q

1

1999Q

3

2000Q

1

2000Q

3

2001Q

1

2001Q

3

2002Q

1

2002Q

3

2003Q

1

2003Q

3

2004Q

1

2004Q

3

2005Q

1

2005Q

3

2006Q

1

2006Q

3

2007Q

1

2007Q

3

2008Q

1

2008Q

3

2009Q

1

2009Q

3

2010Q

1

2010Q

3

2011Q

1

2011Q

3

2012Q

1

2012Q

3

-10

-5

0

5

10

15

Deviations of REER from the equilibrium and market share annual growth[in %]

REER misalignment Market share dynamics

Overvaluation

Slovak economy was supported mainly by the loose interest rate

25

-3

-2

-1

0

1

2

2008Q1

2009Q1

2010Q1

2011Q1

2012Q1

2013Q1

Real interest rate gap(deviations from 2005-2012 average)

CZ SK

tight↑

loose↓

-4

-2

0

2

4

6

2008

2009

2010

2011

2012e

Output gap [in %]

CZ SK

overheating↑

recession↓

Source: EC, ECB, OECD, NBS calculation

Note: deflated with HICP excluding energy and food prices

26

Some lessons learned Most direct benefits of euro have materialized:

transaction costs declined But huge external shock exaggerated the lack of

flexibility of the currency regime vis-a-vis neighbours And the euro area debt crisis introduced additional costs

related to contagion and fiscal contributions to the EFSF and ESM

Indirect benefits not yet visible (higher FDI, trade growth) as the effect of the crisis is much stronger than the monetary integration effect

Very important to have the rest of economy as much flexible as possible to offset the rigidity of the currency regime

27

Thank you for your attention