Electronics Production | November 19, 2008

Russia / CIS – Can Slovakia stay on top?

Despite global financial chaos, the Slovak Republic is still on target to join the Eurozone in January 2009. The country initially struggled after independence was gained in 1993 but now it has overtaken many of its peers in developing a strong economy.
With an anti-reformist Prime Minister, good relations with Russia and striking differences between the Eastern and Western parts of the country, it has still managed to achieve what some of its neighbour’s dream of.

This land-locked country snuggles in the heart of Europe and borders the Czech Republic and Austria to the West, Poland to the north, Ukraine to the east, and Hungary to the south. The country of Czechoslovakia was under communist rule following World War II until the ‚ÄėVelvet Revolution‚Äô, which resulted in the end of Communist rule in 1989. On 1st January 1993, the two states of Czechoslovakia went their separate ways, but the over the next five years, the new Slovak Republic was led into decline by the authoritarian Vladimir Meciar. His style of government created international concerns about the democratic development of Slovakia and little progress was made in the country at that time.

It was Mikulas Dzurinda, the chairman of the Slovak Democratic and Christian Union (SDKU), who headed a reform-oriented coalition from 1998 to 2006. In his time as prime minister, the country made political and economic reforms that enabled Slovakia to enter the OECD, joining the European Union and NATO in 2004. In addition to this, Dzurinda’s government pursued policies that fought corruption, attracted foreign investment and reformed social services, such as the health care system.

The pace of economic reform picked up during Dzurinda’s second-term, which oversaw the simplification of the tax system, reforms of the labour code and pension systems, and a large number of privatisations. The economy grew 8.3% in 2006 (the highest economic growth among OECD members and third highest growth in Central Europe).

All this progress looked to be upset though, when the 2006 elections resulted in Mr Dzurinda being ousted in favour of Mr Robert Fico, the leader of SMER, a left-wing populist party committed to reversing economic reform. The coalition that he leads includes the erstwhile Mr Merciar’s party. Although Mr Fico made election promises to reverse economic reform, industry experts regard him as cleverly avoiding any major changes and thus the major pillars of sound economic reforms remain untouched.

Thus, under this ‚Äėanti-reformist‚Äô government, the Prime Minister remains popular and the country continues in much the same way as it did under the previous government. Under the present government, there have been no major economic reforms and no further privatisations raising fears that the country could come unstuck in the present global financial climate. The Slovak Republic‚Äôs financial institutions have largely avoided the crisis that has hit the US and parts of Western Europe and banks are continuing to lend. Slovakia‚Äôs banking sector, 92% of which is foreign-owned, has been conservative.

The loan-to-value ratio for most mortgage loans rarely exceeds 70% and foreign expertise has also made local banks more stable. The mortgage market has developed rapidly but lending is primarily to urban middle and upper class professionals, whose salaries are rising rapidly. House prices are steadily rising as new automobile factories and other foreign investments rise in western Slovakia. The sound banking system is good news for the economy, which grew by 10.4% in 2007 and is expected to expand by 7.5% in 2008. However, the growth has unleashed higher inflation, which rose sharply in September 2008 to 5.4%, hitting its highest level since December 2004.

The increase was attributed primarily to rising household utility and energy prices ‚Äď including electricity, natural gas and water ‚Äď which rose by 8.9% year-onyear. The European Union has warned Slovakia to keep a close watch on inflation, in preparation for January 2009. This is just one of several factors that threaten Slovakia‚Äôs growth. Joining the Eurozone will have repercussions for the banking industry with foreign exchange transactions shrinking rapidly. This is likely to have a negative effect on local banks, which could be pushed out by larger European banks.

Another possible negative is the reliance of the economy on their automotive industry. The country’s fast growth and low wages have made it a magnet for foreign investors, with an expected US$2.7 billion in foreign direct investment in 2008. A large slice of that investment is in the auto industry making the country the world’s largest per capita car producer but also making it vulnerable due to the cyclical nature of the business. Cars currently account for about a third of exports but if European auto sales fall, it will impact on Slovakia.

Car producers have sucked up the labour market that is currently very tight particularly in the booming west of the country. Slovakia’s national unemployment rate is 7.4% but that conceals enormous regional disparities. With 200,000 Slovaks having left the country to work abroad, there is a skills shortage, particularly in information technology. Likewise, travel between the east and west of the country is not easy, as the infrastructure needs updating. The government has been working hard to encourage other foreign investment but the labour market could end up being too restrictive to further development.

One of the least predictable factors in Slovakia‚Äôs continuing success is the current government. The Slovak Business Alliance (PAS) announced in June that the business environment had deteriorated over the two years that Mr Fico has been prime minister. The government has put more restrictions on retailers, leaned on utility companies to cap prices and has drafted a law that would make ‚Äėunjustified‚Äô price increases a criminal offence. The Prime minister has a dislike of the media and large businesses and seems to be targeting those areas in the name of building social solidarity in the country.

One could be forgiven for thinking that Slovakia faces enough problems in the current global climate and its own development without creating a scenario where foreign investors are scared off.

Post script: Slovakia’s central bank has cut its key interest rate to 3.75% to bring its monetary policy in line with the European Central Bank. This was unexpected due to the high inflation rate in the country.

Source: This is part of the Future Horizons Global Semiconductor Report for November.
Image Source: Wikipedia
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