Slovakia Economic Insights: The name of the game - FUNDS

Slovakia went through a very difficult time during the second wave of COVID-19. Curfew lasted for 4 months, from the second half of December until mid-April. Shops and restaurants were closed or operated only in a very limited way. Thus, expectations of economic growth were very low and a decrease by 1.8% qoq came in as a surprising outcome. This resulted in slight annual growth of 0.2% in Q1 2021.

Over the 1st quarter, due to the curfew, households were pushed to save more. It was mirrored in the fall of household consumption, however, the slump in retail sales indicated an even worse result. Gross fixed capital investments posted a decrease by 10% yoy, already the fifth negative figure in a row. None of the consumption segments were hit so dramatically like investments.

Only thanks to the very robust export, the economy did not lose more from its performance. Industrial production was not affected by the second wave of COVID-19 at all. In year-on-year terms production of industry increased by more than 7% in 1st quarter.

The rest of this year will be of course highly dependent on the speed of recovery and vaccination. We do not expect another wave of the pandemic to be strong enough to shut services down as we saw it in the winter. However, due to the significantly lower than optimal ratio (70-80%) of the vaccinated population, we expect an increasing number of infected people during the autumn. Spreading the virus in the third wave might naturally decelerate economic recovery as well. Another risk for our forecast stems from the lack of chips in the car industry. If the most important part of the Slovak economy is not able to cope with this issue, growth of 5% yoy might be at risk. On a positive note, significant savings of households might boost the consumption with support also from very positive economic sentiment in euro area.

In 2021, investment activity will only hardly catch up with the pre-crisis level from 2019. The real game-changer, however, should come in the following years. There are three packages of European funds at disposal for Slovakia. The first one is a classic EU fund from the budget period 2014-2020. Its availability for drawing was prolonged by 3 years. A similar situation led to a boost in investments in 2015. We are confident that it can be repeated also this time and the government will try to use most of the remaining EUR 8 bn (9% of GDP). The second impetus for investments and GDP growth is the EU Next Generation fund. In the years 2021 – 26 Slovakia can draw EUR 6 bn. Priorities of this package are divided into 6 chapters. More than half of allocated funds will go into the most important areas: green economy and health. Overall, the aim of the government is to narrow the gap of GDP per capita between Slovakia and the average of the EU. The last package is EU funds from the budget period 2021-2027. In that case, EUR 13 bn is at disposal.

For a small open economy like Slovakia, a very important part of the story of economic growth is also the development of core business partners. The growth of euro area GDP provides a ground for economic development in Slovakia. Expectations of both elements, drawing of EU funds and euro area recovery, give solid foundations to assume GDP growth of Slovakia as high as 5% yoy in 2022 and 4.5% yoy in 2023. In the following years, we expect the growth to slow down.

The price development was influenced by a few dampening factors at the beginning of the year. Prices of energy and low demand played a key role in the slowdown of CPI to 0.7% yoy in January. However, the lockdown of the economy veiled processes in the background for several months. More than 20% of items in the CPI basket were only estimated. After reopening the economy at the end of April, CPI jumped to 2.2% yoy in May. Until the end of the year, inflation dynamics will in our opinion even intensify to 2.7% yoy. Nevertheless, the yearly average for 2020 should reach the level of 2% and the increased inflation pressure will influence mainly the following year. We expect that CPI will reach 2.7% yoy in 2022.

The second pandemic wave caused less damage to the labor market than the first one. However, a decrease in employment by 2.5% yoy in ESA terms was a negative surprise. Nevertheless, the unemployment rate did not react accordingly. It increased only marginally from 7.4% in Q4 2020 to 7.9% in Q1 2021, possibly as a result of people leaving the labor market. We assume that economic recovery will revive old or/and create new jobs. However, it may take more than 2 years for the labor market to recover into the pre-crisis state.

The positive dynamic of wage growth is more or less the result of statistical effects rather than result of broad-based growth of payslips. However, economic growth in the following years should gradually spur the increase in wages. In 2023, we expect it to reach the 6% yoy growth.

According to Eurostat, the public finance deficit stood at 6.1% of GDP in 2020. The deficit in 2021 should be at a bit higher level due to more generous help for households and companies — Council for budget responsibility estimates it at 7.7% of GDP. The public debt went up to the level of 60.3% of GDP in 2020 by more than 12 p.p. from 2019. The deficit in 2021 should increase the debt further to 63% of GDP while the strong growth of the economy and reduced deficit in 2022 could stabilize debt around 65% of GDP in the medium term. At the same time, the Slovak debt management agency should not have problems with the financing of debt. The ECB bond-buying programs support demand for Slovak bonds and this support should last throughout the whole of 2021.

Public finances desperately need structural redesign and government should deliver a feasible and credible deficit reduction plan. Currently, the structural deficit stands at 3% of GDP (value for 2020) and is a result of mismanagement of previous government rather than the Covid pandemic. Not addressing this issue could cause debt to remain on an increasing trajectory. That is why we will closely monitor government plans and the actual delivery of reforms.