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Slovakia’s date with the euro

Slovakia has convincingly passed the first of the EU’s tests for euro entry. Armed with the Commission’s recommendation, it is well on the way to introducing the single currency, as expected, on 1 January 2009.

Bratislava: gearing up for the euro
Bratislava: gearing up for the euro

The confirmation came on 7 May 2008, when the European Commission concluded in its regular Convergence Report on euro readiness that Slovakia now meets all the criteria for adopting the single currency.

“Slovakia has achieved a high degree of sustainable economic convergence and is ready to adopt the euro on 1 January 2009,” said Economic and Financial Affairs Commissioner Joaquín Almunia.

The final hurdle facing Slovakia’s bid will come in July 2008 when the EU’s Economic and Financial Affairs Council (ECOFIN) convenes to consider the opinions of the European Parliament and EU leaders before making its final decision.

Rising star

Once it has ECOFIN’s blessing, Slovakia is set to become the fourth of the ten Member States which joined the EU in 2004 to enter the euro area when it introduces the single currency on 1 January 2009. Slovakia will also become the 16th Member State to employ the euro as its national currency, enlarging the euro area to include more than 325 million Europeans.

For Slovakia, the imminent currency switch is not only about economic potential; many Slovaks will view the euros in their pockets as a vote of confidence and confirmation that their country is punching its weight on the European stage after the difficult post-communist years and the ‘velvet divorce’ which saw Slovakia and the Czech Republic go their separate ways.

“We were always considered the ugly duckling of Europe,” one Slovak analyst observed, adding that Slovakia, which was seen as the “smaller, poorer brother” of the Czech Republic, has now become a “shining star” in Central Europe.

Surpassing expectations

Over the last few years, Slovakia has largely surpassed expectations. This may explain why it requested an assessment of its economic convergence from the European Commission and the European Central Bank, which normally occurs when a candidate euro-area country considers that its economy has moved close enough to those of the other members of the single currency.

The rules for economic convergence on which a candidate economy is evaluated were laid down in the Maastricht Treaty, which entered into force in 1993. All the Member States which joined the new euro area in 1999 had to meet the same criteria. The rules cover four main areas: inflation, government finance (deficit and debt), the national currency’s exchange rate, and long-term interest rates.

Upon joining the EU in 2004, Slovakia pledged itself to the eventual adoption of the euro, and joined the exchange rate mechanism, ERM II, in November 2005.

Last year, Slovakia had set itself a general government deficit target of 2.9% of GDP, just shy of the 3% Stability and Growth Pact ceiling. According to the latest update, the deficit actually dropped to 2.2% in 2007, and it is expected to fall further, to around 2% of GDP, in 2008. But Slovakia’s budgetary ambitions do not stop there. Its Convergence Programme foresees the deficit to drop to 0.8% of GDP by 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.

Moreover, the Slovak gross government debt, which hovers at around 30% of GDP, is about half the target level set by the convergence criteria (Graph 1).

Stabilising prices

Tatra mountains in Slovakia
Tatra mountains in Slovakia

From pretty high levels when it entered the EU, Slovakia has brought its inflation level down to 2.2% which is well below the convergence reference value of 3.2% (Graph 2). “The fulfillment of the inflation criterion is no one-day wonder, but the expression of a sustainable development,” the head of Slovakia’s central bank, Ivan Sramko, was quoted as saying.

Although this level is low enough to allay worries about longer-term price stability, the Commission recommended Slovakia remain vigilant to keep inflation at a low level, notably by maintaining wage discipline, adopting a more ambitious fiscal stance and further advancing structural reforms to improve the functioning of product markets. “There’s no reason for panic [about inflation rising] because there is no inflationary impulse from domestic Slovakian developments,” the central bank chief insisted.

Slovakia’s interest and exchange rates have also been satisfactory. The country’s average long-term interest rate over the year to February 2008 was 4.5%, below the reference value of 6.5%. It has been below the reference value since 2004. Although the exchange rate of the Slovak koruna has risen quite strongly against ERM II’s central rate, the Commission concluded that the reasons for this appreciation were sound and that the currency has not experienced severe tensions.

Despite the undoubted successes Slovakia has scored in preparing for euro entry in such a relatively short time, challenges will remain, even after it adopts the single currency. With the spiraling energy and food prices, maintaining budgetary discipline may prove tough in the coming years. In addition, these rising commodity prices, along with the rising cost of labour accompanying economic boom times, could well result in inflationary pressure on the Slovak economy.

“To ensure that the adoption of the euro is a success, Slovakia must pursue its efforts to maintain a low-inflation environment, be more ambitious with regard to budgetary consolidation, and strengthen its competitiveness position,” Commissioner Almunia noted.

Graph 1: Government budget balance and debt (% of GDP)

Graph 1: Government budget balance and debt (% of GDP)(*) Commission services’ Spring 2008 Forecast Source: Eurostat, Commission services

(*) Commission services’ Spring 2008 Forecast
Source: Eurostat, Commission services

 

 

The Slovak economy

 

In the 1990s, Slovakia experienced a less painful transition than many of its neighbours when it transformed its central command economy to a market one, following the collapse of the Soviet Union. The country was aided by its strong industrial base and reform-minded leaders, even though the rate of reform slowed somewhat following the country’s ‘velvet divorce’ from the Czech Republic in 1993.

Building upon the economy’s traditional foundations in heavy industry, Slovakia’s key industries today are automobiles and electronics, both of which have attracted droves of foreign investors eager to take advantage of a cheap and skilled workforce, favourable tax rates and geographic location, and a relatively liberal labour code.

The substantial increases in FDI inflows to the country have also been encouraged by an accelerated reform programme which kicked in to prepare Slovakia for EU membership and, now, for the euro. This has included the restructuring of enterprises and banks, largescale privatisation, as well as reforms to the tax, pensions, healthcare and welfare systems.

Slovakia is currently experiencing good economic times, which has helped it in its efforts to meet the convergence criteria. Its export-driven economy has enjoyed several years of sustained economic growth of up to 10.4% last year, boosted by the FDI inflows mentioned above and the resulting strong manufacturing growth. However, by 2009, real economic growth is expected to have declined to 6.2% according to the Commission Spring 2008 Forecast.

Strong growth and newly built export production capacities – such as new car production plants – are helping to improve employment levels.

Further information

Further information

 

Convergence report 2008

 

The economy of Slovakia

 
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