The fiscal position will worsen markedly this year and next, largely due to the cyclical rise in spending on social benefits and the fall in tax revenues but also to two fiscal stimulus packages enacted earlier in 2009. In 2010, the rise in the deficit will be limited by a set of ambitious expenditure cuts. Over the medium term, further fiscal consolidation will be necessary to ensure the sustainabllity of public finances. Whilst the automatic phasing-out of the stimulus measures at the end of 2010 will help in this regard, additional measures will be needed.
Activity is recovering but unemployment is now very high
After a sharp decline in real GDP in the first quarter of this year, economic activity recovered somewhat in the second quarter. The rebound was largely due to an increase in private consumption (which was supported by fiscal stimulus measures such as the car scrapping scheme and income tax cuts) an d a positive contribution from net exports. The improvement in the trade balance was related to both higher demand from Slovakia's main trading partners and a drop in imports. Private investment by contrast had a negative impact on growth, falling at even higher rates than in the previous quarter. The labour market reacted swiftly to the worsening of economic activity, with the unemployment rate rising to 12% in mid-2009, from 7 1/2 per cent one y ear earlier. Nonetheless, unit labour costs soared. Headline inflation ha s eased substantially on account of declining energy prices. Core inflation, however, remains high despite the substantial slack that has emerged in the economy.
The economic outlook is gradually improving
Available evidence points to a gradual improvement in the economic situation going forward. Business and consumer survey indicators have improved considerably during the summer. Accordingly, retail sales and industrial production have stabilised, albeit at low levels. The sharp drop in export orders also appears to have come to an end, though orders remain well below their long term average. Moreover, the strong increase in unemployment seems to be levelling off so that its drag on private consumption growth is set to peter out.
The government budget deficit is set to widen markedly
As a result of the cyclical decline in tax revenues and the rise in spending on social benefits as w ell as the government's two fiscal stimulus packages (amounting to around 1.3% of GDP) the budget balance is set to worsen considerably this year and next. The cyclical deterioration in the deficit in 2010 will be partly offset by ambitious expenditure cuts, amounting to more than 1% of GDP. Over the medium-term, further consolidation will be necessary to bring public finances back to a sustainable path. The automatic phase-out of stimulus measures at the end of 2010 will be helpful in this respect.
Growth is set to pick up gradually
Real GDP is projected to fall by 5.8% this year, as the sharp drop in the first quarter could not be offset b y the rebound in the second and third quarters. The past increase in unemployment will still weigh on GDP growth during the next quarters by holding back private consumption. Even though house prices have dropped quite considerably during the past months, this decline is unlikely to be an important drag on consumption as households were not overly indebted prior to the crisis and there is little evidence of wealth effects. GDP growth is projected to reach 2% in 2010 and a bit more than 4% in 2011. This recovery will be driven by both a positive contribution from net exports and stronger domestic demand. Slovakia is heavily exposed to economic developments in its European trading partners, and is thus expected to benefit from their rebound. In addition, a normalisation of global credit conditions should also support private investment spending, not least by foreign firms which in the past have made a significant contribution to overall gross fixed capital formation.
High unemployment will hold back wage growth
The unemployment rate is projected to rise a b it further, peaking at around 12.8% in the first quarter of next y ear. This will put downward pressure o n wage growth, particularly in 2010, thereby at least partially reversing the marked jump in unit labour costs recorded in early 2009. Along with the deceleration in wage growth, core inflation is expected to come down to below 2% in 2010 and remain at that level until the end of the projection horizon.
Risks are broadly balanced
The risks to the projection are roughly balanced and mainly relate to the pace of the recovery in Slovakia's main trading partners, which is of crucial importance for decisions about FDI projects in the Slovak Republic.
Slovak Republic: Demand, output and prices 2006 2007 2008 2009 2010 2011 Current Percentage changes, volume prices (2000 prices) [euro] billion Private consumption 31.3 7.0 6.1 -1.0 0.8 4.0 Government consumption 10.6 -13.0 4.3 4.1 -5.9 -2.2 Gross fixed capital 14.6 8.7 6.8 -11.8 2.1 6.9 formation Final domestic demand 56.5 5.9 6.0 -2.9 -0.1 3.6 Stockbuilding (1) 0.7 0.6 0.5 -3.6 0.9 0.0 Total domestic demand 57.2 6.4 6.4 -6.3 0.8 3.7 Exports of goods and 46.5 13.8 3.2 -19.6 5.2 11.6 services Imports of goods and 48.6 8.9 3.3 -20.4 3.2 10.7 services Net exports (1) -2.1 3.8 -0.2 1.2 1.2 0.5 GDP at market prices 55.1 10.4 6.4 -5.8 2.0 4.2 GDP deflator -- 1.1 2.9 -0.6 0.7 3.0 Memorandum items Harmonised index of -- 1.9 3.9 1.0 1.7 2.4 consumer prices Private consumption -- 2.6 4.4 1.9 2.0 2.4 deflator Unemployment rate -- 11.0 9.6 11.6 12.7 12.5 General government -- -1.9 -2.3 -5.9 -6.3 -5.0 financial balances (2) Current account -- -4.9 -6.4 -3.8 -3.1 -2.8 balance (2) Note: National accounts are based on official chain-linked data This introduces a discrepancy in the identity between real demand components and GDP For further details see OECD Economic Outlook Sources and Methods (http.//www.oecd-org. eco/sources-and-methods). (1.) Contributions to changes in real GDP (percentage of real GDP In previous year), actual amount In the first column (2.) As a percentage of GDP Source: OECD Economic Outlook 86 database. StatLink http://dx.doi.org/10.1787/753848702737