When Czechoslovakia split in two 20 years ago, who would have thought that the less economically developed Slovakia would manage to take the Czech Republic’s position as the bright spot of central and eastern Europe?
The Czech economy has shrunk for a third quarter in a row and by 1.2% in annual terms in the second quarter of 2012, according to the European Union’s statistics body, Eurostat. At the same time Slovakia is among the growth champions in both the eurozone and the EU, with its economy advancing by 3% in annual terms.
“This growth is driven by a dynamic increase in exports, led by the car industry. Overall we expect the economy to grow by 2.3% this year and 2.1% in 2013,” says Lubomir Korsnak, an analyst with UniCredit Bank Slovakia.
In an update to its economic outlook for the region in July, the European Bank for Reconstruction and Development called Slovakia one of the “brighter spots” in central and eastern Europe.
About a decade ago Slovaks began reforming their economy and decided to focus on making cars. Volkswagen, Kia and PSA Peugeot Citroën have factories in the country, each with a myriad of suppliers attached. The firms have weathered the crisis relatively well, and this year should be a strong one for Slovakia’s automotive industry, with 40% growth expected for production according to PricewaterhouseCoopers.
“This is primarily linked to the launch of the New Small Family in Volkswagen’s plant near Bratislava, which will almost double its production this year,” says Peter Mrnka, senior manager at PricewaterhouseCoopers in Bratislava.
“KIA’s plant in northern Slovakia has recorded a 10% growth for the first six months of the year. Higher global demand for SUVs and small car models, where Slovakia has a very strong position, drives production up.”
He says that as long as Slovakia keeps its high labour productivity, and carmakers optimize their production costs to stay competitive, the dependency on the automotive industry does not pose a significant risk to the economy.
But there are two issues that might cast a shade over this good news: tax hikes and a weak labour market.
The social-democratic government of Robert Fico, aiming to push next year’s deficit under 3% of GDP, decided to cancel the 19% flat tax introduced in 2004, replacing it from next January with a 23% rate for corporates and a 25% rate for individuals earning more than €3,246 per month. The measure should add an estimated €468.9 million or 0.6% of GDP to the state budget next year.
Finance ministry officials argue that year after year Slovakia’s public finance deficits above the EU average could be balanced by high economic growth and income from privatization. But as nobody expects the economy to return to pre-crisis levels of growth soon, the decision to increase taxes makes sense.
“We are determined to adopt such consolidation measures that will not affect low income people and will have a limited impact on the economic growth,” says deputy finance minister Peter Pellegrini.
From September companies with at least half their revenues from energy, insurance, telecommunications, postal services and transport will pay a special levy of 4.356% each year on profits exceeding €3 million. The measure lasts until the end of 2013 and should generate some €125 million.
From the beginning of 2012 banks have been paying a special tax of 0.4% on corporate deposits. This was extended to private individuals’ deposits from September 1. This is a temporary measure, and the rate will gradually decrease, but the Slovak Banking Association blames it for the 36% decrease in the sector’s profit in the first half. Even the Slovak central bank admits that banks are heavily taxed.
The business community did not receive the news about the tax hikes well. German investors were the first to express criticism. Germany is Slovakia’s main business partner with €20 billion in trade per year and 90,000 people working for German companies.
“We might still have a recession in the world, so you don’t want to make companies nervous now,” says Markus Halt, deputy chief executive of the German-Slovak Chamber of Trade and Industry.
Volkswagen, Siemens and Deutsche Telekom will find a way to deal with these tax hikes because they have big bargaining powers in dealing with policymakers, but there are about 0400 small and medium-size enterprises (SMEs) with German capital in Slovakia where costs will increase.
“As the government plans to decrease labour market flexibility too, some companies might become cautious and put on hold future investment plans,” Halt adds.
QUALIFICATIONS
SMEs complain about a shortage of skilled employees because schools are out of sync with the market. “Recruiters deal with applicants whose knowledge and experience are so poor that to hire and train them is very costly. This is very sad for a country where youth unemployment is more than 30%,” says Halt.
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The government plans to reform the education system by imposing stricter rules for high school admission, hoping to channel more youngsters into vocational schools. It has also earmarked €70 million from EU funds to help create 14,460 jobs for people younger than 29. But all these might not help in dealing with the ugliest skeleton in Slovakia’s closet: the long-term unemployed. Slovakia’s unemployment rate was 13.6% in Q2, and 63% of its jobless people have been out of work for more than a year.
“Many of them don’t stand a chance in the labour market because of poor skills and low mobility,” says labour economist Martin Kahanec from the Central European Labour Studies Institute. “They are dependent on supported schemes such as community service, which spend public money but fail to upgrade their skills. It’s an open secret that many take manual jobs on the black market in constructions or agriculture.”
Halt believes education is just one of various areas that need improvement: “Slovakia needs to invest in education and in research and development where it is seriously lagging behind,” he says. “Infrastructure also needs improvement, mainly in the east. Corruption and the way the judicial system functions are two big factors of risk. It takes years to settle an ordinary debt claim via a Slovak court, and that’s unacceptable.”