Jan Cienski in Bratislava -

Faced with thousands of Slovaks taking to the streets on October 12 to protest government cuts, the country's strikingly blonde new prime minister, Iveta Radicova, is standing firm: "This government is not responsible for the deficit, but it is responsible for what the country looks like in four years time."

The new Slovak government is taking an axe to the budget as it slashes pay, benefits and government programmes while tightening up the tax system, embarking on one of the most ambitious fiscal corrections in the EU which is aimed at reducing the budget deficit from this year's 8% of GDP. "We want to recover from the effects of the economic crisis," Radicova, who took power at the head of a centre-right coalition after June elections that saw the defeat of populist leader Robert Fico, tells bne.

Fico took charge in 2006, just after Slovakia entered the EU, when it was one of Europe's fastest-growing economies thanks to eight years of centre-right rule that had turned Slovakia from a rusting and forgotten corner of the ex-Soviet empire into a lean and modern economy. Fico didn't break the economy, and did take Slovakia into the euro last year, but he did little to reform the pension and healthcare system, while handing out new benefits and presiding over a system where corruption spiralled to one of the worst levels in the EU.

A long fall

Slovakia had a tough recession, with the economy shrinking by 4.7% last year, a far cry from the 10.4% growth it saw in 2007. The contraction was due in large part to the recession in Germany, the largest market for Slovakia's exports of cars, parts and flat screen television sets. More worrying was the accompanying deterioration in Slovakia's fiscal picture, as public debt rocketed from 27% of GDP before the crisis to 42% this year.

Seeing the effects that the crisis has had on weaker Eurozone economies like Greece, the new government decided to act. Radicova is pushing through ambitious cuts that include reducing state employees pay or numbers by 10%, as well as slashing money spent on capital investments. Senior officials will see their salaries reduced by three times the level of the annual deficit, which means a painful cut of 24% for 2,600 people, including the PM herself. Additionally, the VAT rate is being temporarily raised from 19% to 20% and loopholes in the income tax system are being patched.

The net outcome will be a deficit reduction of €1.7bn, with €970m coming from spending cuts - in all about one-seventh of the state budget - and €730m coming from tax increases. As a result, the deficit is supposed to fall to 4.9% of GDP in 2011. "We think that this fiscal consolidation is enough to take the deficit below 3% in 2013," predicts Ivan Miklos, the finance minister and one of the architects of the economic reforms that transformed Slovakia after 1998.

The price paid by the country will be steep. Miklos estimates that the cut-backs will take about half a percentage point off growth in 2011, which should see growth of about 3% after expanding by 4% this year. Other economists are more pessimistic, with some predicting growth of only 1.5% as the cuts begin to bite.

Miklos is determined that Slovakia not slip into a debt spiral again, and is working on a constitutional amendment that will cap the debt/GDP level at 50% or 55%, similar to the debt rule in neighbouring Poland which has a legal debt limit of 55% and a constitutional one of 60%. "It is necessary to provide a permanent improvement," he says.

Cleaning up the past

As part of its clean-up, the new government is also taking aim at the corruption that had become an increasing problem for Slovakia, particularly in large tenders for the billions in EU structural funds flowing into the country. Slovakia has slipped below its neighbours in the corruption rankings prepared by Transparency International. Ministries are going through past contracts, looking for anything suspicious, and weeding out officials responsible for the most egregious abuses.

All new tenders are now posted on the internet - and not on bulletin boards in hidden hallways as used to happen in the past - and each new contract will become valid only after being posted for 10 days and raising no objections. "In the last four years we have risen to top levels when it comes to corruption," says the prime minister. "Corruption has proven to be one of the main barriers to foreign investment in Slovakia."

If the new government manages to get spending under control and reins in corruption, Slovakia will again be one of the more attractive investment locations in the EU, although the massive new car and television factories of the recent past are likely to be replaced with smaller but higher-value investments. Wages are still about a fifth of the rate in Germany, while labour productivity is about half the German level.