INTERVIEW: Slovakia struggles to keep lid on inflation ahead of euro

By bne IntelliNews September 9, 2008

Jan Cienski in Bratislava -

When Slovakia joins the Eurozone at the beginning of next year, the country's populist government will be keeping a sharp eye on the one thing that will definitely upset its voters - steeply rising prices. However, it has a job on its hands containing inflationary pressures as the country's gas monopoly announces it's seeking a 20% price increase from November.

To prevent euro-associated price rises that have afflicted other countries adopting the single currency, since August 24 the government has required that all prices of products and services must by law be displayed in both currencies: the Slovak crown and the euro. In addition, a "price watchdog" is scouring the shelves of Slovak shops and comparing prices to those in neighbouring countries to see if any retailers are taking advantage of the introduction of the new currency to make unwarranted profits. "If they see speculation they can then turn to regulation," says Jan Pociatek, Slovakia's 38-year-old finance minister. "We will try to fight speculative movements."

Making sure that the euro does not cause problems for the supporters of Prime Minister Robert Fico's left-wing Smer party is key for the government's ability to gain from Slovakia's admittance into the euro, one of the world's most exclusive clubs.

When Fico, with Pociatek in tow, won power two years ago, there were widespread fears that they would actually follow through on their populist ideas and gut the economic reforms that had turned Slovakia into one of the world's fastest growing economies. Despite some initial wavering, Fico announced that he would in fact aim to join the euro by 2009, despite the problems that would cause for his cash-heavy electoral promises. Pociatek calls those early fears by the opposition and many economists "crap."

"The reality is that the economy is doing very well. Rating agencies are lifting our ratings. There is a general trust in what we do," he says with evident satisfaction. He says that the remaining gripes heard from the opposition are: "Jealousy that we were able to reach this point and wrap up Eurozone membership... This is one of Slovakia's biggest achievements since independence in 1993."

The Western European reaction to Slovakia banging on the door of the august European Central Bank was less than enthusiastic. The ECB sniffily said Slovakia's bid caused "considerable concerns" and, although Slovakia met all the numerical measures for membership set out under the Maastricht criteria, the final decision to let in Slovakia was taken as much on political as on economic grounds. There was worry in Brussels that finding a way to keep Slovakia out would send a negative message to the larger economies of the region like Poland, which are theoretically trying to join the euro at an undetermined future date.

The main worry was the Slovakia would follow in the steps of Slovenia, the common currency's first ex-communist member, which saw inflation soar as soon as it was safely inside the Eurozone. Indeed, Slovakia's inflation has ticked up ominously in the last months, but the price surge was not enough to derail its euro entry.

Slovakia is well aware of the danger and has promised to keep its belt tight even when the euro replaces the koruna. The government has struck a social pact with unions and employers to keep wage increases below the rate of productivity growth. The budget deficit is supposed to steadily drop, reaching 1.7% of GDP next year and arriving at a balanced budget by 2011. "We have always declared our priority is to have sound public finances," says Pociatek. "We are well aware of the inflationary trap. I don't think we will take the brakes off public spending."

With the inability to dole out euros to its supporters, the government's best hopes for staying popular are keeping a firm lid on price increases and ensuring the economy continues to grow. Last year, growth was 10.4% and Pociatek expects it to clock in at 6.5% this year, despite the slowdown by some of Western Europe's largest economies. On September 3, data showed that economic growth for the second quarter slowed to an annual 7.6%.

Annual inflation is expected to have accelerated to an almost two-year high in August, with the median forecast in a Reuters survey putting annual EU-norm inflation at 4.5% in August, slightly higher than the 4.4% seen in July. The central bank said last month that higher cigarette prices could push the annual inflation rate slightly higher in August, driven by effect of higher excise tax. The hike took effect in January but its effect was delayed by pre-stocking.

However, analysts said the longer-term outlook hangs on energy prices. Here the news doesn't look good. Gas monopoly SPP, which is run by a consortium of France's GDF Suez and Germany's E.On, said it's seeking an average 19.8% price increase for households, effective from November, despite the government's rejection of a request for a smaller rise in August. Fico's government has said it would expropriate the property of foreign-owned utilities if they tried to impose unjustifiable price hikes on consumers too much. SPP cites higher world oil and gas prices in its attempt to raise prices from October, but the state energy market regulator URSO denied SPP's request, saying the company had failed to justify "a significant change in economic variables."

Shielding people from higher energy costs was among key promises that helped Fico win power in 2006. And playing to the base is crucial because PM Fico's populist credentials have become a little battered of late, no thanks to Pociatek. The finance minister is a frequent presence at nightclubs, is chummy with business leaders and is seen roaring about town on his motorbike. This summer he was feted aboard a businessman's yacht anchored in the Mediterranean as Slovakia was preparing to revalue the koruna. The opposition accuses him of spilling insider secrets, something Pociatek strongly denies. He did come in for a tongue-lashing from Fico, but managed to keep his job. "I understood why it was not proper," says a chastened Pociatek.

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INTERVIEW: Slovakia struggles to keep lid on inflation ahead of euro

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