SIGNPOST: Slovakia's economy powers toward its date with the euro

By bne IntelliNews March 7, 2007

Nicholas Watson in Prague -

On Tuesday, Slovakia announced it has revised up its preliminary estimate for GDP growth in the fourth quarter of 2006 by 1 percentage point to 9.6%, just shy of the 9.8% rate posted in the third quarter, which was the highest growth in the country's history.

For the whole of 2006, the economy grew by 8.3%, significantly accelerating from the 6.0% growth recorded in 2005.

The question is: will this level of continue through 2007 and how will it affect the country's stated goal to join the euro in 2009?

Few analysts doubt a continuation of the strong growth this year and into the next.

The surge in the third quarter of 2006 was put down to a "supply-side shock" driven by huge investment and stock-building at new factories and distribution centres in the automotive and electronic goods sectors before they launched operations.

Given there aren't any other FDI projects on the scale of the PSA Peugeot Citroen and KIA Motors auto plants, investment growth is forecast to fall to around 5%. However, replacing this in the GDP figures will be the export-oriented production from these new factories, which the data shows is already happening.

"GDP growth [in the fourth quarter] was driven mainly by net exports – the contribution was 5.2 percentage points," says Miroslav Frayer, economist at Komercni Banka. "We assumed that high growth in inventories in the third quarter would transform into net exports in the following quarter."

As well as the automotive sector, analysts see another "pillar" to Slovakia's export boom in the form of the new electronic plants of Samsung and Sony, whose production will include the increasingly ubiquitous LCD TVs and screens.

Domestic demand will also maintain its important role in GDP growth in 2007, albeit to a lower extent than in 2006. Out of this domestic demand, private household consumption showed the strongest growth, up 5.9% in 2006, and should do so again in 2007 as Slovaks enjoy rising wages and greater employment. Real wage growth probably reached 3.2% in 2006 and should rise to 3.7% in 2007, while the unemployment rate fell to 13.5% in 2006.

UniCredit Group argues that economic growth will peak in the first of 2007 and fall off slightly in the second, bringing the full-year figure to 7.5%. Other analysts such as Frayer and those at Raiffeisen Research believe the 2007 figure will come in higher at around 8.5%. "There could even be room on the upside," reckons Raiffeisen.

Euro, here we come!

One of the advantages of this economic growth over the last few years is that it has made the knotty problem of sorting out the country's public finances far less painful than it might have been. This became especially important following the parliamentary elections in June 2006 that brought to power a new government coalition led by Robert Fico's SMER party, which is not known for its reformist zeal.

In fact, "the new government has shown less ambition than what was originally feared to roll back crucial parts of the liberal economic reforms undertaken by the previous government," says Robert Prega of Tatra Banka in Bratislava.

The Slovak parliament has approved the budget for 2007 with a deficit of 2.94% of GDP. And though there are still some steps the government could yet take to harm the public finances, analyst believe these would be more relevant in a longer-term perspective and the government should be able to meet this Maastricht criterion to join the euro.

"It appears that the plan to join the Eurozone in 2009 has become a question of prestige for the government and that it would be willing to take some extraordinary steps to cut expenditures during the next year," says Prega.

The strong economic growth is not hurting the battle to keep inflation down either, one of other the key Maastricht criteria to join the euro.

In the second half of 2006, inflation started to decelerate due to lower energy prices and a rising currency – a trend that is expected to continue through this year. Though the inflation rate came in a touch above 2.0% in 2006, most economists expect the central bank to meet its 2.0% target by the end of 2007.

"In 2008, the inflation rate should stabilize below the central bank's inflation target and the Maastricht criterion should be met," believes Komercni Banka's Frayer.

The whims of the European Central Bank and politicians notwithstanding, most people still expect the Eurozone to welcome its 14th member in 2009.

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