Slovakia: External Deficits and the Euro
Mid-December 2006, the governor of the Slovak National Bank, Ivan Šramko, voiced preoccupation concerning the strong appreciation of the Slovak koruna.
Joachim Becker - Dec. 27, 2006
The appreciation has amounted to about ten percent since mid-July 2006. Hitherto most experts have welcomed the appreciation of the Slovak koruna – with the exception of the former social democrat minister of finance, Brigita Schmögnerová. The Slovakian governments – in the past led by Mikuláš Dzurinda (SDKU - Slovak Democratic and Christian Union), today led by Robert Fico (SMER) – have considered the appreciation of the koruna a vote of confidence for their economic policies by financial markets. The consumers enjoy cheaper imported goods. The revaluation, however, is not really in line with the figures of the external economic relations, i.e. a huge deficit of the current account and an escalating foreign debt. Judged by these data, the koruna should rather depreciate in order to enhance the competitiveness of exports and to reduce imports. Some exporters have already begun to complain about the appreciation of the koruna. The problematic external balances raise a few questions about Slovakia's envisaged entry into the euro zone.
The development of CEE today and Latin America in the 1990s display some common features: policies of radical opening of the economy, high economic growth, revaluation of the national currencies in real terms, structural deficits of the current account and escalating external debts. In Latin America, this pattern of development has proven not to be sustainable.
Capital inflows are not persisting permanently. When flows to Latin America were drying up, the currencies had to be devalued. In countries like Argentina and Uruguay, the banking systems were shaken to their foundations. GDPs collapsed, poverty became endemic.
When it comes to the Baltic States and Slovakia today, there are signs that indicate a more cautious behavior on part of investors. In Slovakia, new capital inflows were to a large extent short-term in 2005. In the first eight months of 2006, the current account deficit tended to grow in comparison to the same period of 2005. The capital account deteriorated as well. As a consequence, the foreign exchange reserves of the Slovak National Bank declined from US$ 15.48 bn at the end of 2005 to US$ 13.24 bn at the end of August 2006. Although the current account was extremely in the red in September, the koruna has almost continually appreciated over the last months. This development is not in line with the current account. It seems to be rather an euphoria based on economic growth and the expectation of rising interest rates. However, the current account and external debt data should be perceived as warning signal. An exchange rate crisis of another Central European country could easily affect Slovakia as well.
A speculative attack against the koruna is still possible during the ERM II phase. The impact of such an attack might be softened, however, by an intervention of the European Central Bank. This appears as advantage for Slovakia in comparison to the Latin American states. Still, a strong depreciation of the koruna would tend to push prices up. Therefore restrictive economic policies would be the likely consequence of an exchange rate crisis.
Nevertheless, the option of a controlled devaluation would be ruled out as well. This could prove to be a problem for small and medium scale companies because they would face enhanced competitive pressure. This already has proven to be a problem for countries like Portugal, Greece and Italy which are economically stagnating.
Furthermore the restrictive criteria of an entry to the euro zone and the criteria of the Growth and Stability Pact would slow down economic growth. These policy measures are not conducive to a process of catching up to states with a considerably higher per capita income. The budgetary decision-making powers of the parliaments would be curbed, i.e. elected bodies would be partially circumscribed in their powers. Thus entering the euro zone has some serious drawbacks as well.
Joachim Becker is university professor in Vienna and analyst for the Institute for Studies in Political Economy (IPE)
Parallels to Latin America
The combination of rapid economic growth, structural deficit of current account and escalating debt is not a unique Slovak problem. It is shared by most Central and East European (CEE) states albeit to varying degrees. In 2005 Slovakia's current account deficit amounted to 8.7% of GDP. This is one of the highest in the region but was clearly exceeded by Latvia and Estonia which displayed deficits considerably above 10% of GDP. High current account deficits need to be financed by capital imports. Accordingly, Slovakia's foreign debt has rapidly increased over the last years. In current US dollars, it tripled more or less during the years of the two Dzurinda governments (1998-2006). In 2005, it reached 60% of GDP. Like the current account deficit, Slovakia's ratio of external debt/GDP lies in the upper middle field of CEE countries. As far as the Baltic states, Hungary, and Slovakia are concerned, the present figures of current accounts, the growth of external debts and the ratios of external debt/GDP are worse than they used to be in Latin America in the 1990s, just before the financial crises.The development of CEE today and Latin America in the 1990s display some common features: policies of radical opening of the economy, high economic growth, revaluation of the national currencies in real terms, structural deficits of the current account and escalating external debts. In Latin America, this pattern of development has proven not to be sustainable.
Capital inflows are not persisting permanently. When flows to Latin America were drying up, the currencies had to be devalued. In countries like Argentina and Uruguay, the banking systems were shaken to their foundations. GDPs collapsed, poverty became endemic.
When it comes to the Baltic States and Slovakia today, there are signs that indicate a more cautious behavior on part of investors. In Slovakia, new capital inflows were to a large extent short-term in 2005. In the first eight months of 2006, the current account deficit tended to grow in comparison to the same period of 2005. The capital account deteriorated as well. As a consequence, the foreign exchange reserves of the Slovak National Bank declined from US$ 15.48 bn at the end of 2005 to US$ 13.24 bn at the end of August 2006. Although the current account was extremely in the red in September, the koruna has almost continually appreciated over the last months. This development is not in line with the current account. It seems to be rather an euphoria based on economic growth and the expectation of rising interest rates. However, the current account and external debt data should be perceived as warning signal. An exchange rate crisis of another Central European country could easily affect Slovakia as well.
Slovakia's First Steps towards the Euro Zone
Following the example of Slovenia and the Baltic states, Slovakia entered ERM II rather rapidly, at November 28, 2005. This is an obligatory step towards entering the euro zone. It establishes a so-called soft peg. The central exchange rate was fixed at 38.4550 Slovak koruna for 1 euro. The exchange rate may fluctuate +/- 15% around this central rate. If the lower or upper margin is reached, the European Central Bank is obliged to intervene. In case of exchange rate instability within these margins, it might but need not to intervene. An adjustment of the central exchange rate is still possible. In case of strong depreciation or an official devaluation, the entry into the euro zone would be postponed.A speculative attack against the koruna is still possible during the ERM II phase. The impact of such an attack might be softened, however, by an intervention of the European Central Bank. This appears as advantage for Slovakia in comparison to the Latin American states. Still, a strong depreciation of the koruna would tend to push prices up. Therefore restrictive economic policies would be the likely consequence of an exchange rate crisis.
The Euro Option
With the exception of Slovenia, it had been CEE states with high current account deficits and escalating foreign debts (the Baltic states and Slovakia) that entered rapidly ERM II, the step before the euro zone. Membership to the euro zone would provide protection against an exchange rate crisis. The exchange rate with the most important economic partner would disappear. A strong depreciation of a national currency, which would pose a threat to domestic debtors who owe credits in euro, could be ruled out. Thus entering the euro zone might contribute to financial stability.Nevertheless, the option of a controlled devaluation would be ruled out as well. This could prove to be a problem for small and medium scale companies because they would face enhanced competitive pressure. This already has proven to be a problem for countries like Portugal, Greece and Italy which are economically stagnating.
Furthermore the restrictive criteria of an entry to the euro zone and the criteria of the Growth and Stability Pact would slow down economic growth. These policy measures are not conducive to a process of catching up to states with a considerably higher per capita income. The budgetary decision-making powers of the parliaments would be curbed, i.e. elected bodies would be partially circumscribed in their powers. Thus entering the euro zone has some serious drawbacks as well.
Joachim Becker is university professor in Vienna and analyst for the Institute for Studies in Political Economy (IPE)
IPE - Glockengasse 28/9 | A-1020 Vienna/Austria | office@ipe.or.at
