Growth Outlook Deteriorates On Weaker Demand


BMI View: We have lowered our forecast for Slovakia GDP growth in 2013 to 1.2%, from 2.0% previously, as domestic demand is squeezed by further austerity measures and export growth moderates following a bumper year in 2012. Given the importance of external demand, regional headwinds continue to pose a threat to the Slovak economy this year, although should help drive growth from 2014.

Macro Strategy

Economic growth in Slovakia slowed sharply at the end of 2012, as fiscal austerity and regional headwinds hit both domestic and external demand. According to latest data from the Statistics Office of the Republic of Slovakia (SORS), real GDP growth measured just 0.7% in Q412. Following the pattern of much of 2012, in Q4 growth came entirely from external sources (exports were up 7.1%), while consumption and investment continued to decline.

Growth for 2012 as a whole came in at 2.0%, below our estimates of 2.5%, as the slowdown at the end of the year was even more pronounced than expected. Throughout the year, private consumption fell by 0.6% and public spending by 3.5%, while gross fixed capital formation slumped by 3.7%. Net exports, on the other hand, contributed 4.3 percentage points (pp) to headline growth.

Hitting Bottom In 2013
Real GDP Growth (% change)

We do not expect a drastic change in the drivers of growth in 2013, with no sign of a reversal in domestic demand in the near future. Indeed, tighter austerity measures introduced as the government seeks to lower the fiscal deficit to 3% of GDP will weigh on economic activity, while regional headwinds will cap export growth. Meanwhile, growth in the dynamic manufacturing sector - dominated by automobile production - is also likely to slow from the 11.7% expansion posted in 2012.

With this in mind, we have lowered our forecast for real GDP growth in 2013 to 1.2%, from a previous 2.0%. Looking further ahead, we maintain our view for a gradual acceleration of GDP growth in the 2014-2016 period, in line with the wider regional rebound, with domestic demand playing a more important role in headline growth.

Private Consumption

Household spending has been in decline since 2010, as consumer demand waned amid economic uncertainty and rising unemployment. Monthly retail trade except motor vehicles remained in negative growth territory in the first two months of 2013, according to SORS, while real wages, which fell by 1.2% in 2012, continued to fall in most economic sectors over the same period.

Struggling To Recover
Monthly Consumer Confidence Indicator

A key factor in suppressing private consumption has been the steady rise in unemployment, which hit 14.4% at the end of 2012 and looks set to have ticked higher in Q113, sapping consumer confidence and depressing wage growth. Consumer confidence did improve in Q113, hitting -29.6 in March compared to -38.9 at end-2012, though this remains far below the long-term average (-22.9). We target barely positive growth of 0.5% in household consumption in 2013, accelerating to 3% in 2014.

Government Consumption

The government's commitment to reducing the budget deficit to 3% of GDP will not allow any room for growth in state expenditure, which we expect to fall by 2% in real terms in 2013. Though the Smer-SD government is eager to focus its austerity programme on revenue-raising measures, the slowdown in economic activity will undermine the effectiveness of new tax hikes and we expect to see some targeted spending cuts introduced during the year.

Our expectation that the budget target will be missed this year feeds into our forecasts for a slow recovery in government consumption going forward, as we target growth of just 1% in 2014, making a negligible contribution to the overall economic expansion.

Gross Fixed Capital Formation

Private sector investment fell in 2012 for the first time since the recession of 2009, as weakening demand and falling confidence lowered appetite for new business ventures of expansion. The introduction of a higher corporation tax in January will weigh further on the business sector, while weaker demand and adjustments to the labour code tightening regulation for hiring and firing workers will also deter new investments in the near future. A recent survey by seven foreign Chambers of Commerce showed that a majority of European companies operating in Slovakia expected worse economic conditions this year and said the new tax and labour laws made the country less attractive for foreign investment. With this in mind, we forecast a fall in GFCF of 2% in 2013.

That said, the government is pushing to encourage companies to increase investment and create jobs to alleviate the country's unemployment problem, for example offering substantial tax relief on German tyre company Continental's planned EUR250mn expansion project. The country's reputation as a low-cost hub for car manufacturing in Europe will also help draw in investment, with BMW the latest brand considering a new production facility in Slovakia. Based on this view, we expect investment to post strong growth ahead, averaging 8% per annum in the 2014-2018 period as the broader economic outlook improves.

Net Exports

Exports will continue to drive the economic expansion, in our view, though we believe it will be at a slower rate as demand from key eurozone markets remains slack. Indeed, we have recently downgraded our target for eurozone growth in 2013 to -0.1%, from a previous 0.0%, due to downgrades to Italy and Netherlands, both important export markets for Slovakia. In addition, industrial production growth is likely to stagnate after a bumper year in 2012; in particular, the manufacture of automobiles is expected to stabilise in 2013 after stellar growth of 26% last year.

Closely Aligned
Exports and Industrial Output (% y-o-y change)

We forecast a still robust 7.1% growth in exports this year, compared to 8.6% in 2012, while also targeting import growth of 7.4% (down from 8.4%). We expect net exports to rise by 5% in 2013, contributing 0.6pps to headline growth. Going forward, the recovery in domestic demand - particularly investment - will underpin robust import growth in the medium term, with net exports making a mildly negative contribution to growth from 2014.

Risks To Outlook

The risks to our short-term growth outlook come from both sides: on the one hand, with tax revenues set to disappoint, the government may begin to implement more severe spending cuts to try and hit its budget targets, thereby further impacting on domestic demand. On the other hand, a modest recovery in demand in Germany - a key destination for industrial exports - will provide some support for external demand. On balance, however, we view the risks are still tilted to the downside, given ongoing uncertainty over the Eurozone economy in the wake of the Cypriot banking crisis and the continuing political deadlock in Italy.

SLOVAKIA - ECONOMIC ACTIVITY
2008 2009 2010 2011 2012 2013f 2014f 2015f 2016f 2017f
Notes: e BMI estimates. f BMI forecasts. 1 Currency is the euro. For historical data, yearly average exchange rate of SKK/EUR was used as basis for calculation. Sources: 2 Statistical Office of Slovak Republic; 3 World Bank/UN/BMI.
Nominal GDP, EURbn 2 66.8 62.8 65.9 69.1 71.9 74.8 78.0 81.8 86.5 91.1
Nominal GDP, US$bn 1,2 98.3 87.9 87.4 93.3 91.3 93.5 97.5 102.3 108.1 113.9
Real GDP growth, % change y-o-y 2 5.8 -4.9 4.4 3.2 2.0 1.2 2.4 2.8 3.3 2.4
GDP per capita, US$ 2 18,416 16,477 16,376 17,486 17,116 17,517 18,281 19,172 20,270 21,349
Population, mn 3 5.4 5.5 5.5 5.5 5.5 e 5.5 5.5 5.5 5.5 5.5
Industrial production index, % y-o-y, ave 2 3.2 -13.7 19.1 6.5 8.1 3.0 4.5 4.8 5.0 5.2
Unemployment, % of labour force, eop 2 8.4 12.7 12.5 14.0 14.4 14.2 12.5 11.5 10.0 9.0
This article is tagged to:
Sector: Country Risk
Geography: Slovakia, Slovakia