Trade in Slovakia - Term Paper Example

Trade in Slovakia Table of Contents 0 Introduction 3 2.0 Current account and trade trends 7 On the other hand export of goods and services from Slovakia has been on steady rise since 2008 to 2011 when the data was available (Figure 8). This shows that open trade policies and joining of the euro zone has had a positive impact on Slovak exports. 10 10 3.0 Trade composition 10 4.0 Trade destination 11 6.0 Recent trade conflicts 14 8.0 Portfolio investment trends, official foreign exchange and gold reserves 17 9.0 Trends in factor mobility 19 10.0 Exchange rate policy 20 11.0 Nominal exchange rate and real exchange rate trends 20 12.0 Financial, exchange rate, and debt crisis 22 References 24 1.0 Introduction Slovakia is successful, consolidated, and democratic state with a well developed market economy (BTI, 2012). For many years the country was viewed as lagging behind politically and economically by other European countries but it is now considered as one of the models of successful economic transformation in Europe. In January 2009, Slovakia became the first Central European state to join the Eurozone and it is currently the considered the fastest developing country in the European Union (Daborowski, 2009). Despite the impressive economic performance of the country, there are persistent concerns over the political situation attributed to the current and recent governments. BTI (2012) indicates that despite the greater institutionalization of civil society in the country, greater media involvement and increase of political watchdogs, the quality of democracy has deteriorated in recent days. For example judiciary independence and media freedom have worsened in the past five years. The economic achievements enjoyed by Slovakia are attributed to a consistent economic policy characterized by passing of investor-friendly legislation, liberal economic reforms, and institution of effective measures for adoption of the euro. The country has recorded major improvements in the last decade placing it among the leading Central European Economies. Between the year 2002 and 2007 Slovakia’s GDP grew by 6% annually on average. The growth in GDP reduced greatly during and after the global financial crisis to a low of -5% before recovery in 2009 to settle at an average of about 4% (Daborowski, 2009). Figure 1: Slovakia GDP growth in annual percentage (Source: World Bank, 2014) However, Slovakia is not without its own pressing economic issues. The two largest problems facing the economy of the country include inflation and unemployment; however successful steps have been taken in the recent past to address these issues. Between 2002 and 2007, unemployment in Slovakia dropped from 18% to 10% while there was reduction in inflation from 12% to 3 %. In 2008, the global recession affected Slovakia due to the fact that it has a small open economy highly specialized in electro-technology and automotive industries leading to high dependence on exports. Due to the crisis, living conditions in some of the country’s less developed regions worsened. This situation highlighted the negative aspects of the Slovak politics as most of the less developed areas are inhabited by minority groups and they suffer from long-time high unemployment and poor infrastructure. The country also faces other socio-economic issues like massive public corruption which is blamed for poor infrastructure in many areas (IMF, 2012). For example the poor transport infrastructure in peripheral areas of Slovakia is blamed for poor attraction of potential investors. Figure 2 illustrates Slovakia’s population growth in terms of annual percentage growth. Figure 2: Population growth (Source: World Bank, 2014) It is evident that the rate of inflation for Slovakia has been constantly fluctuating over the years. 2004 recorded the highest levels of inflation in terms of consumer prices at almost 8%. Currently inflation rests at about 4%. Figure 3: Inflation on consumer prices (Annual %)(Source: World Bank, 2014) Slovakia has experienced strong recovery from the deep recession and the recovery has been observed to be faster than many other OECD countries. The export-dependent economy has been able to increase productivity and achieve moderation of wages thus increasing its international competitiveness (OECD, 2011). The government budget increased in 2009 and 2010 after the economic crisis but experienced a drop afterwards due to slower economic growth. While unemployment rate has remained constant between 2009 and 2011, it is evident that real GDP per capita has been on the rise. Figure 4: Unemployment in % of total labor force (Source: World Bank, 2014) 2.0 Current account and trade trends As indicated by World Bank data, the current account balance for the Slovak Republic has been on a constant increase since 2005. By the year 2012 the current account balance accounted for 2% of the GDP. Figure 5: Current account balance (World Bank, 2014) In the year 2012, the value of Slovakia’s exports increased by about 2.9% to over 80.8 billion US dollars. The value of imports also rose by 1.3% to over 77.7 billion US dollars. The overall trade balance for the country recorded a surplus of over 3.1 bn US$ which was higher than the previous year. Both imports and exports were diversified across partners with 12 major partners accounting for over 80% of them. Figure 6: Total trade as % of GDP (Source: World Bank, 2014) As illustrated in figure 7, trade in terms of merchandise imports in Slovakia reached its maximum in 2011 and reduced slightly in 2012. Figure 7: Merchandise imports in USD (Source: World Bank, 2014) On the other hand export of goods and services from Slovakia has been on steady rise since 2008 to 2011 when the data was available (Figure 8). This shows that open trade policies and joining of the euro zone has had a positive impact on Slovak exports. Figure 8: Exports of goods and services as % of GDP (Source: UNCTAD, 2014) 3.0 Trade composition Slovakia currently trades in a number of products with its trade partners and this trade is projected to increase in the coming years with expansion in the country’s economy. Slovakia mainly imports office telecom and electrical equipment, fuels and other products that account for over 41% of the country’s total imports. The main exports include vehicles and transport equipment, industrial machinery, and office telecom and communication equipment. Together the exports are projected to make up over 55% of the country’s exports by the year 2017. The main trading partners for Slovakia include Germany, Hungary, and the Czech Republic which together account for over 48% of the total amount of the country’s exports. According to the Observatory of Economic Complexity (2014), the top five origins of imported goods into Slovakia include Germany (19%), Czech Republic (14%), Russia (8.3%), Hungary (7.1%) and Poland (6.6%). Fuel is mainly imported into Slovakia from Russia and the Czech Republic while Germany supplies office equipment, telecom and electrical equipment, vehicles and transport equipment, industrial machinery, and an assortment of other manufactured items. Other than fuels the Czech Republic supplies Slovakia with road vehicles and transport equipment, electrical and telecom equipment. Hungary supplies the country with telecom and electrical equipment while assortments of other products, mainly electronics, are sourced from South Korea (UNCTAD, 2011). Slovakia has a comparative advantage for import of oil because Russian and the Czech Republic are relatively near to the country thus reducing oil transport costs while bilateral agreements provide them with favorable terms for oil export. On the other hand the country does not have a comparative advantage to other central European countries when it comes to export of electrical equipment and telecom equipment because many of the OECD countries produce these products, this creates competition and lowers market prices. Western European countries particularly manufacture similar products for export in greater quantities. 4.0 Trade destination Slovakia’s main export markets include Germany and the Czech Republic. According to Observatory of Economic Complexity (2014), the top 5 export destinations for Slovakia include Germany (20%), Czech Republic (13%), Hungary (6.7%), and Poland and Austria (6.6% each). Slovakia exports a number of products to Germany including transport equipment and vehicle bodies, office equipment, telecom equipment and electrical, industrial machinery and machinery parts, and other manufactured products. Vehicles and transport equipment are also exported to China. To the Czech Republic, Slovakia mainly exports fuels, ores, and metals. Fuels are also exported to Austria while vehicle and vehicle parts also go to France (UNCTAD, 2011). Figure 4 illustrates the key destinations for Slovakia’s exports. Other products that the country exports include basic foods, food products, tobacco and beverages, agricultural raw materials, textiles, chemicals and pharmaceuticals. It is evident that Slovakia’s greatest trading partners include Germany and the Czech Republic. This can be attributed to the fact that in the case of Germany, Slovakia is the greatest producer of motor vehicle bodies and parts; these are in great demand in Germany which is the greatest European motor vehicle manufacturer. In that respect there is some sort of partnership between motor vehicle companies from both companies. In the case of the Czech Republic, Slovakia in not only a neighbor but they were one country at one time and therefore have a lot to share in terms of goods. Most important however is that Slovakia’s oil demand can be easily and efficiently met by the Czech Republic at a lower cost. 5.0 Trade regulation Since the collapse of the former Soviet Union; the European Union (EU) has been a strong influence in trade patterns and policies of countries in central and east Europe. Since the early 90s trade between the EU and members of the Central and East European Countries (CEEC) has been on a steady increase, this includes Slovakia (Pangariya, 2008). This increase in trade has been attributed in part to the liberalization of trade between CEEC countries like Slovakia and the EU through systematic tariff reductions. After the break-up of Czechoslovakia in the early 90s, the two countries Czech Republic and Slovakia utilized different tariffs for many imports, particularly agricultural in nature from the WTO members and for imports from non-members. Usually, the tariffs applied for imports from members of the WTO were charged same or lower than those from non-members. However, after accession into the EU, Slovakia and other states joining the EU gave preferential treatment to U countries and CEEC countries to access their markets. Thus from that time lower tariff rates (referred to as preferential tariff rates) were applied for imports from the EU bloc and from CEEC countries than from others (Kazlauskiene & Meyers, 2003). Between the year 2000 and 2004 the number of preferential tariffs applying to EU and CEEC countries increased significantly to encourage trade, this and other measures are credited for the high economic growth rate that was experienced in this period right up to 2008 when the global financial crisis slowed growth (Pangariya, 2008). According to Kazlauskiene and Meyers (2003), tariffs increased for most commodities joining the EU when border protection measures were adopted. In the case of Slovakia, accession led to the increase in tariffs with the rest of the world. On average there was an increase of up to 8.6 percentage points. Most of the countries that have acceded to the EU over the past two decades have signed Association Agreements and Europe Agreements in the process leading to their joining the EU. One of those signing these agreements was Slovakia; the agreements introduced free trade in almost all industrially produced goods while providing more limited liberalization in agricultural goods. As part of the agreement to join the EU, Slovakia had to terminate any other bilateral agreement outside of the Union. Some of the other trade bloc in which Slovakia participates includes the EFTA free trade agreements with a number of other countries, the Central European Free Trade Area (Slovakia, Czech Republic, Poland, Hungary), the Customs Union between Slovakia and the Czech Republic, and Slovak Republic and Slovenia Free Trade Agreement. 6.0 Recent trade conflicts Slovakia rarely experiences strikes and trade conflicts, only three real industrial strikes have taken place between 2005 and 2010. The only internal trade conflicts in Slovakia have involved strikes by workers in various sectors; these generally affect Trade because the country’s exports are affected on one hand due to disruptions. On the other hand such industrial action may lead to issues with Trade and working condition standards stipulated by the EU of which Slovakia is a member (Harvan & Machlika, 2011). In 2006, strikes by limited numbers of workers in the country’s healthcare sector were organized mainly to lobby for higher wages. In 2007 there was a strike by air traffic controllers at Bratislava Airport which affected the aviation sector; the airport was grounded for a while with the workers demanding greater air traffic safety. In 2008 there was yet another industrial action by workers with employees at Kromberg & Schubert Company striking for better working conditions in the engineering department of the company. Finally, the year 2011 experienced only a singly symbolic strike. The Federation of Engine Drivers in Slovakia, which is a member of the Railways Trade Union Association carried out a one hour warning strike in the month of May to express dissatisfaction with the planning process for restructuring railways (Harvan & Machlika, 2011). There is a number of dispute resolution mechanisms used to handle industrial and trade conflicts in Slovakia. Between the year 2009 and 2011 alone over 15 different cases of collective labor disputes were handled by the Ministry of Labor, Social Affairs and Family. Various different industrial and trade dispute resolution mechanisms were utilized leading to the solution of all collective labor conflicts through arbitration. None of the disputes ended up into strikes, this is because the country seeks to avoid strikes that negatively affect trade. One of the methods utilized to deal with industrial conflicts is tripartite concertation; this involves national tripartite social dialogue through the Economic and Social Partnership Council (RHSP). This kind of social dialogue occasionally takes place in some sectors with a recent example being talks in the transport, post and telecommunications sector. The dialogue mainly deals with issues touching on public policy implementation as well as adoption of legislation related to business environment development. Another effective method that has been utilized effectively to deal with industrial conflicts in the country is by ensuring sufficient workplace representation through the Labor Code. Workers are represented by trade unions, work councils, or employee trustees. 7.0 Foreign Direct Investment (FDI) trends Until the year 2000, FDI in Slovakia remained low in volume and lagged behind that of other countries undergoing economic restructuring. However for the decade starting 2000, FDI has greatly gained intensity. Big investments into several industries including petrochemicals, telecom, and metal works have been gradually increasing (Lee & Carter, 2005). This process has also been helped by privatization of the gas industry and a number of large banks. Figure 9 shows the growth of FDI in Slovakia in the preceding years up to 2012. Figure 9: Volume of FDI in Slovakia up to the year 2012 (World Bank, 2014) It has also been noted that the channels through which FDI comes into Slovakia have widened. This is mainly attributed to change of legislation and accession to the EU. Slovakia now has a more favorable environment for foreign investors and therefore attracts investors into various different sectors through many ways. Whereas previously FDI came into the country exclusively through direct investments within the business sector, now it also comes in the form of shares (Slovakia Investment Climate, 2009). In 2004 major tax reforms were in introduced in Slovakia leading to improved competitiveness among foreign investors. The Act on investments stipulated that there would by a 100% tax holiday for the first five years of operation for foreign companies investing in Slovakia and a 50% tax holiday for the second consecutive five years. The country also started competing for FDI using a variety of generous government incentives for foreign investors especially for areas with poor infrastructure. Currently, there are investment incentives for three major categories of FDI including technological centers, industrial production, and shared service centers (Johnson and Turner, 2010). There are different forms of investment incentives including cash grants, partial tax reliefs, subsidy of new job employee wages and others. FDI in Slovakia originates from a number of different countries, the greatest contributors being the Netherlands and Austria. Table 1 lists the origin and size of FDI over three years between 2007 and 2009. Table 1: FDI into Slovakia by country of investor in million EUR (Source: www.nbs.sk) Different industries in the country attract different levels of FDI, it has been evident that manufacturing, gas, electricity. Construction, telecom and real estate are some of the industries that have been attracting the greatest investment. 8.0 Portfolio investment trends, official foreign exchange and gold reserves Currently, foreign capital movements in Slovakia take place mainly from FDI, portfolio investment, bank loans, and long-term credits. Portfolio investment (PI) represents the transfer of ownership of security in businesses; it is affected by factors such as interest rates, yields in securities, and speculation. The Bratislava Stock Exchange started monitoring the share of foreign investors in the total volume of trading and generally monitoring portfolio investment as recently as 1996. The figures are presented in the stock exchange’s annual bulletin but they do not include the volume of trading through RM System Slovakia. The BCPB accounts for about 92% to 95% of the total volume traded by foreign investors, and thus it is the most reliable source to monitor PI. Data on PI investment in Slovakia shows that by 2009 the investment in the country had reached over 2, 000 Sk million while portfolio investment abroad surpassed 3,000 Sk million leading to a total of over 3,000 Sk million (NBS, 2010). The official exchange rate for Slovakia has been on a constant drop from 2004 as illustrated by figure 10. Figure 10: Official exchange rate (World Bank, 2014) As at January 2014 the country had 1.022 millions of fine troy ounces in gold reserves (UN Stats, 2014). As illustrated in figure 11 below, the total reserves for the country (gold and current US$) dropped sharply during the financial crisis in 2008 and have remained low in the recent past. Figure 11: Slovakia total reserves (World Bank, 2014) 9.0 Trends in factor mobility In general, Slovakia is a country with a relatively low number of foreigners although the numbers have been rising gradually. In 2011, only about 70,727 foreigners officially resided in Slovakia, representing 1.3% of the country’s population. Emigration trends show that there has been a steady flow of emigrants from Slovakia in recent years. Over 85% of all migrant Slovak citizens in the past three years have been going to other EU countries mainly in search of employment or for business (Daborowski, 2009). Reforms in the banking sector in Slovakia and other central European countries were closely related to bank privatization and entry of foreign capital into the country in the late 1990s (Banker, 1999). Slovakia privatized its financial sector and sold some major financial institutions to foreign investors so as to increase investment efficiency. However, this did not pay off until about 2002 when results started being seen, in the previous years, financial market reforms were slow and thus the country remained unattractive to investors until the reforms were fast tracked in the early 2000s. From 2002, Slovakia had high volumes of foreign capital flow and high quality capital structures. Borrowing and lending for business purposes in the country increased in this period of high economic growth as the capital structure was well managed and a positive balance of capital inflows and outflows maintained (Blommestein, 2007). 10.0 Exchange rate policy According to IMF (2009), the Slovak Republic is among the countries that maintain a managed floating with no pre-announced path for the exchange rate regime. This regime is sometimes referred to as managed floating or dirty floating. This involves a situation whereby the monetary authority (Slovakia’s Central Bank) influences exchange rate movements through direct or indirect active intervention measures that counter long-term trend of exchange rate without a specified predetermined exchange rate path. This may sometimes be done without a specific exchange rate target. In the case of the Slovak Republic, the indicators for management of the exchange rate are broadly judgmental, for example through stating balance of payments positions, international reserves, and parallel market developments (IMF, 2009). 11.0 Nominal exchange rate and real exchange rate trends In mid-2008, the ECOFIN Council of Slovakia decided that the country would join the euro area starting January 2009 and therefore set the rate of conversion of the Slovak koruna into the euro. This rate was set equal to the prevailing central rate of the Slovak koruna (SKK) in the Exchange Rate Mechanism II. Therefore, the nominal exchange rate of the SKK against the euro was fixed by this decision. This became evident for the rest of 2008 as market developments indicated that the SKK was trading close to its conversion rate with the euro irrespective of the considerable global financial market turbulences existent at the time (Egert, 2004). From the end of 2004, Slovakia changed from implicit to explicit inflation targeting. Thus the Slovak koruna came into the ERM II in late 2005 with an initial central parity at 38.455 SKK/EUR. The koruna was however revalued by 15% from May 2008 to 30.1260 SKK/EUR so as to accommodate ongoing improvements in underlying fundamentals. The equilibrium exchange rate estimate identifies real effective exchange rate undervaluation at the beginning of the accession period which is characteristics of most countries in transition. Keeping of the Slovak currency in the fixed exchange rate regime helped its growing real overvaluation for the period between 1994 and 1996 after joining the EU. The adoption of restrictive measures and change to floating exchange rate in 1998 was necessitated by imbalances in the economy manifested through double deficit of foreign exchange. Between 2004 and 2009 the real effective exchange rate index for Slovakia increased gradually before slowing down after 2009 to remain relatively constant as illustrated in figure 12. Figure 12: Real effective exchange rate index (World Bank, 2014) From the year 2000 to the moment of euro adoption the real exchange rate did not deviate for longer periods from equilibrium levels. The real exchange rate only became temporarily overvalued temporarily after fixation of the crown’s nominal exchange rate to the euro in 2009. The continued positive development of the equilibrium exchange rate after the recovery of the Slovak domestic economy and foreign demand from the impacts of the 2007/2008 economic crisis enables real appreciation without threatening the competitiveness of the Slovak economy in the future (MacDonald, 2007). 12.0 Financial, exchange rate, and debt crisis The recent global financial crisis severely impacted the Slovak economy. It caused a decline of the GDP by 4.9% in 2009. Foreign trade was the most affected element of the economy with exports falling by as much as 20% (Fidrmuc & Hainz, 2010). The policy of active investment promotion that the country was pursuing at this time greatly supported it financially in terms of investment and enabled it to recover very quickly from the crisis and resume growth as early as 2011. According to Walch and Worz (2012), an active investment promotion policy, low corporate taxes and business friendly structural reforms helped boost FDI inflows into the country leading to faster recovery. As illustrated in figure 7 below, FDI inflows have exerted a strong influence on the growth of the Slovak economy. There is a positive correlation between employment growth and FDI inflows into the country while the real exchange rate has appreciated during the periods when there have been large capital inflows. Until 2009, there was gradual increase in FDI inflows and growth in employment with appreciation in the real exchange rate. In 2009, slight depreciation in real exchange rate led to slight deceleration of employment growth and FDI inflows (Fidrmuc and Hainz, 2010). 13.0 Conclusion Since breaking with the Czech Republic and accession into the EU, Slovakia has been in a period of transition. From the early 2000s the country had a high rate of growth of the GDP and economic development in general influenced by structural adjustment and good legislative environment for business. However the economy was affected by the 2008 global financial crisis just like many other economies and as a result there was a slowdown. The Slovak economy has shown a very positive recovery after the financial and economic crisis and shows signs that it will remain one of the strongest in the OECD. However, one of the disappointing key issues is that of job creation. The domestic demand of the country remains subdued and there is always the risk of external drivers of economic growth fading away. The biggest priority for the country now is restoration of public finances while ensuring that domestic drivers of growth are restored. There is need for greater emphasis to be placed on activation of labor market policies that seem to be currently insufficiently developed. There is also need for reformation of public employment services and allocation of more resources for placement services. There is also need for greater fiscal consolidation to protect growth of the economy, spending cuts and revenue increased will be required so as to address fiscal consolidation. References Blommestein, H. (2007). The Impact of Institutional Investors in the OECD Financial Markets. Financial Market Trends, 68, 15-54 Blommestein, H., & Biltoft, K. (2005). Trends, Structural Changes and Prospects in OECD Capital Markets. Paris: OECD Documents, 287-320, European Commission (2012). 2012 Ageing Report: Economic and budgetary projections for the EU27 Member States (2010-2060). EC, Brussels. Fidrmuc, J., & Hainz, C. (2010). Default rates in the loan market for SMEs: Evidence from Slovakia. Economic Systems 34 (2), 133-147. Harvan, P., & Machlica, G. (2011). Slovakia has the tenth most flexible Labor Code in the OECD since September. 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