Slovakia - Economic update May 2019

Economy holding up well, but slowdown expected

Similar to the Czech Republic, Slovak economic activity is gradually slowing too. Q1 annualised growth amounted to 3.8%, only marginally below the 3.9% figure for Q4 2018. However, there are clear signals that this strong economic performance is unlikely to be maintained in the near future. In February, industrial production growth fell to 5.6% yoy from the 7.2% achieved in January. Indeed, industrial performance has been volatile in recent months. Both positive and negative factors played a role. On the one hand, it was negatively affected by the weaker growth in Western Europe. On the other hand, a positive impact came from the launch of a significant new car factory.

In particular, the figures for February show a slowdown in Slovak transport vehicle production. However, there are also base effects at play considering we saw a strong year-on-year increase in February 2018. Metal production, one of the strong pillars of the domestic manufacturing industry, has fallen dramatically for the fifth month in a row (-9.4% yoy in March 2019), clearly affected by cyclical factors (figure SK). For the time being, machinery production has been doing well, recording a year-on-year jump of more than 25% Production in this subsector continues to accelerate, although the question remains how long this trend will last.  

Figure SK – Slovak manufacturing production (CA, % change year-on-year)

Source: KBC Economics based on SUSR

There is clear uncertainty about future developments in the Slovak industrial sector. The lead indicators in Slovakia and abroad have been falling, suggesting a cooling down in demand for Slovak industrial products. Business sentiment in the domestic industry dropped significantly in March 2019. This is a consequence of deteriorating expectations regarding both current and future product demand. The domestic market is also worried about the unfavourable development of purchase factory orders in the German market. Together with the poor development of confidence in the services and construction industry, the deterioration in industrial sentiment suggests a further deceleration of economic growth in the first half of 2019. This was reflected in the EC’s spring forecast, which reduced GDP growth estimates from 4.1% to 3.8% in 2019. For next year, the EC expects 3.4% growth instead of 3.5%. These estimates are closer to our current prediction.

In March, inflation grew from 2.3% yoy to 2.7%. The drivers included rising prices of fuel and food, as well as higher prices for air tickets and used cars. Even core inflation, which is an indicator of demand pressures, has also risen to 2.4% yoy from 1.9% a month earlier. The developments in the first quarter are more or less in line with the overall expectations. Inflation is expected to slow down in the second half of the year, which is also linked to the current deceleration of economic activity.

The deficit has shrunk, but elections are looming

Eurostat confirmed that the general public deficit fell to -0.7% of GDP in 2018, decreasing by 1 percentage point compared to last year. The result was also 1 percentage point better than the budget target thanks to better economic developments. The EC adjusted downwards its outlook for this year’s target by 0.2 percentage points to -0.5% of GDP. Given the upcoming parliamentary elections and the increase in proposed social spending, we are more pessimistic and assume that any further deficit reduction would be difficult to achieve. However, this is unlikely to affect government bond rates very much. The interest on government bonds is supported by the ECB’s simulative monetary policy. Moreover, the Slovak public debt ratio is one of the lowest in the EU. In 2018, Slovakia’s public debt was 48.1% of GDP while in the euro area, the average figure is 87.1%. The risk premium for ten-year bonds should therefore only slowly keep rising from its current 50 basis points above the German Bund towards 65 basis points by the end of 2020, as the ECB is expected to announce the start of further monetary policy normalisation.

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