Prichádza e uro

1. Prichádza euro Ekonomický výhľad do roku 2010 Jan Toth Hlavný ekonóm, ING banka Slovenské združenie pre značkové výrobky 27. máj 2008

2. Slovakia – Regional Setting • Size of the market • Living standards, productivity • Structural indicators: • Economic growth • Economic freedom • Business conditions • Foreign direct investment • Labour costs • Tax rates • Fiscal policy • EUR race

3. Size of the market Total economy output and population Note: GDP adjusted by Purchasing Power Parity, 2008 forecasts. Source: EUROSTAT

4. Economic growth (regional comparison) Slovakia strongly outperforms its regional peers Source: Local statistical offices, ING forecasts

5. Living standards, 2008 forecast GDP per capita, in % of EU15 (“old EU”) average Source: Eurostat, November 2007.

6. Living Standards: 12 year experience in CE Slovaks overtake Hungarians while Czechs remain the richest. Note: During the period 1997-2008, Czechs converged 11.2%, Hungarians 14.3%, Slovaks 17% and Poles 10.2% towards old EU15 average. Source: Eurostat

7. Economic “freedom”, 100 score the best Czechs and Slovaks top CE, Slovakia has made the biggest improvement. The lowest point reached in 1999, but improvement levels off for Slovakia. The ranking looks at regulation, trade, fiscal and monetary situation, quality of government, investment and financial indicators, property rights and corruption. Source: The Heritage Foundation and Wall Street Journal, Index of Economic Freedom.

8. Competitiveness – CE pauses in reforms ? Country ranks - the smaller the number, the better The ranking ranks and analyzes the ability of nations to create and maintain an environment in which enterprises can compete. It has 4 categories: Economic Performance, Government Efficiency, Business Efficiency and Infrastructure. 2/3 of the ranking is based on statistics, 1/3 weight is given to survey. The top3 countries are US, Singapore and Hong Kong. Source: Institute for Management Development, Switzerland

9. Foreign direct investment inflows: CE comparison FDI flows per capita (US$) Hungary’s lead replaced by Czechia; Slovakia is catching up with Hungary. Note: 30% of GDP mark reached in Slovakia in 2002 (in Hungary 4 years earlier, in the Czech Republic 3 years earlier).

10. Hourly labour costs in manufacturing (in EUR) Slovakia trades still relatively cheap at the present exchange rate. Note: Labour costs include all costs borne by an employer. CE exports mainly consist of industrial goods. The average annual increase for CE costs was 8.5% in 1996-2006 period while it was 3% for EU15 and 1.7% for Germany. Source: 1996 -2006 is EUROSTAT data, the rest is an ING estimate. The latest data based on present exchange rates.

11. Premium/Discount over CE average labour cost Slovakia is the cheapest manufacturing place in CE, CzechR the most expensive

12. Taxing the capital (average tax rate) Slovakia taxes capital the least by far. Effective averate tax burden on capital expressed as tax revenues as % of the potential tax base. Source: Eurostat (2007)

13. Taxing the labour (average tax rate incl. social contributions) Slovakia taxes labour less, together with Poland. Effective averate tax burden on labour expressed as tax revenues as % of the potential tax base. Source: Eurostat (2007)

14. What employees get as % of GDP Slovaks and Polish workers get the least. Source: Eurostat (2008)

15. Fiscal accounts: 2003–2008 (% of GDP), incl. pensions Including pension reform costs, Slovakia to meet 3% Maastricht in 2007. Note: Czech Republic has not started the pension reform and therefore does not face an additional deficit of 1-1.5% of GDP. Source: ING

16. EUR adoption race. When and at what level? Slovakia likely to be the first CE4 country to adopt the euro Source: ING

17. Basic indicators • GDP growth • Unemployment • Inflation

18. Real GDP growth (vs. domestic demand) + 8% growth rates due to new capacity increases in industry

19. Gov’t economic policy vis-à-vis today’s growth Survey: Dzurinda’s 2nd government the most influential, tax reform, EU membership and labour market reform have the biggest impact Source: INEKO (2008 survey)

20. Unemployment – down, we fall Labour market witnesses 85,000 new jobs a year, 36,000 created abroad Note: Statistical Office methodology is based on surveys only, but comparable across countries. National Labour Bureau methodology is based on hard data. Source: NLB, Stats Office, ING calculation

21. Unemployment – average trend

22. Unemployment vs. long-term unemployment Finally, we see some signs of long-term unemployment falling… Source: Stats Office, ING calculation

23. Unemployment vs. long-term unemployment Unemployment in thousands of people Source: ING

24. Inflation – history and forecast Harmonized CPI (HICP) is used against Maastricht criterion. HICP is 0.1-0.5% lower compared to national CPI.

25. Inflation details – watch market services prices Market services inflation could be a good proxy for demand-pull price pressures

26. Productivity vs. real wages, employers still benefit

27. Inflation vs. wages Wage-bargaining process is backward-looking Note: Impact of tax reform (*) 2003: Some of the bonuses were shifted from 2003 to 2004, artificially lowering the real wage growth (w/o the impact, real wages would be around –0.3% instead of –2.1%). (**) 2004: Due to the cuts in personal income taxes, net real wages has increased by an estimated 1.2% more than gross wages in 2004, i.e.3.7%.

28. External economy and interest rates • External growth environment • Current account deficit • Foreign direct investment • Interest rates • Ratings • Reforms

29. EU growth forecast EU countries (incl. new members) represent 90% of Slovak export destinations. Germany and CzechR are the biggest trading partners.

30. External (im)balance manageable Trade deficit as % of GDP Note: IMF referred to the current account in the old methodology. There was a change in methodology from 2005 on concerning retained earnings, boosting both C/A deficit and FDI surplus (ie, neutral impact on balance of payments). It amounts to an estimated 2.3% of GDP in 2005. Therefore, to have a more consistent time comparison, we prefer to look at trade balance figures. The latest 2004 data suggested 3.4% of GDP trade deficit and 3.3% of GDP current account deficit (in the old method.).

31. Foreign direct investment Net FDI (EURm) Note: To be comparable, the effect of the new methodology is excluded from figures (ie, the inclusion of reinvested profits).

32. Greenfield foreign direct investments Agreed projects ( total amounts, not real flows, EURbn) Note: Agreed projects and their total amounts. To compare, the Czech Republic secured EUR1.5bn of FDI in 2004. Source: SARIO investment agency

33. Short-term policy rate SKK key rate to meet the ECB’s in 3Q08.

34. 10 year SKK interest rate outlook (annual avg) …depends crucially on German 10yr government bonds… …. since spreads over bunds should be small

35. Price of money – economic policy risk perception Local currency spreads vs. 10Y German Bunds (bps) Czechs and Slovaks enjoy the best risk perception of their government’s future economic policies.

36. Country ratings Slovakia is expected to be upgraded in 2H08-1H09 on euro adoption • Recent Credit Ratings Changes • Moody’s upgrade to A1 (stable outlook) • S&P’s upgrade to A (positive outlook) • Fitch – upgrade to A (positive outlook) Note: Hungary’s ratings have negative outlook. Source: Rating agencies

37. The End of Reforms ? Both indicators HESO and PAS point to some reform reversal Higher values indicate increase in the reform capital. Negative values indicate a net destruction of the reform capital. Source: HESO survey on reforms (INEKO, www.ineko.sk), Business Environment Index (PAS, www.alianciapas.sk)

38. Reform capital destroyed by 12-25% ? Reform build-up - Dzurinda 2002-2006 period set to equal 100% Based on Business Environment Index (PAS, www.alianciapas.sk), computed by ING. 100% equals to 22 points in index.

39. Euro adoption • Euro in theory • Practical implications for business • Final conversion rate • Outline for technical preparations

40. Inflation trajectory after EMU entry After entry, inflation tends to rise in cheaper countries Source: Eurostat

41. Income level ( as % of euro area at euro entry) Slovaks the most poor to enter Eurozone, but the gap narrows Source: Eurostat (Nov 2007 data), calculated by ING

42. Good or Bad ? – theoretical perspective, part 1 • Big uncertainty. UK governor – give me 200 years of data and I will answer your question • A> • Will monetary policy suit our needs ? Will the structure of the economy be similar with an average eurozone country (ie, big countries?) • Trade links could support specialisation (eg, autos/electronics for Slovakia) and thus the structure of the Slovak economy might not converge. Hence, ECB monetary policy might be sub-optimal • B> • Will there be higher growth (say by 0.5-1% a year)? • Causality: Assumption 1> euro adoption dramatically increases trade volumes • Assumption 2> greater trade increases sustainable growth rates via more space for labour division/specialisation • Assumption 1> is not clear

43. Good or Bad ? – theoretical perspective, part 2 • C> • Will euro import policy discipline ? • Even if sub-optimal, euro could still turn out better than expected if the local government happens to be less experienced • Attractive argument for post-communist countries • However, one assumes that fiscal penalties stay in place and will not be discredited. • If not, euro could actually be a change for the worse since local government will no longer be disciplined by the local financial markets (financial markets acting as a watchdog on economic policy via exchange and interest rate pressures).

44. Euro – practical perspective • “Slovak” inflation and “German” rates produce low real interest rate environment good for investments (corporates) and bad for savings (households) • SME & households will increasingly enjoy lower interest rates and thus demand more credit • Low interest rate environment could induce overheating • Lower inflation will no longer be supported by exchange rate channel • Inflation is expected to increase from 2-3% to 4-6% range • Export-oriented companies will benefit for 2-3 years as the growth in labour costs in euro will likely decrease • Welfare transfer from labour to owners of capital

45. Wage increases, the past and the future Source: StatsOffice, calculation and forecasts of ING Bank

46. Euro – practical perspective, part 2 • Lower unemployment will change the wage-bargaining process with employees being more influential • Nominal wage growth demands should increase over time • If the final conversion rate is perceived to be likely (much) stronger than the market rate, big motivation to hedge for exporters (for all years of operations) • Practical solution for hedging 20-30 years if euro adoption believed in (market currently prices negative interest rate differential and risk limits could prevent taking long hedges): • Hedge all 20-30 years of proceeds (not 1-2 years of proceeds) till January 2009 and then realise profit (or roll over with zero forward points)

47. Exchange rate model based on the total economy and main trading partners suggests 30.4 for average 2009 GDP adjusted for “cigarette” taxes, eurozone inflation adjusted for food prices (demand-pull price inflation for Slovakia). 2003-2004 period assumption of “equilibrium” situation (judged by trade deficit in 2004-2005).

48. ING forecast: 30,5 – 31 (point forecast 30,5) KEA survey, May 23 2008: Conversion rate - conclusion

49. Outline • Last week: Application to join submitted • April: Maastricht criteria (fiscal deficit 2007, inflation March 2008) • 28 April: EC forecasts • 7 May: EC convergence report • May - June : EC recommendation to EU Council, EU parliament discussion • June-July: new parity might be announced, not necessarily • 7 July 2008: Ecofinto set the final conversion rate • From July on: Mandatory dual pricing in all documents • January 2009: “Big Bang”: only first 2 weeks in 2009 there is dual circulation, all transfers in euro only • Exchange of coins by June 2009, notes by Dec 2009

50. Long-term planning kit (till 2010)