Slovakia’s incoming technocratic government has warned that the country’s fiscal position is at “great risk” and that it will have to propose deep cuts.

“Slovakia has no choice but to consolidate,” Prime Minister Ludovit Odor, a 46-year-old former central banker, told Bloomberg on June 14. “Public finances are not in good shape.”

The warning comes as neighbouring Czechia and Estonia have begun launching austerity programmes to cut their swollen budget deficits after the pandemic and cost of living crises. This belt-tightening drive is likely to be especially painful as it is coming at a time when interest rates are still high, many economies have yet to emerge from recession, and the Eurozone downturn threatens to dampen any nascent recovery.

The Slovak general government budget deficit is forecast is soar from 2% of GDP last year to 6.2% this year – the highest in the European Union – as a result of handouts to alleviate rising energy prices, together with indexation of benefits at a time of rising inflation.

The deficit of the narrower state budget reached €3.32bn in the first five months of the year, almost double the €1.55bn in the same period last year.

According to the outgoing government’s Stability Programme submitted to the European Commission in April, the deficit will be in breach of the EU’s Stability and Growth Pact – which mandates a deficit below 3% – both next year (when the suspension of the pact is cancelled) and in 2025. It forecasts a deficit of 4.7% of GDP in 2024, 3.2% in 2025 and 2.2% in 2026.

If Slovakia cannot meet the 3% rule it risks being penalised under the Excessive Deficit Procedure unless it can show it is reducing the underlying structural deficit each year. The Commission said in May that a 0.7pp reduction in the structural deficit would be appropriate in 2024.

The deficit is also set to push gross public debt above the ceiling mandated by the country’s debt brake rule. The Stability Programme predicts debt will reach 58.7% of GDP by the end of this year, up from 57.8%, or €63.38bn, at the end of 2022.

“If we continue like this, the financial markets could punish us in the future,” Odor told Bloomberg. “We need to communicate that the party is over, ” he added.

Ratings agencies Fitch and Moody’s currently have Slovakia on a negative outlook because of the uncertainty caused by the the Ukraine war and the looming election at the end of September. Slovakia's centre-right coaltion government lost a vote of no-confidence at the end of December and then Eduard Heger continued as head of a caretaker cabinet until that also fell apart, forcing President Zuzana Caputova to appoint a technocratic cabinet last month to rule until early elections could be held.

The country’s fiscal watchdog, the Council for Budget Responsibility, has recently raised its estimate of this year's deficit by some €503mn and it now says the deficit can reach €7.5bn, 6.2% of GDP, up from €2.23bn, 2% of GDP, in 2022.

Even more worryingly, the Council has warned that the structural deficit is set to rise to 4.3% of GDP, up from 1% last year. It has said deficit cuts worth 6% of GDP are needed over the next few years to ensure long-term fiscal sustainability.

If the country does nothing, in 15 years Slovakia's debt will exceed 100% of GDP, Council member Martin Šuster told Slovak daily Dennik N this week. With such a debt, according to him, "the markets would stop trusting us and we would go on the so-called Greek road".

Severely constrained

The new technocratic government has made it one of its top priorities to prepare a 2024 budget by October 15, and it is also likely to propose some cuts for this year.

However, the government looks unlikely to win a vote of confidence, so it will be severely constrained in what it can do, and in any case it will only be able to stay in power until a new government is formed after the September 30 snap elections.

Moreover, at the moment the political parties do not appear ready to begin an austerity drive. So far they are ignoring the country’s fiscal plight in their election campaigns, and they have even recently pushed through extra spending measures such as the valorisation of pensions from July 1, and increases in parental tax allowance and minimum pensions.

The leading parties according to opinion polls – Robert Fico’s populist Smer and Peter Pellegrini’s centre-left Hlas  – are both promising citizens more help with coping with the cost of living crisis, and are likely to try to use threats of austerity measures to increase their lead over the outgoing centre-right coalition parties.

“Nobody is talking about austerity,” Michal Lehuta, economist at VUB Bank in Bratislava, told bne IntelliNews. “The caretaker government cannot really do anything in parliament but they are already being used as a scapegoat, even by the [outgoing] coalition parties.”

Under the country’s expenditure ceiling legislation, approved in late 2022, the government must save €1bn next year (around 1% of GDP) and another €1.3bn in 2025.

These short-term cuts should be achievable by ending energy price subsidies, or making them more targeted on the poorest, as Odor has suggested.

Odor and Finance Minister Michal Horvath, who is also from the central bank, have indicated that they will produce a range of options that the new elected government can put together like “Lego blocks” to bring down the deficit in the short term. These measures are likely to include a windfall tax on banks and a freezing of public sector wages.

What will be more difficult is bringing down the deficit in the long term low enough so as not to breach the country’s debt brake rule in 2026, after a two-year grace period for the new government runs out.

“Today, however, we are in a situation where we have run out of simple solutions,” Horvath told Dennik N in an interview earlier this month. “The path to the future has probably never looked so demanding.”

The longer-term measures the technocratic government are likely to recommend include changing the tax mix so that work is taxed less (apart from for the self-employed) and some tax exemptions are removed, while VAT and property taxes are increased and an environmental tax is introduced.

If the debt continues to be over the threshold of around 55% of GDP in 2026, the debt brake would force the new government to run a balanced budget, at a time when it faces new spending demands because of arms procurement, population ageing, and the transition to a more environmentally sustainable economic model.

“The new government will have to meet the balanced budget requirement in two years,” says Lehuta. “It could be a problem in two year’s time.” END