SLOVAK ECONOMY GROWING AT RECORD PACE

UNCLAS SECTION 01 OF 02 BRATISLAVA 000331

SIPDIS

SIPDIS

DEPT PASS TO USTR FOR RDRISCOLL
TREASURY FOR AALIKONIS
USDOC FOR MROGERS AND STIMMINS

E.O. 12958: N/A
TAGS: ECON EFIN EINV ETRD LO
SUBJECT: SLOVAK ECONOMY GROWING AT RECORD PACE


1. SUMMARY: In the last quarter of 2005, the Slovak economy
reached an all time record for economic growth of 7.6
percent, the fastest rate among the four biggest economies
that joined the EU on May 1, 2004. A high volume of
investments and fast-growing household consumption were the
key growth engines, while external factors played a negative
role. Unemployment over the last three months of 2005
dropped to the lowest rate since the first quarter of 1999
and wages rose at one of the highest rates in the whole EU,
exceeding productivity growth. Economic analysts expect
further interest rate hikes in the coming months. END
SUMMARY.


2. Slovakia's GDP rose at a historic annual rate of 7.6
percent in real terms (9.9 percent in nominal terms) during
the last quarter of 2005, to SKK 384.1 billion (USD 12.4
billion). For the full year 2005, the Slovak economy
accelerated by 6.0 percent year-on-year, the highest rate in
10 years, to SKK 1,439.8 billion (USD 46.4 billion),after a
5.5 percent growth in 2004. The private sector generated
90.6 percent of GDP last year. Slovakia's growth matched
the Czech Republic's economic performance, while it was
ahead of Poland with 3.2 percent and Hungary with 4.1
percent rates for 2005.

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STRUCTURE OF GROWTH REMAINS THE SAME
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3. The main driver of the economy was domestic demand, led
primarily by investments. The gross investment showed an
extraordinary 33.5 percent year-on-year increase in the
fourth quarter, contributing 6.6 percentage points to the
growth rate. Significant components of this high growth
rate were changes in stocks and inventories. (NOTE: Some
retailers built up their stocks of cigarettes due to the
increase in excise tax of tobacco effective January 1,
2006). Fixed investments alone grew 15.1 percent, providing
3.9 percentage points to the overall rate. Household
consumption, the second strongest growth engine, slowed down
to an annual 5.9 percent rise, from 6.2 percent in the third
quarter, extending its growth to the eighth consecutive
quarter after two years of stagnation in 2002 and 2003.
Government spending rose 3.8 percent in the reported period,
accelerating from 0.9 percent in the preceding quarter.


4. External demand played a negative role in the last three
months of 2005. Net exports (exports minus imports) knocked
off 3 percentage points from the growth rate, with imports
rising 17.7 percent and exports 15.0 percent year-on-year
during the last quarter. The trade balance deteriorated
primarily in December, which itself produced 33.4 percent of
the full year trade deficit. The massive growth in
investment indicated that a significant portion of imports
were technologies for the two car plants under construction.
(NOTE: French PSA Peugeot is scheduled to kick off its
production in May, while South Korean Kia should start in
November. Both plan their annual output for 300,000 cars at
full capacity). Rising import prices of commodities also
contributed to the overall foreign account deterioration as
Slovakia is almost fully dependent on Russia for natural gas
and oil.

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UNEMPLOYMENT AT A SIX-YEAR LOW
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5. According to the Statistical Office (using data based on
random telephone surveys),Slovakia's unemployment rate
dropped to 15.3 percent in the fourth quarter of 2005, the
lowest rate since the first quarter of 1999. Compared to
the same period in 2004, the number of unemployed people in
4Q05 declined 10.4 percent to 407,600. For the whole of
2005, the unemployment rate fell by 1.9 percentage points to
16.2 percent, while the number of unemployed people was down
by 11.1 percent to 427,500 (This data is taken as an average
for the full year and is therefore higher than the fourth
quarter numbers). Statistics provided by the Ministry of
Labor, which are more in line with the U.S. methodology
focusing on those actively seeking employment, indicated
that unemployment dropped from 15.6 percent in 2003 to 11.36
percent in December 2005. The strong economic growth also
resulted in a 2.1 percent annual rise in employment for

2005. At the end of the year, 2.26 million people in
Slovakia had jobs, a rise of 2.5 percent or 54,900 on the
year.

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BRATISLAVA 00000331 002 OF 002


WAGES OUTPERFORMED PRODUCTIVITY
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6. Average nominal monthly wages grew by 9.2 percent year-
on-year in 2005, to SKK 17,274 (USD 560),or 8.4 percent in
the last quarter, to SKK 19,466 (USD 628). For the same
period, real wages rose 6.3 percent and 4.7 percent,
respectively. In 2004, real wages increased 2.5 percent on
an annualized base. In comparison, the labor productivity
slowed down to 3.7 percent in 2005, from 5.2 percent in the
previous year. The central bank noted that if such a strong
relative wage increase over productivity growth as seen in
2005 was repeated this year the economy would face serious
inflationary risks.


7. COMMENT: The central bank cited robust economic growth
based on strong growth of investments and household
consumption as one of the principal reasons behind a 50
basis point interest rate hike in February, 2006. Despite
the slow down in household spending during the last months
of 2005, the GDP structure in combination with wages (rising
faster than productivity) and retail sales data still imply
potential demand-led pressures on consumer prices. This
suggests that the central bank may incline to further
monetary tightening. Strong household consumption assisted
by increased employment, rising real incomes and better
access to credit confirmed the fast growth in improving
living standards, which is theoretically good news for a
governing coalition facing early parliamentary elections in
June. The positive effects are not being felt equally
throughout the country, however, and may not be enough to
bring about a third-term for a Dzurinda-led center-right
coalition. The upcoming start of production at the two car
plants will provide strong one-time impetus for the economy
and could accelerate its growth to over 7 percent this year.

VALLEE