SLOVAKIA STRUGGLES TO COMBAT ECONOMIC CRISIS

UNCLAS SECTION 01 OF 03 BRATISLAVA 000084

SENSITIVE
SIPDIS

STATE FOR EUR/CE L. LOCHMAN, K. ERTAS
STATE FOR EUR/ERA J. KESSLER
STATE PLEASE PASS TO TREASURY/L. NORTON

E.O. 12958: N/A
TAGS: ECON EFIN EINV LO
SUBJECT: SLOVAKIA STRUGGLES TO COMBAT ECONOMIC CRISIS

SUMMARY
--------------


1. (SBU) After hoping for several months that it might have
dodged the global economic crisis, the GoS has recently begun
to face up to the fact that it hasn't. The auto industry has
turned in gloomy forecasts, and every week another company or
two announces cutbacks, layoffs, or closures. In response,
the GoS has brought forth two legislative packages aimed at
stimulating new investment, lowering payroll costs, and
speeding up infrastructure projects. Local economists
complain that the infrastructure projects are problematic,
and that most of the measures do not go far enough to keep
businesses open.


2. (SBU) The GoS intends to finance much of the EUR 330
million package by cutting government spending--to include
heavy cuts in transfers to the local and city levels of
government--in an effort to keep the deficit below 3 percent
of GDP. These cutbacks may negate some of the benefits of
the stimulus. Generally, the GoS's reaction to the crisis is
slower and less effective than one could wish, but PM Robert
Fico appears to be listening to the business community and
avoiding potential protectionist pitfalls. End summary.


WAVES OF BAD NEWS
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3. (U) The news of economic recession began to crash over
Slovakia in the latter part of January, as the natural gas
crisis was coming to a conclusion. The news here has been
growing bleaker by the day. Automakers and their suppliers,
a disproportionately large segment of the Slovak economy,
have seen sharp drops in orders since October; in December,
production was down 35.7 percent from a year ago. The
outlook for 2009 is a 25 percent drop from 2008 production.
Hyundai/Kia is still running two shifts, but last month it
cut the workday from 8 to 6 hours, and it is said to be
contemplating a move to one shift. PSA Peugeot Citroen
recently announced its first layoff of permanent workers,
having already laid off most of its short-term contract
employees.


4. (SBU) U.S. supplier Molex, which employs 1,000 Slovak
workers to produce electrical connectors, announced at the
beginning of February that it would close its operation here
over the next year. U.S. Steel, whose Kosice plant supplies
materials mostly for household appliances and the auto
industry, is down 50 percent in new orders and is idling its
workers one day a week at 60 percent pay. Most producers and
suppliers have resisted layoffs, favoring cutbacks in working
hours.


5. (U) Though the automotive industry is the hardest and
earliest hit, the recession is being felt across the board.
Real estate values are falling, and the construction industry
with them, and even the relatively robust services and
technology sectors are contracting. At least two U.S.
companies are approaching the Slovak Government with
proposals to re-open their investment incentive packages as
they consider global restructuring. Overall economic growth
estimates have been dropped from 7 percent to 4.6 percent to,
most recently, the 2 - 2.5 percent range, and many expect
further downward revisions.


THE GOS REACTS
--------------


6. (U) Late in January, the government formed the "Committee
for the Financial Crisis," composed of key ministers,
parliamentarians, labor unions, industry groups, and bankers.
The group has proposed two packages of emergency measures,
the so-called second and third crisis packages (the "first
package" was a bundle of 27 measures aimed at preventing the
spread of the financial crisis to Slovakia),and a budget of
EUR 330 million in crisis funding. Further packages are
expected as the situation continues to deteriorate and
industry demands stronger measures.


7. (U) The second package, approved in early February,
includes government grants for newly self-employed workers,
for creating so-called "social enterprises" (essentially

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community make-work programs aimed at long-term unemployed),
subsidies for commuting, and grants to cover social insurance
deductions for employers furloughing workers at 60 percent
wages (on the U.S. Steel model). The third package, just
passed in parliament, includes a higher floor for personal
income tax (from EUR 3435 to EUR 4026 annual compensation),
additional tax deductions for self-employed workers, quicker
reimbursement for VAT returns (from 60 to 30 days),a lower
threshold for investment incentives, concessionary financing
for small businesses, employment retention incentives for
distressed businesses, and a government guarantee on
mortgages. Both packages also contain a number of minor
measures to encourage new investment.


THE CRITICS WEIGH IN
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8. (SBU) The government is also aiming to accelerate the
start of a series of highway construction projects using
public-private partnerships (PPPs) and EU structural funds.
The PPP projects, already delayed and fraught with charges of
opaque tender proceedings and cronyism, have run up against
the credit squeeze, and the GoS is considering funding these
itself. The most widely shared criticism of these projects
is that the GoS would be better served using the
hard-to-spend EU monies on these projects, rather than
attempting to manage two large baskets of highway
construction--much of it as yet unplanned. As well,
suspicions of corruption have turned much of the Slovak
public against the PPP; most economic experts would rather
see the money channeled through the higher auditing standards
of the EU.


9. (SBU) A more telling criticism among economists is that
the packages contain mostly half-way or misguided measures
that do little to keep people employed. Since Slovakia
depends heavily on exports, there is little to be done to
stimulate domestic demand, apart from plussing up government
spending. New investment, the goal of many measures from both
packages, is not a real possibility in today's credit- and
cash-poor environment. That leaves only one additional
target for the stimulus: employment, and the GoS's measures
are generally thought not to be sufficient to keep businesses
open with a full workforce.


FINANCING STIMULUS WITH SPENDING CUTS
--------------


10. (SBU) Perhaps the most unrecognized problem is the
proposed method of financing the EUR 330 million effort.
Socialist PM Robert Fico, having got anti-deficit religion
from Slovakia's euro adoption process, has become fixated on
keeping budget deficits to a minimum. It was not until late
in 2008 that he publicly entertained the possiblity of
relaxing the 1.7 percent goal agreed internally in mid-2008.
More recently, he has been setting expectations in the 2.5
percent range, though gradually conceding that the crisis may
require going all the way to the Maastricht ceiling of 3.0
percent. While economists generally like fiscal discipline,
they have begun calling for even more flexibility on deficit
ceilings until economic trends swing upward. OECD
Secretary-General Angel Gurria made this point during a visit
earlier this week.


11. (SBU) If the deficit ceiling is sacrosanct, how to raise
EUR 330 million for the stimulus packages? By cutting other
government spending, especially funding for local
governments. Conventional wisdom would say this is an
especially bad time to rob local governments, but the local
community of economists has yet to raise its collective voice
against this line of cannibalistic thinking.


COMMENT: IT COULD BE WORSE
--------------


12. (SBU) All in all, the reaction to the crisis is better
than one might expect from a Slovak government that describes
itself as socially oriented. The government is properly
focused on employment, and it is talking to businesses about
what they need to stay open. While far from perfect, the
stimulus packages do at least try to address the needs of

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employers and the working (and recently laid off) public.
The government could do more to bring in the ideas of the
pro-business opposition, which it has gone out of its way to
spurn. But that constituency has offered mostly recycled
ideas for stimulating new investment through tax breaks
(including a reduction in the flat tax rate) and streamlined
government. At least the GoS has ignored the calls of
unions, older industries, and agricultural businesses to
combat the recession with a slug of old-fashioned
protectionism.


13. (SBU) Of more concern is the slowness with which the GoS
has grasped the situation and its limited reach for ideas to
deal with it. Fico's idee fixe of financing the stimulus out
of hide may well negate much of the positive effect of
accelerated public spending. By the same token, the failure
to understand that public spending has to happen within the
next 6-12 months to have an effect may lead to a procyclical
inflationary trap as the economy revives itself. This is a
hard time for Fico to learn economics on the job, but he has
done this once before, with the successful adoption of the
euro. And this gives us some cause for hope.

EDDINS