Process of Euro Introduction in Slovakia Seminar for the NBP Elena Kohútiková, VUB bank Date 10. July 2008 Agenda Preparations for the Euro Compliance with Maastricht Criteria Euro Changeover Plan Information gained from the process 2 Agenda Preparations for the Euro - Political and Macro Backdrop - Common Interest in the Euro - Benefits of Early Euro Adoption Compliance with Maastricht Criteria Euro Changeover Plan Information gained from the process 3 2003: Year of Grasped Reform Opportunity Surprisingly to many observers, pro-reform political forces that over the years 1998-2002 successfully reintegrated Slovakia into the western structures (EU, OECD, NATO) had been confirmed in power in September 2002 parliamentary election The re-election gave the second government of PM Dzurinda mandate for further reforms and yet closer integration into the EU institutions The government grasped the opportunity in full and introduced comprehensive structural reforms (described on the following slides) that made Slovakia an economic front-runner in the newly acceding EU member countries 4 Tax Reform Objectives: Reduce work and entrepreneurship disincentives of taxation Increase the transparency of the tax system Reduce distortions from tax exemptions and double taxation Means: Introduction of a flat income tax rate of 19% for both personal and corporate income effective January 2004 (previous rates ranged from 10%-38% and 25%, respectively) VAT rates were unified at 19% (from a two rate system of 14% and 20%) and excise taxes raised closer to the levels prevailing in the EU All tax exemptions and special regimes were abolished, except for deductible allowances for low income earners, which were increased to improve work incentives Gift and inheritance taxes were abolished, dividend tax rate was set to zero 5 Pension Reform Objectives: Enhance viability of the public pay-as-you-go (PAYG) pension scheme Ensure long-term sustainability of the system by adding privately funded scheme Means: Parametric changes to PAYG, involving increasing the statutory retirement age for both men and women to 62 years from previous 60 and 55 years, respectively. System changes to PAYG, introducing the “merit” principle with benefits made dependent on work and contribution history Introduction of the second, privately funded pillar in 2005. Pension contributions, 18% of gross wages, were equally split between the first pillar, PAYG, and the second pillar, run by private asset management companies. 6 Social Security Reform Objectives: Reduce abuse of the welfare system, make it better targeted Stimulate work Means: Benefits cut by half to able-bodied citizens who are voluntarily unemployed Registration for unemployment benefit was made tighter to exclude employees working in the informal economy. Unemployed had to regularly visit labor offices to claim benefits or risk losing them Child and family benefits distributed partly as tax bonuses to reward earned income Incentives provided to unemployed who actively seek job, for example via accommodation payments for those willing to move 7 Labor Market Reform Objectives: Stimulate supply of labor Stimulate demand for labor Means: Cut in social contributions rate by 3 percentage points Targeted employment subsidies for job creation in high-unemployment regions Simplified legal requirements for enterprise registration introduced to encourage self-employment and small scale businesses in job-intensive service activities Labor Code approved in July 2003 provided more flexibility for employers by simplifying procedures for hiring and firing (however, modifications prepared by new government valid since September 2007 shifted the balance again towards labor unions and employees). 8 Other reforms – planned for 2004 but unfortunatelly not fully implemented Healthcare reform Education reform ¾ Reforms involved mainly measures to ¾ Reform in the sector intended, for prevent further build-up of debt in the example, to motivate municipalities to heavily indebted Slovak healthcare. economize on basic school financing and introduce fees for university education. ¾ Such measures included, for example, introduction of a fixed payments for drug ¾ Consensus, however, formed very prescription, and stay in hospital hard, reform was eventually modified Local Governance Law Enforcement ¾ Decentralization. Responsibility for the ¾ The main goal of the reform was to provision of the main public services was optimize the judiciary system and make transferred to sub-central governments as the judges’ work more effective of 2003. ¾ Funding set to motivate regions and municipalities to save and improve service 9 Thanks to reforms and entry into the EU , economic growth was about to take off, boosting convergence to EU Real GDP growth (%) Slovakia: convergence % EU15 11 EU entry 10 65 9 60 8 7 55 6 5 50 4 45 3 2 40 1 0 35 9 0 4 5 f 9 0 0 0 9 998 9 0 003 0 0 0 1 1 2 2001 2002 2 2 2 2006 2007 0 GDP per Capita (PPP) Price Level 2008e 2 1997 2000 2003 2006 2008e Slovakia EU15 10 inflation wassetto declinegradually Price distortionshavelargelybeen corrected, 10 20 30 40 50 0 I-00 Development ofinflation in2000-08(y/y%) VII-00 I-01 Headline inflation Headline VII-01 I-02 VII-02 I-03 VII-03 Regulated prices Regulated I-04 VII-04 I-05 VII-05 I-06 Core inflation VII-06 I-07 VII-07 I-08 11 Fiscal performance was about to improve dramatically... Fiscal deficit 2000-10 (% of GDP) Public debt 2000-2010 (% of GDP) 13.0 65 Public finance deficit inc. 60 11.0 pension reform costs Public debt / GDP (in %) Public finance deficit ex. 55 Maastricht fiscal criterium - Public debt 9.0 pension reform costs 50 Maastricht criterium 7.0 45 5.0 40 35 3.0 30 1.0 25 -1.0 20 2000 2001 2002 2003 2004 2005 2000 2001 2002 2003 2004 2005 2006F 2007F 2008F 2009F 2010F 2006F 2007F 2008F 2009F 2010F 12 ...all of which boosted interest rate convergence and value of the Slovak koruna Development of 10 year govt Development of EURSKK bond yield (2001-2008) (2000-2008) 9.0 44 8.0 42 7.0 40 38 6.0 36 5.0 34 4.0 32 3.0 30 I-01 IX-01 V-02 I-03 IX-03 V-04 I-05 IX-05 V-06 I-07 IX-07 V-08 I-00 IX-00 V-01 I-02 IX-02 V-03 I-04 IX-04 V-05 I-06 IX-06 V-07 I-08 13 Both the government and the central bank have had a common interest in the Euro... 2003: Strategy of Euro Adoption in the Slovak Republic - A joint conclusion of the government and the central bank that it is advantageous to adopt the euro as soon as possible after having met the Maastricht criteria in a sustainable way (2008, 2009) 2004: A Detailed Strategy of Euro Adoption - Target date for euro adoption 1.1.2009 - Maastricht criteria compliance in 2007 - Approved in parliament by votes of both coalition and opposition 2005: National Changeover Plan - Detailed plan of practical steps toward smooth introduction of the euro currency 14 ... and concluded that adopting the euro later than 2009 would needlessly deprive the country from the benefits of the single currency financial transaction costs benefits administrative transaction costs exchange rate risk Long-term increase of GDP by 7-20 % costs cost of currency changeover loss of 0 0,1 0,2 0,3 0,4 independent (% GDP) monetary policy Source: NBS 15 Pros and Cons of Euro Adoption summarized Advantages Disadvantages Economic advantages: Economic disadvantages: Elimination of transaction costs Technical costs of currency Elimination of exchange rate risks changeover Higher price transparency Loss of independent monetary policy Increase of foreign trade Some increase in inflation Higher attractiveness for FDI inflow Loss of fx revenues and temporarily Acceleration in economic growth higher expenses of the banking sector Non-economic advantages: Economically unfounded fears: Higher credibility of Slovakia abroad Increase of prices because of Better cooperation on juridical and changeover / rounding police field, environmental and R&D General fears of the future of the projects Eurozone 16 To be sure, there were some relevant arguments for delayed Euro adoption… Insufficient readiness of the economy for the common market, insufficient real convergence, insufficient competitiveness Insufficient cycle synchronization of the economies of Slovakia and EMU Insufficient flexibility of the labor market (constrained movement of Slovak employees to some countries of EMU) Insufficient consolidation of public finance Incomplete liberalization of some markets 17 ...yet, in retrospect, the Euro process and associated reforms put them aside Accelerated real convergence (p. 10) Improved competitiveness (CGI ranking in 2007: 41 vs 2003: 49) Improved flexibility of the local labor market Improved consolidation of public finance (p. 12) Accelerated liberalization of remaining markets 18 Economic Policies Supporting Euro Adoption Short-Term Target: meeting Maastricht criteria - continue to decrease inflation - decrease public finance deficit - assure stability of the koruna exchange rate (joint task of the central bank and the government) Long-Term Target: increasing the flexibility of the economy - structural policies, involving mainly the labor market, plus support of the growth potential of the economy - Benefits of the euro are not automatic, they will materialize only if they are accompanied by right policies 19 Concluding remarks on € preparation stage The EURO project has been an integral part of and the driver of reforms NBS took the initiative of EURO implementation Consensus in the project was demonstrated by common submission of materials for the