Eco Emerging

Energy dependency

10/09/2022

All growth drivers weakened in the second quarter of 2022. With a high exposure to Russia for its oil and gas supplies, Slovakia could be amongst the most affected Central European countries by the consequences of the war in Ukraine. The steep rise in energy costs, as well as supply disruptions, will have an adverse impact on industrial activity, which has not yet returned to its pre-Covid level. Moreover, inflation has increased rapidly but is still more moderate compared to other countries in the region. Finally, public and external accounts will deteriorate in the short term, but this situation remains manageable.

The Covid pandemic led to a GDP contraction of 4.4% in 2020. The rebound in activity of 3% in 2021 has not yet enabled the economy to return to its pre-crisis level. The catching-up will not happen before 2023 given diminished growth outlook for the next two years.

Growth is slowing down

Slovakia economic forecasts

Economic activity weakened in Q2 2022, with a GDP print of 1.8% year-on-year compared with 3.1% in the first quarter. Growth was dragged down by net exports and by government consumption, which resulted in negative contributions of -0.3 and -1.3 points respectively. Exports suffered from supply disruptions in industry, particularly in the electronics sector.

The contribution made by investment was practically nil. Consumption slowed down, but was still the main driver of growth. Households have drawn on their savings to maintain their purchasing power to some extent. The partial freeze on electricity tariffs for households since the beginning of the year has also helped.

Industrial production and retail sales

The soft patch in investment reflects the deterioration in the business climate. The uncertainties related to the war in Ukraine, alongside with the squeeze on margins due to soaring production costs, and labour shortage have undoubtedly resulted in the postponement of investment projects.

In terms of economic indicators, retail sales are struggling to exceed their pre-Covid level. They have slowed in recent months, to +1.2% year-on-year in July after +1.5% in June and +7.8% in May. Another point to note is that registrations of new vehicles continue to record very sharp declines (-20.3% year-on-year in July, -29.5% in June and -15.9% in May). The slowdown in domestic demand is likely to continue in the short term.

Strong dependence on Russian oil and gas

Of the Central European countries, Slovakia, the Czech Republic and Hungary are amongst the most vulnerable to the consequences of the conflict in Ukraine, given their dependence on Russia for energy. Thus, the Slovak economy is likely to be hit harder than Poland or Romania in the short term. This fragility is due to the country’s high exposure to Russia for its supplies of gas and oil (85% of gas imports and 100% of oil imports). The reduction in gas deliveries via Nordstream 1 pipeline, followed by its shutdown since September, reinforces this vulnerability.

The Slovakian government has sought to diversify its sources of gas supply since the war began in Ukraine. Agreements have been signed with Norway and the United States to supply liquefied natural gas. A new pipeline between Poland and Slovakia also became operational at the end of August. This will allow Slovakia to source supplies from Norway or the Baltic Sea. The country’s gas reserves were 87% of maximum capacity at the end of September. Furthermore, Slovakia along with Hungary and the Czech Republic have obtained an exemption from the EU to continue importing Russian oil until the end of 2023.

While these efforts provide some respite, the industry is still being hit hard. Industrial production fell by 6.4% year-on-year in July compared to -4.8% on average over the past three months. It is still a long way from pre-Covid levels. The latest figures confirm that all sectors have been affected, including power, electronics, transport equipment and machinery. Energy-intensive industries are on the front line, as their energy bills are soaring. Under these circumstances, production at some aluminium plants has been temporarily suspended.

The country is also very dependent on the automotive sector, which represents 48% of its industrial production.This sector was particularly badly affected by supply disruptions in 2021. The war in Ukraine is likely to exacerbate these issues this year. Increases in production costs and energy bills will also hurt this sector. In order to support its industrial sector, the authorities announced at the start of September that they were considering extending the freeze on electricity and gas tariffs to companies.

Inflation has not yet peaked

Inflation rate

The rise in the Harmonised Index of Consumer Prices (HICP) has continued to gather pace, reaching 13.6% year-on-year in September after 13.4% in August and 12.8% in July. It is above the Eurozone average (+9.1% in August) but significantly lower than neighbouring countries. In Hungary and the Czech Republic, the Harmonised Index of Consumer Prices rose by 18.6% and 17.1% respectively in August.

This regional difference is partly due to higher wage growth in these countries. It was 13.5% year-on-year on average in the second quarter in Poland and 15.2% in Hungary compared to 7.4% in Slovakia.

According to the latest available figures, inflation is being driven mainly by food and transport items. Food prices rose by 21% year-on-year in August and contributed 4.8 points to the HICP inflation figure. The surge in energy prices will continue to fuel food production costs. In addition, temporary halts of production at fertiliser plants in Poland could also have an impact on the price of agricultural goods. Transport contributed 1.3 points.

Core inflation, which is also rising sharply (+9% year-on-year in September), is the result of supply constraints, higher wages and production costs. To contain inflation, the authorities decided in February to implement a partial freeze on household electricity tariffs until 2024. Inflation could peak at the end of the year or early in 2023.

With regards to monetary policy, the ECB has raised its key policy rate by 125 basis points since June. Meanwhile, the pace of monetary tightening has been greater in neighbouring countries, mainly in Hungary, with a cumulative rate hike of +1240 basis points since May 2021.

Deteriorating current account balance and public accounts

The current account balance deteriorated significantly during the first seven months of the year, to -4.1 billion euros compared to -0.3 billion euros over the same period last year and -1.9 billion euros over 2021 as a whole (-2% of GDP in 2021). In 2022 and 2023, this deficit is expected to increase to 5.5% and 6.0% of GDP respectively. The trade balance, which has been in structural surplus for years, could show a deficit in 2022, mainly due to higher energy bill. Over the first 7 months of the year, the trade balance was -2.8 billion euros. Financing the deficit should not be a major problem. It should be partly financed by foreign direct investment flows (2.1 billion euros since January 2022) and European funds under the resilience plan.

As for public accounts, the budget deficit is likely to remain high at 5.5% of GDP in 2022, according to our estimates. Supportive measures aimed at containing inflation risks are estimated at 1% of GDP this year. They have taken the shape of subsidies (100 euros per child) and tax rebates for families with children. With regard to pensions, the thirteenth month’s payment will be brought forward to support pensioners. A nationwide freeze on electricity and gas prices is also being considered. Fiscal easing is likely to continue next year, as in most central European countries. The process of fiscal consolidation is expected to resume after 2023 and public debt should gradually return to the level observed before the Covid-19 crisis. Public debt-to-GDP slightly exceeded the 60% threshold in 2021, at 63.1%, and is likely to stay above 60% in 2022.

Article completed on 6 October 2022


THE EXPERT ECONOMISTS WHO PARTICIPATED IN THIS ARTICLE

Other articles from the same publication

Emerging Countries
Double whammy

Double whammy

Excluding China, activity in emerging countries was stagnant in Q2 2022 and business and household confidence surveys indicate that the economic slowdown will continue [...]

Read the article
China
A weaker economy ahead of the Party Congress

A weaker economy ahead of the Party Congress

The recovery in activity since the end of the lockdowns imposed in Shanghai in the spring has been very gradual. It picked up in August, notably supported by public investment and tax measures, but it is likely to lose steam again in September [...]

Read the article
India
Firm resistance against strong pressures

Firm resistance against strong pressures

Although it remains dynamic, economic growth slowed in the first quarter of the current fiscal year [...]

Read the article
Indonesia
A less favourable outlook

A less favourable outlook

During the first six months of 2022, the economy proved to be quite resilient to the consequences of the conflict in Ukraine and China’s zero-Covid policy [...]

Read the article
Thailand
Cautious optimism

Cautious optimism

The recovery is continuing in Thailand. The rebound in private consumption and the gradual return of tourists should help, at least in the short term, to compensate for the slowdown in exports [...]

Read the article
Poland
Losing steam

Losing steam

The economic slowdown is likely to continue in the coming quarters. Poland is facing several challenges. Firstly, the country is highly dependent on coal imports, and the price of this commodity has soared since the end of 2021 [...]

Read the article
Brazil
Bucking the trend

Bucking the trend

Accelerating growth, slowing inflation, falling unemployment and the interruption of monetary tightening differentiate Brazil from most of the world’s major economies [...]

Read the article
Mexico
Prudence

Prudence

The economic dynamism seen in the first half of 2022 is waning. The rebound in private consumption is being held back by rising inflationary pressures, while exports are weakening due to slowing growth in the United States and global demand [...]

Read the article
Egypt
Persistent pressure on the balance of payments

Persistent pressure on the balance of payments

Egyptian external accounts have been under pressure since the beginning of the year and the outlook is uncertain [...]

Read the article
Qatar
Gas revenues provide robust economic prospects

Gas revenues provide robust economic prospects

The Qatari economy, which is poorly diversified and based on long-term gas export contracts, has not experienced the same volatility as elsewhere in the Gulf during the last five years [...]

Read the article
Tunisia
Growing concerns

Growing concerns

Two years after the shock of the pandemic, Tunisia is now being hit hard by the consequences of the conflict in Ukraine. The rise in commodity prices is leading to a dangerous deterioration in external accounts and public finances [...]

Read the article
Kenya
Uncertainties

Uncertainties

In 2020-2021, thanks to its diversified economy, Kenya was relatively more resilient to the shock of the pandemic than other sub-Saharan African economies [...]

Read the article