Is Default of Slovakia Realistic?

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The current social package worth more than a billion euro has definitively confirmed that Slovak government is going kamikaze in the area of public finances. After all, the money is “lying on the pavement” (even though we already have the highest corporate tax rate in all of Eastern Europe), so what’s the problem? Even before the package, Slovakia already had the worst long-term sustainability of public finances in the EU.

While in 2012 less than EUR 24 billion was collected in taxes and levies, in 2021 it will be EUR 40 billion. EUR 16 billion more to spend. That buys almost three nuclear power plants. Every year.

Although revenues grew, deficits did not disappear. When times were good, politicians gave handouts under the slogan “we’ll share!”. When times were bad, politicians handed out under the slogan “we help!”. Thus, Slovak public finances have never seen a budget surplus in their 30-year history.

The first sign that all may not always go smoothly with our public debt appeared in the spring of 2020. The rapid onset of the pandemic scared investors and Slovakia struggled to sell any debt for a few weeks. However, the situation quickly calmed down and debt could again be sold in any quantity and at a ridiculous interest rate.

But the second blow came. Years of flooding the markets with quantitative easing money combined with pandemic helicopter money handouts and serious inflation began to take off in the world.

While the ECB hesitates, bond markets react. In December 2021, investors were willing to pay negative interest of -0.35% for a 10-year German bond; today they are demanding positive interest of 1%. The Italians were paying 0.5%, today 3%. The Slovak 10-year bond in mid-May had an average yield of 1.8%, compared with 0.24% in January.

This is no reason to panic. Slovak debt is relatively stretched, with an average maturity of eight years. Even a steeper rise in interest rates would mean increased costs in the bearable order of hundreds of millions of euros in the coming years. Investors are also interested in our debt because the Slovak economy is intertwined with the German economy – for better or worse.

But we will come back to the title of this commentary in two- or three-years’ time. Bankruptcy is not yet imminent, but the days of ‘arbitrary’ deficits are coming to an end. The new government, whatever it may be, will have to make public finances an absolute priority. This means cutting a number of items from the many dozens of measures in the five or six ‘social packages’ so far.

I am afraid, however, that Slovakia will not be able to form such a government; the social system is politically untouchable. And we will end up making these cuts under the supervision of the International Monetary Fund.

The article was originally published in Slovak in Economic Daily

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