Slovak Brief Experience with Euro during Global Recession Ján Tóth Deputy Governor National Bank of Slovakia

2 Warning  Euro (lack of nominal currency flexibility) effective since 2H08 in Slovakia  However - at the same time – the Great Recession has started  Great Recession – a unique event in magnitude  Slovak brief euro experience has been impacted by such an unusual external shock – therefore “average” long-term experience could be different that the present 5-year one

3 Summary: brief euro experience in Slovakia  Most direct benefit has materialised: transaction costs declined (0.3 % of GDP)  More important indirect benefits (higher FDI, trade growth, potential GDP growth) not yet visible  The euro area debt crisis introduced additional costs related to contagion and contributions to the EFSF and ESM  Real exchange rate not stable, quite the opposite  Greater adjustment through employment  Today weak real exchange rate provides additional stimulus

4 Outline  Output and employment  Inflation  Foreign trade and investments  Flexibility of the economy  Euro debt crisis

5 Output and Employment

Euro adoption coincided with the global crisis  Global shock introduced by the economic crisis stressed the lack of flexibility of the currency  Real exchange rate stability has not been achieved as important trading partners kept the local currency  In fact, not having local currency might have increased the volatility of the real exchange rate  A comparison with similar economy (Czech Republic) also hit by the crisis helps to focus on the impact of euro adoption on Slovakia (net of the crisis impact) 6

Exports contributed to the deeper Slovak recession and faster recovery compared to Czech Republic 7 Source: ECB. Eurostat. NBS calculation.

Manufacturing experienced stronger adjustment in employment in EA countries Source: Eurostat, NBS calculations.

How deep was the crisis? How deep was the crisis? Real output worse than forecasts by cumulative 10.7 % in CR and 15.3 % in SR during Forecasted CZ growth Actual GDP growth Difference Source: CNB forecast (7/8/2008) Forecasted SK growth Actual GDP growth Difference Source: NBS forecast (P3Q-2008) 9 Source: NBS, CNB, NBS calculation

How fast is the recovery? How fast is the recovery? Recently recovery stronger in Slovakia compared to forecasts in relative terms (-3.2 % in CR and % in SR) Forecasted CZ growth Actual GDP growth Difference Source: CNB forecast (5/8/2010) Forecasted SK growth Actual GDP growth Difference Source: NBS forecast (P3Q-2010) 10 Source: NBS, CNB, NBS calculation.

Slovak real exchange rate more volatile (higher overvaluation and greater undervaluation) 11 Source: ECB. NBS calculation.Note: Deviations from HP-filter. 5 quarters centered moving averages are presented.

Initially the currency had restrictive impact on growth. Now it is expansionary. 12 Source: ECB. Eurostat. NBS calculation. Note: REER is based on PPI – manufacturing. 5 quarters centered moving averages are presented.

The first stage was heavily procyclical while today it is significantly countercyclical 13 Note: REER is based on PPI – manufacturing. 5 quarters centered moving averages are presented. Source: NBS calculation.

14 Illustrative example – currency in (real) equilibrium model scenario Difference from level of outcome [in %] Source: Eurostat. NBS calculation.

Illustrative examples  In such a neutral scenario, Slovak output could have been smaller than real data  Should SKK follow nominal path of CZK, in such a CZK scenario, output could have been still higher than reality 15

16 Inflation

17 Euro period: so far very low (core) inflation HICP prediction before the crisis and its actual development Services and tradable goods – comparison of prediction and reality Initially, the lagged impact of the currency appreciation pushed inflation lower. Later weak domestic demand (global crisis) keeps core inflation low. Changeover effect estimated up to 0.2 %.

18 Despite low inflation. CZ has had even lower one since 2009 Non energy industrial goods at constant tax SR versus CR Inflation of tradeables as well as services very similar in SK compared to CZ during CZ inflation lower since. Services at constant tax SR versus CR

Higher inflation in SK creates more space for real interest rates to adjust in ZLB scenario 19 Note: 3M MM deflated by HICP excluding food and energy prices. Source: ECB. OECD. NBS calculation. 3M real interest rates (in %)

20 Foreign trade and Investment

21 Export Volumes Source: Eurostat, NBS calculation. Only very moderate improvement of export dynamics in intra EA. Market shares Average QoQ growth [%] 2000Q Q4 2009Q Q2 Total Intra Extra Real export. ESA data Average QoQ growth [%] 2000Q Q4 2009Q Q2 Total export Intra EA Extra EA

22 FDI (% of GDP) FDI inflows/GDP (3Y MA)

23 Flexibility, structural reforms

24 Flexibility of the economy, structural reforms  To mitigate the nominal exchange rate inflexibility, the economy should be reformed such that the other parts are as flexible as possible  Average reform progress similar in EA to ex-EA EU  Both SK and CZ below average improvement

25 Pace of the reform process differs Ease of Doing Business Index shows that Slovakia is also lagging behind the average trend improvement.

26 Labour market flexibility in Slovakia EPL Index (eprc_v3) – OECD countriesEPL Index - Slovakia

27 Euro debt crisis

28 OECD+EU countries: some relationship between the cost of debt and indebtness. Source: OECD. Eurostat Note: Averages for Estimates for 2013 by OECD. Sovereign debt vs. cost of debt

29 But for the euro area the relationship seems to be more pronounced (no local central bank as the lender of last resort). OMT helped. Source: OECD. Eurostat Note: Averages for Estimates for 2013 by OECD. Sovereign debt vs. cost of debt

30 Slovak rating cut together with other EA countries Rating S&P Grade AA- CZ A+ SK A CZSK A- CZSK = CZ BBB+ CZ BBB BBB- BB+ SK BB BB- SK grades -4 grades Investment Grade Non–Investment Grade

SK bond yields – CZ bond yields 31 Source: ECB. SK bond yield-CZ bond yields (in pp)

32 Some lessons learned  Most direct benefit of euro has materialized: transaction costs declined, changeover effect low  But huge external shock exaggerated the lack of flexibility of the currency regime vis-a-vis neighbours  And the euro area debt crisis introduced additional costs related to contagion and fiscal contributions to the EFSF and ESM  Weak real exchange rate seems to provide currently much needed additional stimulus (SK not in recession in 2013)  The most important indirect benefits not yet visible (higher FDI and trade growth). The effect of the crisis is much stronger than the monetary integration effect  As suggested before the crisis, it is very important to have the rest of economy as flexible as possible to offset the rigidity of the currency regime

33 Thank you for your attention