Organisation de Coopération et de Développement Economiques
Organisation for Economic Co-operation and Development
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POLICY INTERDEPENDENCE DURING ECONOMIC TRANSITION: THE CASE
OF SLOVAKIA 1999-2000
ECONOMICS DEPARTMENT WORKING PAPERS NO. 253
Joaquim Oliveira Martins and Tristan Price
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Most Economics Department Working Papers beginning with No. 144 are now available through
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This paper sets out a framework to analyse the interdependence of reforms in different policy areas during
the transition process. It identifies four broad policy blocks related to liberalisation, stabilisation, exit and
entry. The transition process in Slovakia is a case study of the striking interdependence between these
different policies. Along these lines, the paper analyses the reform programme that was implemented in the
Slovak Republic during 1999-2000, focusing on macroeconomic stabilisation and structural reforms in the
banking and enterprise sectors. It appears that success in making up for a period where economic reform
had stagnated and even been reversed depends on being able to reform on a broad front. In particular, this
means addressing the difficult situation of financial deadlock between all major players in the economy
and the large costs associated with restructuring. Fostering deep restructuring in the large enterprise sector
is the main structural challenge in the Slovak economy. This must be faced if the economy is to promote
sustainable growth that results in the job creation necessary to bring down high levels of unemployment.
During the transition, the many pressures from restructuring are likely to converge on the budget, which
will become an indicator of strain in the economy.
JEL Classification: P21; P27
Keywords: Transition; policy-interdependence; structural reform; Slovak Republic.
Cet article propose un cadre d’analyse sur l’interdépendance des réformes économiques au cours du
processus de transition. Quatre grands blocs de politiques sont identifiés : libéralisation des prix,
stabilisation de l'économie, cadre économique pour la sortie et l’entrée de firmes. Le processus de
transition en Slovaquie est un cas d’étude intéressant de cette interdépendance des politiques économiques.
L’étude analyse le programme de stabilisation macroéconomique et les réformes structurelles dans les
secteurs bancaire et des entreprises, mis en œuvre en République Slovaque pendant la période 1999-2000.
Pour rattraper avec succès le retard accumulé dans le passé, il serait nécessaire que ces réformes soient
effectuées sur un front assez large. Il est notamment indispensable de surmonter les blocages financiers
entre les principaux agents de l’économie et d'assumer les coûts liés à la restructuration. Le défi majeur est
l’accélération de la restructuration en profondeur du secteur des grandes entreprises. C'est la réalisation de
ce défi qui permettra de promouvoir une croissance économique soutenable génératrice d'un nombre
d’emplois suffisants pour faire baisser le chômage. Pendant la période de transition, il est probable que les
comptes publics devront supporter un grand nombre de contraintes liées à la restructuration et qu'ils seront,
par conséquent, un indicateur de la pression sur l’économie.
Classification JEL: P21; P27
Mots-clés: Transition; interdépendance des politiques économiques; reformes structurelles; République
Copyright: OECD 2000
Applications for permission to reproduce or translate all, or part of, this material should be made to:
Head of Publications Service, OECD, 2 rue André-Pascal, 75775 PARIS CEDEX 16, France
TABLE OF CONTENTS
POLICY INTERDEPENDENCE DURING ECONOMIC TRANSITION:
THE CASE OF SLOVAKIA 1999-2000 ....................................................................................................... 4
1. Introduction............................................................................................................................................ 4
2. Interdependence of policies.................................................................................................................... 5
3. The macroeconomic stabilisation package............................................................................................. 7
3.1 Adjustment measures........................................................................................................................ 7
3.2 Social impact.................................................................................................................................... 8
3.3 Continued nominal convergence...................................................................................................... 9
4. The first step of restructuring: the financial sector ................................................................................ 9
4.1 The banking system was deeply implicated in widespread indebtedness ........................................ 9
4.2 The first phase of banking sector restructuring.............................................................................. 10
4.3 Role of the banking sector in economic restructuring.................................................................... 12
5. Deepening reform: restructuring the large enterprise sector.................................................................13
5.1 Financial deterioration in the enterprise sector............................................................................... 13
5.2 Enforcing exit mechanisms ............................................................................................................ 15
5.3 Creating the conditions for entry of new firms............................................................................... 17
6. Closing the circle: the impact of restructuring on the budget.............................................................. 18
6.1 Pressures on the budget.................................................................................................................. 18
6.3 Financing reform............................................................................................................................ 19
7. Summary.............................................................................................................................................. 20
TECHNICAL ANNEX................................................................................................................................. 24
POLICY INTERDEPENDENCE DURING ECONOMIC TRANSITION:
THE CASE OF SLOVAKIA 1999-2000
Joaquim Oliveira Martins and Tristan Price1
between macroeconomic developments and structural reforms. After early debates between ‘gradualists’
and those advocating ‘shock therapy’, and on the optimal speed of reforms (Aghion and Blanchard, 1993),
it has become increasingly evident that reforms are strongly interdependent. The success of any individual
policy depends on being able to reform on a broad front. A certain uncompressible time is also needed to
build up institutions to support market mechanisms. Thus the focus of the debate has shifted from the
speed to the scope and coherence of reform (Stiglitz, 1999).
The transition process in central and eastern Europe has provided strong evidence of the links
structural underpinning of transition was neglected in the early stages of reform and latterly the
macroeconomic position had started to deteriorate. Between 1996 and 1998 the Slovak economy had
accumulated substantial external and fiscal deficits, along with an unsustainable level of public investment
and expenditure. Although economic growth had been maintained, it was not soundly based (OECD,
1999a). Policy changes quickly followed the parliamentary elections in September 1998. Shortly after, the
National Bank of Slovakia (NBS) had to abandon the fixed exchange regime that had been in place since
independence in 1993. An initial economic programme was approved in December by the new
government. But the measures were not enough, and a second austerity package was implemented in May
The current stage of transition in the Slovak Republic well illustrates these policy links. The
contained and the austerity measures to slow down domestic demand induced a substantial reduction in the
current account deficit, which nearly halved compared with 1998. The government further liberalised
controlled prices of energy and public utilities which increased headline inflation significantly, even
though inflationary pressure remained subdued. While a recession might have been expected, Slovakia in
fact grew by nearly 2 per cent in 1999. This moderate growth was not enough to prevent unemployment
rising to nearly 20 per cent.
Policy during 1999 was targeted at macroeconomic stabilisation. The state budget deficit was
1.OECD Economics Department (Email: email@example.com and firstname.lastname@example.org). This work was
carried out in the context of the country and regional programmes of the OECD’s Centre for Co-operation with
Non-Members (CCNM). The authors wish to thank Silvana Malle, Val Koromzay, Andrew Dean, Elena
Kohútiková, Katarína Mathernová, Juraj Rencko and Ján Jursa, for their valuable comments on an earlier draft of
this paper. We are grateful to Anne Legendre for statistical assistance. The views expressed are those of the
authors, and do not necessarily reflect those of the OECD or its Member countries.
measures intended to improve the situation in the financial sector and pave the way for hardening budget
constraints in the enterprise sector. The first microeconomic reform was the adoption of a bank
restructuring programme that began in December 1999. The large state banks were recapitalised and a
tranche of their bad loans transferred to a new bank restructuring agency. These steps were intended to
prepare the banks for rapid privatisation. The problems in the banking sector are linked to those in the
enterprise sector. In the absence of enterprise reform the benefits of bank restructuring cannot fully
materialise. This is a typical example of the interactions amongst reforms that are the focus of this paper.
Together with this restrictive stabilisation programme, the government initiated a number of
macroeconomic policies and microeconomic reforms. It moves on to the immediate macroeconomic
stabilisation measures adopted in Slovakia and their impact on the real economy.2 It then considers the two
main areas of structural reform, the financial and enterprise sectors, and their interaction. In turn, structural
changes will make themselves felt at the macroeconomic level. The circle is closed in the final section by
analysing the impact of these reforms on the macroeconomic position. Given the limited scope for
monetary policy, the budget is the primary gauge of strain in the economy. Along these lines, the paper
highlights the challenges that lie ahead in reducing public sector expenditure and debt creation. It ends with
The paper starts by setting out a framework enabling to identify the main linkages between
2. Interdependence of policies
different economic policies. At the outset, all transition countries were offered roughly the same liberal
policy package designed to make use of market mechanisms to obtain the best possible allocation of
resources, which in turn creates the conditions for sustainable growth and an improvement of living
standards. In retrospect, one aspect perhaps overlooked at the time was that such a package needs to be
internally coherent. In order to reap the full benefits from this approach to reform, policies in the different
areas of the reform programme must, as far as possible, be implemented in parallel.
Observations from a decade of transition provide evidence to explore the linkages between
can often not be disentangled. Ideally, in order to analyse these simultaneous interactions a general
equilibrium formulation would be required. In reality, providing evidence and specifying structural
interactions would not be straightforward as the environment during transition is very volatile and many
aspects are difficult to quantify.
Precisely because reforms are interdependent, the direction of causality between different policies
most important policy areas and their links in the sequence they were typically observed in Central and
Eastern European transition countries. This sequence may reflect not only policy choices but can also
result from the relative ease of implementation or different political pressures. In the first place, most
transition countries liberalised trade and a large basket of prices.3 As a result, the true pattern of demand is
revealed as relative prices adjust. This was followed by stabilisation, but if the right macroeconomic policy
mix is not in place, notably when a budget deficit is financed through monetary creation, price
liberalisation is quickly followed by high and accelerating inflation. In turn, macroeconomic stabilisation
can only be sustained and lead to economic recovery if significant and steady progress is achieved in the
A more pragmatic approach was adopted here, which is summarised in Figure 1. It sets out the
2. Additional information, which is not used in this paper but that may be useful as background information for the
reader, can be found in OECD(2000a).
3. Typically prices of energy, housing and transport lagged the liberalisation in other areas.
area of structural reform.4 For example, efforts to achieve and maintain budget discipline are undermined
where enterprises face weak budget constraints and draw resources from the public sector. The channel for
this is often not direct subsidy from the budget, but instead over-easy access to credit from the banking
system, often itself in full or partial state ownership. Another example of indirect support is where the state
maintains an artificially overvalued exchange rate in order to facilitate imports of raw materials or energy
to unrestructured heavy industries (OECD, 1998). This situation persists until firms that fail to add value
are forced out of the market. During transition, privatisation and restructuring have all been used to
encourage this outcome. But often this process has been held back by insufficient use of liquidation, the
result of ineffective bankruptcy procedures and weak creditor rights (Malle, 1999).
Figure 1. Policy interdependence: a framework for transition
restructuring is undermined in the absence of external financial discipline, typically imposed by the
banking sector. Either banks do not lend, regardless of companies’ creditworthiness, to prevent a new
accumulation of bad debts, thus reinforcing existing credit constraints. Or else, under pressure to resume
the flow of lending to unrestructured enterprises, financial problems in the banking sector re-emerge.
Likewise, if bankruptcy proceedings are not effective, banks cannot both provide credits and impose
financial discipline. More generally, positive structural interactions do not necessarily follow policy
implementation. The problem is not only to solve the question of stocks, such as bad debts, but also to
ensure that the flows are right, namely exit and entry of firms, new financing and investment. When the
flow problems have not been solved, the stock problems tend to re-emerge, with the risk that their
resolution becomes even more costly. Where exit mechanisms are enforced and induce enterprise
liquidations but where the conditions for entry of new enterprises are not in place, the pace of restructuring
may become politically unsustainable as unemployment rises and the economy fail to recover rapidly.
Lack of progress in one area affects other structural reforms. For example, large enterprise
recent comparative study of the three Baltic States (OECD, 2000b) concluded that it was more important to
get the links right rather than pushing reform in any single area. These links should also incorporate
institutional development (Havrylyshyn and van Rooden, 2000).
These policy linkages have been the focus of the OECD approach towards transition countries. A
Table 1, reflects growing awareness of the interdependence of structural reforms. However, decisions on
the actual implementation of policy were slow to emerge. The government had to develop a modus
operandi within the different parties that comprise the coalition, an illustration of the interaction between
economic policies and the political system. Nonetheless, the reform programme finally gained momentum
during 1999. Key measures were adopted in fiscal policy, price liberalisation and bank restructuring.
However, progress on enterprise restructuring and financial discipline requires a higher degree of political
consensus, which has proved difficult to achieve.
The initial reform programme approved by the Slovak government in December 1998, outlined in
Table 1. Slovak reform programme and policy implementation, 1999-2000
4. Evidence on this point is provided in several OECD Surveys of transition economies (OECD, 1996, 1997, 1998,
1999a,b and 2000)
3. The macroeconomic stabilisation package
3.1 Adjustment measures
unsustainable. During 1998 the Slovak Republic recorded a current account deficit of 10.4 per cent of GDP
and a fiscal deficit of 4.8 per cent of GDP (Table 2). The government was also faced with the risk of
collapse in vital public services such as healthcare and education. The coalition government which took
office in late 1998 focussed its initial programme on macroeconomic stabilisation. Policy aimed to reduce
the fiscal deficit, slowing domestic demand and in this way bringing down the current account deficit.
After some months it became apparent that these measures were not sufficient to stabilise the fiscal
position (IMF, 1999a-b). It was politically difficult for the government to adopt firmer measures in
advance of a presidential election that took place in May 1999. But it also took time for the four coalition
partners5 to reach an agreement on a mechanism for taking decisions, and indeed on the extent of economic
adjustment required. In fact, a second package of austerity measures was announced just prior to elections
at the end of May and implemented immediately afterwards.
By the end of 1998 the macroeconomic situation in the Slovak Republic had become
Table 2. Macroeconomic performance, 1995-1999
increase revenue and reduce expenditure. The State budget came close to balance for the months August to
November, having already reached more than three-quarters of its planned total before the end of July. The
government was able to cut the budget deficit without implementing its plan to reduce the numbers of civil
servants by twenty thousand; government employment actually rose during 1999. The most important
revenue measures were the imposition of a temporary import surcharge (at 7 per cent), and increases in the
lower rate of VAT and in certain excises. There was also a first round of increases in the price of energy
and public utilities and a reduction in proposed improvements to welfare benefits. The consolidated budget
deficit6 was also reduced, though at 3.6 per cent it remained nearly double the state budget deficit.
The state fiscal deficit was brought under 2 per cent of GDP by government action to both
current account deficit. In Slovakia the trade balance effectively determines the current account balance,
given that the high service revenues from energy transportation approximately cover the invisible trade
deficit in other areas. Weak domestic demand combined with the import surcharge imposed half way
through the year led to a considerable reduction in the demand for imports, which fell by some 14 per cent
in US dollar terms. After three years of double-digit deficits the current account for 1999 fell to
5.8 per cent of GDP. This moved Slovakia’s external position back onto a sustainable footing. This point is
illustrated in Figure 2, which relates the level of the current account deficit, nominal GDP growth and the
debt to GDP ratio.7
The major achievement of the adjustment package, however, was a dramatic reduction in the
Figure 2. Sustainability of the current account deficit
5. The coalition comprises the Slovak Democratic Coalition (SDK), Party of Democratic Left (SDL), Civic
Reconciliation Party (SOP) and the Hungarian Coalition Party (SMK). The SDK is itself a coalition of five
separate parties that remain independently registered: the Christian Democratic Movement (KDH), Democratic
Union (DU), Democratic Party (DS), Slovak Social Democratic Party (SDSS) and the Slovak Green Party (SZS).
In January 2000, the Prime Minister formed a new party, the Slovak Democratic and Christian Union (SDKU).
6 The consolidated budget deficit includes the expenditures of local authorities and, importantly, extra-budgetary
funds such as the welfare and road building funds. The welfare funds in particular have continued to incur
considerable cash deficits (see Section 6 below)
7. See the technical annex for a definition of current account sustainability.
the sharp contraction of investment (Figure 3), after the peaks of 1996-97. The seemingly excessive ratio
of investment to GDP in Slovakia (OECD, 1999a) suggested a degree of over-investment not justified on
economic grounds, and so pointed towards the need for the adjustment recorded in 1999. The government
reduced its capital expenditure by 20 per cent during the year. Another element of the adjustment was the
reduction in real wages. Average real wages were stagnant during the first half of 1999, and fell by
6 per cent during the third quarter. For the year as a whole real wages fell by 3.1 per cent compared with
1998. The fall in real wages was mainly due to increased headline inflation as the government moved to
liberalise controlled prices and froze public sector wages.
In aggregate terms, the most important factor behind the reduction in final domestic demand was
However, their impact was mitigated by a persistent upswing in exports during the year. Overall, the
slowdown in growth left room for a 1.9 per cent increase in GDP during 1999.
These austerity measures were widely expected to produce a significant slowdown in growth.
Figure 3. Contribution to GDP growth of final demand, 1993-99
3.2 Social impact
unemployment. Registered unemployment increased from 16 per cent at the beginning of the 1999 to more
than 19 per cent by the year-end. This measure is typically higher than those that are based on a labour
force survey (LFS). But even LFS unemployment rose to more than 17 per cent by the end of 1999. This
singles out the Slovak Republic from other transition economies as peak unemployment in the
neighbouring transition economies of Poland, Hungary and the Czech Republic never reached these levels.
The cost of both internal and external adjustment has been quickly reflected in higher
1998 and 1999 roughly half the increase in unemployment (of 100,000) was due to net destruction of jobs.
This particularly affected traditional sectors such as agriculture and heavy industry (machinery, basic
metals and mining). At the same time, employment increased in the service sector and in some
manufacturing industries such as textiles, but not by enough to offset job losses in other sectors. This
sectoral reallocation is evidence of structural change (see Table 3).
In part, increasing unemployment could be seen as a result of restructuring, given that between
Table 3. Labour market changes, 1998-99
99 the labour force increased by roughly 50,000, largely due to the number of young people joining the
labour market. This is reflected in the substantial increase in unemployment amongst the youngest cohorts
in the labour force that can be seen from the strong cyclical component of monthly unemployment, which
peaks at the end of the school year in July (Figure 4). Actually, the rising trend in registered unemployment
had already started before 1999, showing that previous growth in the economy had failed to generate
sufficient new jobs. Nevertheless, the slowdown in growth that followed the austerity measures was a
contributory factor to the increase in unemployment. Stronger growth was needed to absorb the natural
increase in the labour force. Despite this continuing pressure from labour force growth, the rising trend in
unemployment seems to have levelled off towards the end of 1999. However, this only emphasised the
need to press on with structural reforms, especially since yet greater pressure on unemployment could be
expected as restructuring progressed, not least as new bankruptcy procedures began to affect hitherto
unrestructured parts of the enterprise sector.
But a large part of the rise in unemployment was due to demographic factors. Indeed, over 1998-
Figure 4. Monthly change in registered unemployment, 1997-2000
tightening the qualification criteria for unemployment benefit. It also sought to develop active labour
market measures to alleviate youth unemployment in particular, and to increase the degree of labour
mobility within Slovakia. This latter measure was designed to help reduce quite strong and persistent
regional differences in unemployment. However, the social pressure associated with rising unemployment
and tightening benefits inevitably interacts with, and complicates, the political process. This is a crucial
aspect of reform (see Fidrmuc, 1996), which is not covered further in this paper.
The government took some measures to reduce the registered rate of unemployment by
3.3 Continued nominal convergence
Monthly CPI inflation shows clearly the level adjustments that followed three increases in regulated prices
without raising the trend (Figure 5). The effectiveness of the austerity programme was enhanced by a
consistently prudent monetary policy. The latter was gradually relaxed as the focus of economic policy
shifted to the fiscal account, and the National Bank of the Slovak Republic (NBS) succeeded in stabilising
and reducing the level of interest rates.8
Despite the increase in ‘headline’ consumer prices (CPI), underlying inflation remained subdued.
Figure 5. Monthly consumer price inflation, 1997-2000
contrary. During December 1999 the NBS intervened several times to prevent Koruna appreciation.9 The
real effective exchange rate, a broader measure using consumer prices (CPI) weighted by trade share,
shows the Slovak crown appreciated by some 10 per cent during 1999 (Figure 6). The appreciation was
rather less using producer prices, reflecting that the rising CPI stemmed mainly from price deregulation.
Over the medium term, as a result of the EU accession process, monetary policy may place greater weight
on stability of the exchange rate against the Euro. This does not pose a threat to the continued improvement
in the trade and current account balances whilst it is matched by productivity gains. For this external
constraint to be effective, however, the enterprise sector will need to restructure rapidly in order to increase
the quality and variety of Slovak exports (see Section 5 below).
The reduction in interest rates did not lead to downward pressure on the exchange rate. On the
Figure 6. Real effective exchange rate, 1996-2000
4. The first step of restructuring: the financial sector
4.1 The banking system was deeply implicated in widespread indebtedness
re-establish financial discipline in the Slovak Republic. In line with OECD recommendations (OECD,
1999a), the government’s Medium Term Economic Policy Priorities (European Commission, 2000)
There was agreement within the government that bank restructuring was the first step needed to
8.At the beginning of 2000 the NBS introduced repurchase (“repo”) contracts in order to reduce interest rate
volatility. Initially it offered an overnight rate, with plans to move gradually to a two-week contract. This facility
supported monetary stability by allowing banks to manage their liquidity much more actively. It had an
immediate impact on interest rates in Bratislava: overnight BRIBOR rates in January 2000 were some 10 per cent
less than a year earlier, and by April 2000 they had fallen below 8 per cent.
9.The NBS has publicly stated that it has a target corridor for the exchange rate, without revealing the upper and
lower rates of the band.
emphasised that restructuring in the enterprise sector cannot succeed where the banking system either fails
to extend credit, or extends credit without proper attention to creditworthiness.
40 per cent of gross loans were classified as substandard or below. Most fell into the bottom ‘bad’
category. This proportion was subsequently reduced to 18 per cent following the first steps in the
government’s bank restructuring programme. Provisioning by the commercial banks had been
strengthened, and the shortfall from NBS standards at the end of 1999 was about 2 per cent of GDP. It is
noticeable that the level of bad loans climbed during 1999, and was concentrated not only in the troubled
large banks (Group 1), but more widely in the banking sector. The fall in economic activity was one factor,
but it seems likely that other factors were also at play: supervisors at the NBS had gained in experience,
and the central bank had put more effort into on-site supervision. The incentives to declare non-performing
loans also increased once banks sensed that the government was about to embark on a state-funded clean-
up of the sector, and indeed the NBS encouraged banks to reveal non-performing loans.
By the time bank restructuring was launched in Slovakia, towards the end of 1999, more than
4.2 The first phase of banking sector restructuring
agency, a joint stock company called Slovenská konsolidacná (SKA), to operate alongside the existing
consolidation bank, Konsolidacná banka (KAB). No explicit justification has been given for establishing a
new bank restructuring vehicle. However, it seems that a new institution, with new management, better
trained staff and operating under different rules, was expected to break up the relationships between the
state, large banks and enterprises that contributed to the original problem. The new structure is also
designed to allow more active management of the loan portfolio than would have been the case under the
KAB. Indeed, the government has systematically allocated different clients to the two consolidation
institutions. The KAB’s portfolio includes those loans where the state, or its agencies, were directly or
indirectly involved as both creditor and debtor, e.g. state subsidised loans for housing. Thus, the KAB in
effect became a vehicle for consolidating lending and borrowing that falls inside a boundary round the
wider public sector, whereas the SKA has taken on bad loans from the enterprise sector.
The centrepiece of the bank restructuring plan10 was the creation of a new bank restructuring
this is not expected to have a major impact on restructuring in the enterprise sector. The KAB holds few
direct loans to enterprise, although these do include liabilities of the state armaments group, DMD
Holding. Moreover, the KAB is small compared with the SKA, with total assets of some SKK 40 billion,
of which half represents loans acquired before restructuring. By contrast, the SKA has total assets of some
SKK 130 billion.
While it seems likely that the KAB’s asset portfolio will continue to be managed only passively,
Vseobecná úverová banka (VUB), Slovenská sporitel’ná (SLSP) and Investicná a Rozvojová banka (IRB).
The process of restructuring has proceeded along the following steps:
The SKA was designed to create the conditions for rapid privatisation of three largest banks
a)? The NBS transferred profits of SKK 21 billion to the Ministry of Finance that it made in writing back
unused provisions created in December 1997, when it originally took IRB into administration. This
was used to recapitalise the three largest banks (IRB, VUB, SLSP) and the Slovak Insurance Company
10. The plan had been developed in co-operation with the World Bank, the EU (through its PHARE programme) and
b)? VUB, SLSP and SLPO lent the IRB SKK 8 billion under state guarantee. IRB used its capital increase
plus these additional resources to meet its obligations (around SKK 13.5 billion) towards the central
bank and, in this way, was released from NBS ‘conservatorship’ (administration).
At this stage, the capital adequacy ratio of VUB and SLSP had been increased and the IRB could be put up
for sale. In net terms, the central bank had injected SKK 7.5 billion into the rest of the banking system.
c)? The SKA was established with a minimal amount of equity capital (SKK 1 million) jointly owned by
the three banks and the KAB (19 per cent each), and the Ministry of Finance (24 per cent).11
d)? In order to give the SKA the means to buy the bad loan portfolio from the commercial banks, the
commercial banks themselves lent around SKK 63 billion to the SKA under state guarantee. This was
then used by the SKA to buy an equivalent amount of bad loans in VUB, SPSP and IRB. Only
SKK 11 billion of bad loans were transferred to the KAB at the same time. The total of SKK 74 billion
represented a little over 40 per cent of total classified loans.
e)? In March 2000, the Slovak Ministry of Finance made a Euro Bond issue of EUR 500 million (around
SKK 200 billion). Part of these resources were used to increase the state’s equity stake in the SKA,
which in turn used its capital to repay the loans it had taken out from the commercial banks.
f)? In June 2000, the Ministry of Finance severed the last link between the SKA and the banks when it
bought back their residual equity holding in the SKA.
In summary, the commercial banks have been recapitalised with money from issuing state bonds, using the
SKA as a transfer vehicle. A further transfer of bad assets to the value of SKK 34 billion took place in
privatisation. In February 2000 the government decided to sell all of its remaining stake (85 per cent) in
VUB, and either 64 or 87 per cent in SLSP, along with its stake12 in IRB. The government also recognised
that the banks, in particular IRB, would probably not be saleable as going concerns, and so allowed for
separate sale of specified bank assets.
This process reduced the volume of classified claims (see Table 4) and prepared banks for
Table 4. Selected banking sector indicators
act principally as a vehicle for bank restructuring. Nonetheless, the Slovak government intends that the
SKA promote a more active approach to collecting loans. Indeed the agency itself consists of only a small
number of staff, answerable directly to the government. The SKA’s function is to sell parcels of assets to
third parties who will then have strong incentives to maximise their yield, providing the sales had taken
place at arm’s length on commercial terms. In this way, the SKA may in practice become integrally
involved in enterprise restructuring, although it is impossible at this stage to assess whether it will be
effective in managing and disposing of its portfolio of bad enterprise loans. But the government seems to
have realised that in the absence of decisive action these companies would act as a dead-weight in the
enterprise sector, a source of delayed or non-payment. Even when they are unable to obtain direct credit
Contrary to the approach adopted in the Czech Republic (see below), the SKA was designed to
11. The 19 per cent figure is carefully chosen. Where a parent holds more than or equal to 20 per cent in an entity,
the entity has to be consolidated into the parent(s)’ balance sheet. In this case negating the whole purpose of the
12. Held through the National Property Fund and indirectly through state-owned financial institutions, banks and the
State Insurance company; the overall state stake is some 70 per cent of the bank’s capital.
from the banks, the quasi-protected position of some companies would have allowed them to exploit
indirect financing, such as by increasing arrears to suppliers, public utilities (transport and electricity), tax
authorities and the social funds. The likely rate of recovery on the bad loans is low: about 80 per cent of
the clients in both portfolios, as they stood in April 2000, were in bankruptcy.
Comparison of the Slovak and Czech loan restructuring agencies
There are substantive differences between the Slovak and Czech loan restructuring agencies. The Czech
Revitalisation Agency (RA) is wholly-owned by the (Czech) Konsolidacni Banka and intended to operate at
arm’s length from government. The RA’s task is to restructure the debt, and where necessary the management, of
large firms. Although it may select firms for revitalisation, the government exerts influence over the decision by
‘pre-selecting’ firms that meet four criteria (workforce must exceed 2000; annual purchases from domestic
suppliers must exceed Kc 1 billion or some USD 28 million; debts to the three largest banks must exceed
Kc 3 billion; and, they must make an operating profit).
In Slovakia no such filtering exists since the SKA is mainly targeted towards bank restructuring. By default,
classified loans in the official programme are transferred to the SKA. In both countries, the agencies have a wide
mandate to administer assets, implement cost cutting programmes, and formulate new business plans. The
objective is to maximise their portfolio value through liquidations, restructuring and sale. The agencies’ success
will be determined by the ability of their managers to take decisions on the basis of objective economic and
business assessments. This assumes the government will refrain from influencing the process. In both countries,
weak bankruptcy legislation and poor protection of creditors could hamper the work of these agencies.
than the NBS. In principle this allows a better oversight of how the SKA’s manages its portfolio of bad
loans, but it may also leave it more exposed to political pressure. In any case, the government plans to
terminate its involvement in the SKA by 2003, by which time the agency would be liquidated or sold; it
seemed likely that the KAB will remain in existence for some time beyond this date.
Since the SKA does not hold a banking license, it is supervised by the Ministry of Finance rather
first phase of restructuring only included ‘bad’ loans. This was cautious, in that loans presently classified
as ‘standard’ because they are covered by a state guarantee could prove to warrant a lower ranking. This
would mean that guarantees amounting to some 16 per cent of GDP in total could begin to crystallise and
become a cash charge on the state budget. Once the banks had been privatised, the government would no
longer be able to control the rate at which these liabilities were released onto the budget. This feedback of
bank restructuring into the fiscal position is discussed below.
Whilst there has been this positive progress in bank restructuring, further action is needed. The
4.3 Role of the banking sector in economic restructuring
between large enterprise and state banks is expected to free-up resources to the new private sector (e.g.
small and medium sized enterprises) and to the rest of the financial sector. This is essential to improve the
functioning of exit and entry mechanisms. After government action to restructure the sector, credit was no
longer readily available, and lending was often tied to demands for sovereign guarantees. Bank lending to
enterprise fell sharply in real terms, and the NBS acknowledged a ‘credit crunch’: only 3 per cent of
lending to enterprise was long term. In addition, falling interest rates were not matched by falling spreads
in the commercial market, which exceeded 10 per cent for long term loans, and 3 per cent for short term
loans. The spread on short-term debt even rose quite significantly during the last quarter of 1999. Overall,
nominal credit to households and enterprises rose by some 6 per cent during 1999, but this was
substantially below the rate of growth of nominal GDP. In real terms credit fell.
Financial intermediation had reinforced existing economic structures. Dissolving the link
discipline. But the enterprise sector suffers until banks are able accurately to assess credit risk and
This suggests that banks were responding to new incentives and enforcing tighter financial
commence lending to viable enterprises and projects. For this to occur, the business environment must
provide for secure credits and recourse to legal remedies such as workable bankruptcy procedures.
stockmarket is small (only 46 listings by end-1999) and suffer from thin volumes, poor supervision and
suspicions of insider trading. This lack of confidence was encouraged by weak securities legislation (e.g.
even in early 2000, physical bearer shares were still permitted) and licensing requirements that resulted in
large numbers of poorly capitalised brokerages. The lack of transparency in Slovak privatisation up to
1998, including the role played by insiders, also did much to undermine confidence in the market.
Amongst large enterprises only few believed that listing would attract new capital. The market regulators
and government started to introduce changes designed to attract new members. The most important was
the creation of a new financial markets supervisor in June 2000. This office did not add to existing
regulatory capacity, but drew together supervision of capital markets and insurance13. Although these
institutional changes are important steps, the behavioural changes they are intended to promote will
inevitably take time.
Domestic capital markets are not yet an alternative source of viable funds. The Bratislava
5. Deepening reform: restructuring the large enterprise sector
5.1 Financial deterioration in the enterprise sector
for rapid enterprise restructuring. Previous studies of large enterprises in Slovakia concluded that some
restructuring had taken place despite strong insider ownership and the absence of foreign capital (Djankov
and Pohl, 1997). However, OECD (1999a) pointed out that the restructuring which had taken place was not
sufficiently deep to put enterprises in a sustainable position over the long run. This has been confirmed by
evidence on the deterioration of the financial discipline in the Slovak enterprise sector during 1997-99
(Table 5). Uncertainty during transition makes it difficult to discriminate between entities that face
liquidity constraints and those that face a more fundamental problem of solvency. It is also difficult to
disentangle what are the net debtor and creditor positions between enterprises and different parts of
government. However, in Slovakia it was clear that in aggregate the financial situation in the enterprise
sector had deteriorated. Profitability and return on assets fell, even though turnover rose.
The limitations of the financial market and the lack of available bank credits emphasised the need
Table 5. Selected indicators of enterprise financial performance
were turning down (Tables 6). There was a strong increase in the level of inter-enterprise arrears during
1998, and by the end of the year these amounted to a little under 20 per cent of GDP. This trend intensified
through 1999 as growth slowed and domestic demand fell sharply. An accumulation of arrears is not in
itself conclusive evidence that insolvency has increased. Firms may face a genuine liquidity constraint if
banks become too risk averse to lend; besides enterprises may face an incentive to obtain credit by late
payment if this incurs penalties at a lower rate than that at which bank loans can be obtained. Increased
inflation is also an incentive to delay payment. However, in Slovakia profits and returns in the financial
13. Banking supervision will remain with the NBS until at least 2002, though (as noted in the text) it does not have
responsibility for the new SKA. The NBS itself opposed the proposed changes in the organisation of financial
market supervision on the grounds that administrative effort and resources would be better placed in training
regulators within existing organisational boundaries. There is also an ongoing debate about whether the Ministry
will retain the power to veto changes to market rules. There is similarly a debate about how to guarantee the
Office’s independence. The Office will be responsible for supervising market participants, issuing licenses and
It is noticeable that an upturn in arrears occurred at a time when many other enterprise indicators
and non-financial sectors fell sharply in 1998. This applied as much to the private as the state-owned
sector. Turnover continued rising, but this only papered over the underlying accumulation of arrears and
Table 6. Inter-enterprise and tax arrears, 1997-99
the public sector at large. The development of arrears to the Social Insurance Agency (SIAG) and the
policy measures adopted to collect outstanding debts are evidence of the vicious circle arising from the
lack of structural reforms. The most immediate source of credit to the enterprise sector was the SIAG,
along with other government welfare insurance funds (see below). Total debts to the SIAG at the end of
1999 amounted to some SKK 43 billion. Although the SIAG has the right to commit firms to bankruptcy to
obtain payment, this option was almost never followed on the grounds that it yields little, and is not
effective as it takes too long. Instead, the SIAG negotiated directly with enterprises, in particular on the
timing of repayment. The agency is able to forgive any outstanding penalties and interest once firms have
repaid the principal owed. Indeed, given the state of Slovak enterprises, there was a widespread
expectation that the SIAG would not seek to collect interest and penalties, and firms built this expectation
into their planning. This added to the lack of incentives to financial discipline. The SIAG acknowledge that
a significant proportion of its debt may not have been collectible. It claimed, however, to have used the
ability to forgive penalties once principal has been repaid as a powerful incentive to collect at least some of
what it is owed. But the evidence does not support this. The actual amounts were small (SKK 200 million
of collections followed by SKK 40 million of forgiveness). Along with arrears in social security payments,
tax arrears also rose (Table 6). This accumulation of arrears further blunted the incentives to restructuring
in large enterprises (EBRD, 1999, ch.9)
The most problematic aspect of poor enterprise performance is that it affects the balance sheet of
were beginning to tighten their policy on enterprise arrears to government in the second half of 1999 and
on into 2000, with a corresponding increase in penalties. As an example, one of the regional electricity
distributors had become more active in using disconnection as a way to procure payment and, by contrast,
management in another was dismissed as a result of poor performance in this area. Enterprises also
reported a tougher attitude on the part of government agencies in collecting their debts. This approach
would reveal quite quickly which enterprises were fundamentally insolvent rather than just suffering a
temporary cash flow shortage. Another source of potential credit was the state railway (ZSR). Although
direct evidence of this is hard to come by, repayment terms are 15 days for freight and payment in advance
for passenger traffic; but average repayment duration at the end of 1998 comfortably exceeded three
Another reason behind the increase in inter-enterprise arrears may have been that the authorities
enterprises at the beginning of 2000, it seems likely there has also been a strong increase in insolvency.
Existing bankruptcy rules had been inadequate to deal with this problem. A previous amendment to the
bankruptcy law in 1998 did not have the expected impact. Although it simplified procedures and allowed
much greater scope for creditors and debtors to reach a settlement, it did not in practice turn bankruptcy
into a tool of restructuring. A large accumulation of bankruptcy petitions remained unprocessed during
1993-97. The situation did not improve much in the period to 1999 despite the 1998 changes, which placed
debtors under a legal obligation to declare their insolvency. Declarations increased, but only added to the
volume of outstanding cases. (Table 7).
Therefore, although there was an element of genuine liquidity constraint amongst Slovak
Table 7. Bankruptcy, 1993-99
ECO/WKP(2000)26 Download full-text
5.2 Enforcing exit mechanisms
mechanisms to promoting the conditions for enterprise creation. In this respect, the main steps taken in
Slovakia were the improvement of bankruptcy legislation, the removal of protected status for some
enterprises, and promotion of FDI. Possibly as a result of policies implemented after 1998, preliminary
data for 1999 showed that profitability picked up from its low level (Table 5), supported by the increase in
controlled prices and the growth in export revenues.
According to the framework set out in section 2, reform typically progresses from enforcing exit
5.2.1 Enhancing bankruptcy
rules, this group acquired the right to appoint the administrator and to approve restructuring plans. The
system was also simplified, principally by reducing the number of creditor rankings, which worked to
ensure that most creditors gain nothing when an enterprise is bankrupted. An important feature was the
introduction of an exact test to establish bankruptcy: non-payment of a liability after 30 days would act as a
trigger for bankruptcy. Whilst the changes left a few creditors worse off, mainly the state, it improved the
position of the majority, giving them an incentive to use the system more actively. The most important
objective was to make the system faster.
Changes to bankruptcy legislation mainly strengthened the position of creditors. Under the new
that commercial banks had a stronger incentive to use the new procedures. But this type of reform can only
take hold slowly. Judges and legal professionals have to be trained14, and participants have to learn about
the new procedures. In the particular circumstances of transition it also requires a more widespread
understanding of bankruptcy as a means to re-organise business and as a way to recover assets. These
changes will however take time to embed themselves in Slovakia’s business and governmental
environment. Although the time taken to adopt some transitional reforms may be compressed, institutional
changes of this kind take longer to become effective. But neither could time be lost. In the absence either
of new bank credit or the liquidation of insolvent enterprises, inter-enterprise arrears and arrears to the
government would just continue to rise. A feature, as described above, of Slovakia in the recent past.
These amendments were a move in the right direction. Changes in the banking sector mean also
5.2.2 Restructuring large enterprises
consensus, particularly in the case of large enterprises. The changes are difficult to implement as they
almost inevitably lead to increases in unemployment and restructuring or liquidation of firms that were at
one time regarded as ‘strategic enterprises’. Indeed these companies tend to be located in less dynamic
economic areas, meaning there is less enterprise creation to compensate for loss of employment due to
restructuring. In the past, the label ‘strategic’ was a sign that the government was convinced of an
enterprise’s future potential economic value, and wanted to buy time for gradual restructuring. Hence,
these firms were typically also those that hoped to receive supplementary funding with less pressure to
restructure. The situation was further aggravated by the previous government’s Revitalisation Act, which
created an expectation of ‘easy’ terms or forgiveness of past debts. This Act was repealed by the current
administration soon after it took office. This was an important step towards re-establishing financial
Enforcing new standards of bankruptcy demands both political will and a degree of political
14. An IBRD grant is being used to set up a training programme.