Public finances under pressure due to the public debt
In recent years, Slovakia has faced multiple crises that have negatively impacted the public budget balances, leading to a significant increase in the public debt. This rise in public debt has been one of the most rapid among all EU countries, surging from 48% of GDP at the end of 2019 to 59.6% of GDP in the middle of this year. This exceeded the maximum threshold set by the domestic debt brake, which stands at 55% of GDP for 2023. Over the last 3.5 years, only Romania, Czechia, and France have experienced more substantial increases in public debt.
High levels of public debt present a challenge, not only due to the limitations imposed by the debt brake, such as requiring a caretaker government to present a balanced budget, but also concerning the long-term sustainability of public finances. While low interest rates have helped manage debt service costs in previous years, rising interest rates are expected to gradually raise these costs. So far, they have only increased by 0.1% of GDP to 1.2% of GDP. However, the impact on debt service will depend on the debt structure and the proportion of new debt with higher interest rates.
Therefore, the new government faces the demanding task of consolidating public finances. Unlike most other EU countries, Slovakia's public budget balance did not improve this year due to various factors, including the way energy prices for households are regulated, which shifted a significant portion of subsidies from last year to this year. Additionally, the political cycle (upcoming elections) and tax reform (parental bonus) contributed to the situation aggravation. Consequently, the budget deficit in the first half of this year (seasonally adjusted) deepened to 4.5% of GDP, which is 2.8% of GDP higher than in the same period last year, making it the second most significant year-on-year increase in the EU, right after Hungary. Further deterioration of the budget balance is expected in the second half of the year. The caretaker government's budget proposal for the next year anticipated a deficit of 6.2% of this year’s GDP.
To gradually reduce public debt below the debt brake thresholds, it is necessary to consolidate the structural budget balance at a level of 0.75% to 1% of GDP annually. However, the new government coalition is considering consolidation at a rate of only 0.5% of GDP annually, which may not be sufficient to stabilize the public debt. While the first two years after the vote of confidence in the government will not be subject to sanctions under the debt brake, the government will have to address its consequences in the subsequent years.
In terms of public finance health, which is reflected in risk premiums, the yield on the 10-year Slovak government bond is currently close to 4%, making it approximately 130 bps above the level of German Bunds. Higher risk premiums in the eurozone can only be found in Italy, comparable to Greece, Latvia, Malta, or Cyprus.
Ľubomir Koršňák
Economist of UniCredit Bank
