World Bank EU8 Quarterly Economic Report October 2004

1
World Bank EU-8Quarterly Economic ReportOctober
2004

• Thomas Laursen
• Lead Economist
• World Bank
• October 15, 2004

2
The Political Economy Background

• Changes in the political landscape continued
• New government in Poland and the Czech Republic,
  new Prime Minister in Hungary
  
• Parliamentary elections in Slovenia - shift from
  the incumbent center-left government toward the
  center-right
  
• In Lithuania the ruling coalition lost to the
  Labor Party in the first round of elections
  
• Governments busy preparing 2005 budgetslittle
  further progress on broader reforms, with
  exception of Poland, Slovakia and Czech Republic.

3
The Political Economy BackgroundSlovakia

• Voter preference for government has improved
  since start of year
  
• Government was able to push through controversial
  but much needed health care reform
  
• Also approval of new system of revenue sharing
  with local governments
  
• Slovakia leading global reformer in 2003 (World
  Bank Doing Business 2005) and now in world Top-20
  (only Lithuania in the region shares this
  achievement)
• First multi-year budget 2005-07fiscal deficit to
  reach 3 of GDP in 2006/07 consistent with Euro
  adoption 2008-09 (depending on final verdict on
  pension funds).

4
Macroeconomic Policies and Developments Output
growth EU-8

• Output growth remain robust through the second
  quarter of 2004 on the back of the ongoing
  recovery in Europe and improved competitiveness.
  
• But dynamics this year affected by stock-building
  in relation to EU accession, some signs that
  activity is becoming somewhat less buoyant.

5
Macroeconomic Policies and Developments Output
growth Slovakia

• Robust output growth continued
• Real GDP growth steady at 5 ½ y/y in Q2-2004
• Growth driven by investment and consumption while
  net exports contribute negatively
  
• Agriculture and industry most dynamic sectors
• Unemployment declining slowly, but remains high
  (18.5 in Q2-2005 according to LFS)
  
• Significant uncertainty about poverty data

6
Macroeconomic Policies and Developments Inflation
EU 8

• Stabilizes following the jump in the level
  related to EU accession. Should ease as the
  impact of one-off factors fades, and tighter
  monetary conditions feed through.
• Unemployment high in several countries in the
  region, wage pressures moderate - rapid closing
  of output gaps, emerging bottlenecks in some
  labor markets, and risks of further increases in
  oil and other commodity prices suggests that
  monetary authorities need to remain vigilant.

7
Macroeconomic Policies and Developments
Inflation Slovakia

• Headline inflation stabilized (6.7 in
  September)
  
• Core inflation moderate at less than 3

8
Macroeconomic Policies and Developments Fiscal
performance EU 8

• Better than expected, on the back of strong
  output and revenue growth
  
• Hungary stands out negatively
• Budget plans for next year point to some further
  consolidation where most needed (Poland and to a
  lesser extent Hungary)
  
• Little further progress in the Czech and Slovak
  Republics, budgets eased in the Baltic countries
  
  
• In view of the cyclical upturn in the region,
  stronger fiscal consolidation would have been
  warranted.

9
Macroeconomic Policies and Developments Fiscal
performance Slovakia

• Budget implementation in 2004 on trackhigher
  revenues mostly committed to increased spending
  
• Corporate tax revenues as a share of GDP
  unchanged from 2003 but lower than in 2002 (when
  adjusted for extra payments this year on 2003
  profits)
• General government deficit for the year expected
  at 3.9 of GDP (ESA95) compared to 3.6 of GDP
  in 2003

10
Macroeconomic Policies and Developments Fiscal
performance Slovakia (2)

• 2005 budget targets a general government deficit
  of 3.8 of GDP
  
• No improvement envisaged in fiscal position
  2005-06 (but losses from pension reform offset
  through savings)
  
• New budget emphasized increased spending on
  social programs and highways.

11
Macroeconomic Policies and Developments External
imbalances EU 8

• Remain worrisome in Hungary, but also sizeable in
  the Baltic countries and the Czech Republic
  although with a higher coverage by FDI
  
• Meanwhile, current account positions remain
  strong in the other EU-8 countries as exports are
  booming.

12
Special TopicCorporate Taxation and FDI in the
EU-8

• Unfair tax competition concerns in the wake of
  sizeable CIT cuts in the new member states
  
• Tax bases largely harmonized with many incentive
  schemes abandoned in the new member countries,
  several old members also moved to cut rates,
  effective tax rates remain significantly lower in
  the EU-8 countries
• But large differences between very low rates in
  the Baltic countries and Slovenia and moderate
  rates in the other countries in the region

13
Special TopicCorporate Taxation and FDI in the
EU-8 (2)

• Lower effective corporate tax rates attract FDI,
  but other factors more important(i.e. labor and
  other production costs, overall investment
  climate)
• Meanwhile, flow of capital from old to new member
  states is a natural part of the income
  convergence process, including because of low
  labor mobility from new to old member states
• EU-8 countriesin particular those that have
  already reduced statutory CIT rates to relatively
  low levelsmay well be better off easing very
  high taxes on labor than lowering further CIT
  rates. This should go along with rationalizing
  social spending.

14
Special TopicCorporate Taxation and FDI in
Slovakia

• Tax burden in Slovakia smaller than EU average
• but share of CIT in GDP similar (about 3 of GDP
  before latest rate cuts)
  
• Nominal CIT rate reduced to 19 in 2004 (compared
  to average of 31 in EU-15)
  
• Effective tax rate around 20 before latest
  reduction in nominal rate. Lower than in EU-15,
  but around average in the region
  
• Some tax holidays remain for enterprises with
  foreign capital.