As a frigid wind whips the parapets of Bratislava Castle and roils the slate waters of the Danube below, an aging tour guide holds on to his cap and recites Slovakia’s traditional litany of laments. Gesturing toward the recently restored medieval quarter of the capital, he traces with a finger the “coronation route,” the triumphal procession through the cobblestone streets of Bratislava taken by newly crowned monarchs from Hungary, who ruled over Slovakia for nine centuries until World War I.
Pointing across the river to the south, the guide indicates sites where the Nazis inflicted hideous losses on Slovak partisans. Turning north he motions toward the ugly, stone monument towering two miles away that commemorates the thousands of Russian soldiers who died liberating Slovakia from the Germans -- and imposing Soviet occupation. After detailing each calamity, the guide utters the timeworn coda, “Poor Slovakia, always forgotten by God.”
Such pessimism and self-denigration -- raised to cult level by many older Slovaks -- may finally be outdated. Over the past couple of years, Slovakia has embraced forceful economic policies that have enabled it to outshine bigger neighbors such as Poland, Hungary and the Czech Republic, which will also be joining the European Union in May. These policies include a labor code that makes it easy to fire and hire, a well-conceived pension reform, a willingness to sell off even strategic state-owned industries and, last month, the imposition of a flat tax rate of 19 percent for corporations and individuals. As the International Monetary Fund noted in an August 2003 report, “The government’s skillful economic management and commitment to reform have contributed to a major improvement in the perception of the Slovak economy abroad.”
Indeed, some politicians and economists argue that the most powerful stimulus to economic reform in the region isn’t coming from the EU but rather from tiny Slovakia. Prime Minister Mikulás Dzurinda, now six years in office, brags about the unaccustomed acclaim. “Poland’s prime minister [Leszek Miller] asked me to send him the entire plans for the reforms -- so I did,” says Dzurinda in an interview with Institutional Investor (see box). Citing the need for lower taxes and other economic measures to attract foreign investment to his own country, Senator Mirek Topolánek, a conservative opposition leader in the Czech Republic, says, “We have no choice anyway because Slovakia has already gone ahead.”
The envy of Czechs sounds especially sweet to Slovaks. When Czechoslovakia split apart in 1993, many Czechs were frankly relieved to be rid of Slovakia along with its money-losing state industries and authoritarian political leader, Vladimir Meciar, a barely reformed former Communist. Besides hounding political opponents and muzzling the media, his government scared off investment, inflated the public deficit, stifled economic growth and created widespread disaffection. Meciar’s antidemocratic antics and economic mismanagement caused Slovakia to be excluded from the North Atlantic Treaty Organization; it seemed likely to miss out on EU membership as well. Meciar was flushed out of office in the 1998 elections that gave Dzurinda and his allies 93 of the 150 seats in Parliament. Dzurinda’s coalition of four center-right parties was whittled down to 78 seats in the 2002 elections after a center-left party defected to the opposition. But despite his narrow majority, the prime minister insists many, if not most, of the 5.4 million Slovaks believe his economic reforms are urgent. “We felt we had fallen behind the rest of Europe,” says Dzurinda, who has led his country into NATO and to the verge of EU accession.
An economic turnaround is now evident. In 2002, GDP grew by 4.4 percent -- twice the rate of that in the Czech Republic -- and expanded by an estimated 4 percent in 2003. In 2002, Slovakia drew $3.7 billion in foreign direct investment -- six times more than Hungary. From 1998 to the end of 2003, foreign investment totaled an estimated $9.3 billion. A hefty share of this investment is going into auto manufacturing, an industry in which Slovakia is emerging as the regional powerhouse, much to the chagrin of Czechs, Hungarians and Poles (see box, page 70). “Slovakia is becoming the biggest recipient of FDI per capita in the region,” says Nora Szentivanyi, a London-based economist for J.P. Morgan Europe.
Slovakia shares some of its attractions for foreign investors with its neighbors: a location in the heart of Europe, wages well below the EU norm and a commitment to the economic reforms promoted by the EU and the IMF. But while other countries treat reforms -- such as reducing inflation and keeping deficits down to the 3 percent of GDP decreed at Maastricht -- as benchmarks to spur on politicians, Slovak officials speak with a capitalist zeal that recalls the heady days of globalization and emerging-markets growth in the 1990s.
“We’re not just trying to fulfill the Maastricht criteria,” says Finance Minister Ivan Miklos, the architect of the key reforms, which he advocated as head of an economic think tank before joining the government. “There is an overall strategy here to make sure everything encourages savings and investments and a faster-growing economy.”
Charges of nonegalitarianism -- leveled by the center-left Smer, or “Direction,” party, the Communists and followers of Meciar -- are brushed aside. “Whatever works is socially fair,” says Prime Minister Dzurinda. Concepts such as progressive taxation and equal social security benefits, which have their roots in Slovakia’s pre-Communist era, are dismissed as outmoded left-wing notions. “The ‘solidarity principle’ has been removed,” says Jan Tóth, chief economist at Bank ING in Bratislava.
But other, more negative practices from the bad old days appear to have survived and could undercut the government’s vision of a brave new capitalist world. Corruption remains a common complaint. “There is a continuously high public and professional perception of widespread corruption in Slovakia, and tackling it should be a priority,” the European Commission stated in its November 2003 report on Slovakia’s preparations for EU membership. Even a local business booster like Jake Slegers, executive director of the American Chamber of Commerce in the Slovak Republic, expresses serious concern. “Corruption pervades the political and business worlds, and the perception that it is widespread has had a strong negative impact on foreign investment,” says Slegers. “I’m talking about contracts that aren’t transparently bid for, bribes to avoid bureaucratic inspections -- basically, whatever you can imagine.”
Some government officials, including Dzurinda, acknowledge the problem but assert that it is prevalent in countries making the transition from Communist to free-market economies and will diminish as democratic governments take root. Other officials denounce allegations of corruption as politically motivated. “Some people are just repeating negative remarks that are hurting this country’s image,” says Economy Minister Pavol Rusko.
Those critics might risk ending up on an enemies list. Individuals who reportedly served as sources for stories published in a British magazine, Jane’s Intelligence Digest, that were critical of Slovakia’s intelligence service, the SIS, wound up on one such list, which was handed over by Dzurinda to a special prosecutor in August. The list included prominent businessmen, journalists and even ranking members of security agencies who supposedly criticized the SIS for not ridding itself of Communist-era secret police. Adding to its notoriety, the list was at least partially based on illegal wiretaps conducted by officials in the Dzurinda government.
One of the “enemies” on the list is Martin Simecka, a novelist and newspaper editor who had also been listed as an “enemy” by the Meciar government and whose father, Milan, was a famous dissident jailed during the Communist era. “This isn’t an authoritarian regime,” notes Simecka, who says he suspects his phone is still being tapped. “But not enough has been done to clean up the security agencies.” Prime Minister Dzurinda insists that the enemies list scandal has been overblown and that any remaining Communist-era officials will soon be purged from the security apparatus. But the scandal has helped his poll ratings plunge into the single digits. “People still believe in the reforms, but not in the government,” says Simecka.
AMONG THE ECONOMIC REFORMS, THE MOST talked about both at home and abroad is the 19 percent flat tax rate for corporate, personal income and value-added taxes that went into effect in January. Besides shrinking corporate taxes from 25 percent and the highest personal income tax bracket from 38 percent, the flat rate is expected to make tax collection much easier.
“This should reduce the incentives for corporations and individuals to engage in tax evasion, which is very high,” says Vladimir Zlacky, chief economist at Vseobecná Uverová Banka, Slovakia’s largest bank and part of Italy’s Intesa BCI Group. It should also pare down an internal revenue bureaucracy whose reputation for inefficiency and corruption is legendary. For advocates of the flat tax, its biggest selling point, though, was an expected boost for savings and investment -- which are also likely to increase because of the abolition of taxes on real estate transfers and on inheritances.
“Slovakia will now have one of the lowest tax rates in Europe,” says Robert Prega, Bratislava-based chief economist at Tatra Banka, a member of Austria’s RZB Group. “Poland and the Czech Republic will be under pressure to lower their corporate taxes further, and meanwhile, foreign investors will be drawn here.” In fact, Poland dropped its corporate tax rate in anticipation of Slovakia’s tax reform -- and may drop it further. Finance Minister Miklos says “the flat tax is a good story” but points out that foreign investment had already been pouring in for other reasons.
Chief among them is a skilled labor force that is cheap even by regional standards. Incomes are about half those in Poland and Hungary. Though unemployment has been dropping, it still hovers above 14 percent -- enough to prevent upward pressure on wages. The new employment code, in effect since July, loosens the labor market even more by making dismissals and hiring easier than in neighboring countries. “It gives us one of the most flexible labor markets in all of Europe,” says Miklos.
Yet another key economic shift under way is pension reform. Up until now, the pension system has operated as a state-run, debt-ridden, pay-as-you-go scheme, with all retirees receiving the same income. “Over the next three years, the system will basically reflect what a contributor puts into it,” says Bank ING economist Tóth, who follows pension reform closely. Moreover, the retirement age, which was 55 for women and 60 for men, has been raised to 62 for both sexes.
Beginning in January 2005 the state-run system will be supplemented by a second pillar -- a privately funded system administered by foreign and domestic asset management companies, including financial firms and insurers. Of the 19 percent of an employee’s income slated for pension contributions, half will go into the state-run system and the other half into the private system. Under the private system, money will be invested in three types of portfolios, ranging from a stock-heavy one more appropriate for younger contributors to a government-bond-dominated one for older people, with a more balanced mix of equities for those in between. Initially, at least, half of all funds must be invested in Slovak stocks and bonds, says Economy Minister Rusko, “because we want to strengthen the local capital markets.”
The government is spending about half the revenue from the privatization of state companies, or about $1.6 billion thus far, to help cover the transitional costs of pension reform. Privatization revenue is expected to rise sharply in the next few years because of the passage in August of yet another key economic reform. Previously, the government had to maintain at least a 51 percent interest in strategic enterprises, such as the fixed-line telephone, gas and electricity monopolies. Now up to 100 percent of those companies can be sold to the private sector.
The most closely watched prospective privatization involves electricity monopoly Slovenské Elektrárne, or SE. Slovakia has approached the sale of this strategic industry with more flexibility than its neighbors. For example, in the Czech Republic the privatization of electricity monopoly CEZ has stalled because the government was dissatisfied with the bids. “But there is no insistence by the Slovak government on a minimum price for SE,” says Peter Mitka, the Prague-based lead manager for PricewaterhouseCoopers, which has been hired as the consultant for SE’s privatization. “And most important, the government is neutral with respect to any bidder -- whether Russian, German, French or even Czech.”
Just how much of its 100 percent share in SE the government will sell and what revenue it can expect from the privatization will depend on how a deal is structured, of course. SE’s most unattractive features are its two nuclear power plants, built by the Soviet Union in the 1980s. A number of potential bidders are prohibited from acquiring nuclear assets by their own countries’ laws or by their shareholders’ insistence. So, according to Rusko, the minister in charge of privatizations, SE might be sold off either as a whole or split into one company with conventional power generators and another with nuclear plants. “If SE is privatized as a whole, then the sale could be completed by the end of 2004. If it is sold in parts, then the process would take until mid-2005,” says Rusko, who declined to speculate what the purchase price might be.
Several reasons lend urgency to the privatization of SE. It doesn’t own or operate electricity distribution companies or the national electricity grid, and it is facing increasing competition from imported electricity. “This is why SE needs a strong strategic investor that owns distribution companies,” says PricewaterhouseCooper’s Mitka. Of the three distribution companies already operating in Slovakia, one is co-owned by Germany’s E.ON, a second by RWE (also German) and a third by Electricité de France -- placing these three foreign firms among the strongest bidders for SE.
Another reason to move ahead quickly with SE’s privatization is the company’s huge debt, estimated by the government at more than $2 billion. Within the next four or five years, electricity production at SE will decline by 15 to 20 percent, partly because its aging nuclear plants will be decommissioned, and there are doubts that SE could find the capital on its own for new production capacity. “All this requires billions of dollars the Slovak state doesn’t have -- which is why a strategic investor is needed,” says Rusko.
Yet a third reason to hasten SE’s sale is to help the government reduce its debt-to-GDP ratio to the 3 percent ceiling mandated by Maastricht and thus make Slovakia eligible to join the euro zone. “Over the next four years, we will reduce our fiscal deficit from 7.2 percent of GDP to 3 percent,” vows Finance Minister Miklos. “That is a huge cut, considering we are simultaneously reducing the tax burden.” According to Miklos, overall expenditures as a share of GDP will be cut from 44.7 percent this year to 40.8 percent in 2006. This would be a lower ratio than in Poland, Hungary and the Czech Republic. But with pension reform costs amounting to almost 1 percent of GDP, Miklos concedes that adoption of the euro in Slovakia may have to be delayed by a year -- until 2009.
Some economists suggest that there is room for further reductions in government spending. “Health care is one area where cuts could be carried out,” says Anton Marcincin, a Bratislava-based economist for the World Bank. “The system is incredibly inefficient and was in arrears by about 600 million crowns [about $17.6 million] every month in 2002.” But the government already is slicing away 100 million crowns a month from health care spending, and some politicians fear that further cutbacks could lead to a popular backlash.
The wonder is that the government has encountered so little opposition as it steamrolls ahead with painful reforms. The coalition of four center-right parties barely has a working majority in Parliament -- only 78 out of 150 seats, including three fence-sitters who say they will support the coalition on a case-by-case basis. Issues such as abortion rights and the wiretapping scandal have threatened to tear the coalition asunder. “But most tensions in the government coalition have been due to noneconomic issues,” says J.P. Morgan’s Szentivanyi. “On the economic reforms all four parties strongly agree.”
At the same time, the opposition parties are even more divided than the ruling coalition. The Movement for a Democratic Slovakia, the party of authoritarian former prime minister Meciar, still holds the largest parliamentary bloc -- 36 seats. But it is in decline, having fallen from 27 percent of the popular vote in 1998 to 19.5 percent in 2002. The center-left Smer, the party with the most public support in recent opinion polls, is uncomfortable with the notion of forming a government with Meciar and rejects outright an alliance with the Communists. Smer officials offer only tepid criticism of the economic reforms. Legislator Igor Suláj, Smer’s leading economic expert, worries that pension reform will force pension savings abroad because local capital markets are too underdeveloped. He calls for public projects to provide jobs in regions where unemployment is high. And, turning to the most controversial of the economic reforms, he decries the unfairness of the flat tax rate for allegedly benefiting only the affluent, but then adds, “We would like to see the flat tax rate introduced more gradually.”
Such waffling doesn’t surprise Grigorij Meseznikov, president of IVO, a Bratislava-based political think tank funded mainly by American foundations. “Most people feel there are no alternatives to the government’s economic program,” says Meseznikov. “Even politicians who say they are against the reforms would probably carry out the same programs if they were in power.”
INTERVIEW
Dzurinda: Slovakia’s marathon man
Prime Minister Mikulás Dzurinda, a 48-year-old former business lawyer and conservative legislator who has been in power since 2002, may be the only chief of government who can claim to be a marathoner. He looks like one -- short, with a thin upper body and powerful legs -- and relies on the image of a long-distance runner to convey his political determination. He is willing to endure the short-term pain of public complaints, he says, to advance the long-term goal of economic reform. Institutional Investor Contributing Editor Jonathan Kandell recently met with the prime minister at his office in a cavernous white neoclassical palace near the medieval center of Bratislava for a wide-ranging interview.
Institutional Investor: What led you to embrace such seemingly radical economic reforms as the flat tax rate?
Dzurinda: We felt we had fallen behind the rest of Europe and were looking to speed up economic development. The flat rate tax seemed a good tool to accomplish this.
What made your government believe that despite its razor-thin majority it had a mandate to move ahead with these reforms?
In the last elections the people voted in favor of the economic reforms and for joining the European Union. Also, I believe that this is one of the few places in the world where the government and the main opposition party have basically agreed on taxes.
What impact will the flat tax have on economic growth?
I think it’s a stimulus not only for big corporations but for small and medium businesses as well. Since I became prime minister six years ago, the corporate tax rate has fallen from 42 percent to 19 percent. Any business would be encouraged to invest if it could keep such a large portion of its profits.
How do you answer critics who say the flat tax is socially regressive?
Whatever works is socially fair. And I believe the flat tax will work.
What has been the reaction to Slovakia’s economic reform program among prime ministers in neighboring countries?
The Polish prime minister asked me to send him the entire plans for the reforms -- so I did. And now Poland is also moving toward a flat tax of 19 percent for corporations -- though not for individuals. The Czech Republic hasn’t shown the courage to adopt the flat tax.
The image of Slovakia has improved dramatically among Czechs, many of whom used to hold negative views about the Slovak economy and political situation. Can you envision a time when the two countries will reunite?
We cannot cross the same river twice, as the old saying goes. But we can become close friends under the same large roof known as the EU.
Recently, there has been a controversy about the phone tapping of prominent individuals by officials in the security services. Do you believe that a thorough purge or shake-up of the security apparatus is necessary?
The issue has been blown out of proportion. I don’t know whether to laugh or cry over the hysteria surrounding this case. We are a very young nation -- only a decade old -- so we are entitled to suffer childhood illnesses. But I believe that within a few months we won’t have anybody in the secret services left over from the Communist-era agencies.
The business community often cites corruption as one of its leading complaints. Are such concerns exaggerated, or is the government planning a major initiative to deal with the problem?
This is a phenomenon common to countries that have moved from Communism to a free-market economy. I have been under a great deal of pressure in parts of the media because I’ve taken steps against corruption by some business groups. But I want to ensure that international tenders for Slovak state companies will be transparent.
What do you consider your biggest disappointment thus far?
Sometimes people don’t see me the way I’d like to be perceived. The economic reforms are very difficult and influence everyday life. And of course, nobody likes pain.
What do you consider your government’s most important legacy?
Leading Slovakia to the brink of membership in the EU. I feel like a marathon runner who is just a few feet short of the finish line.
Besides its economic impact, what does Slovakia’s integration into the EU mean for you personally?
For me it’s a feeling of maximum security. I am a Slovak and a European. I remember very well what this continent has lived through. The last century created fascism and communism. I remember being unable to enroll in a university of my choice because the Communists declared my father [a schoolteacher who refused to join the party] persona non grata. So I believe the EU isn’t just about money or regulations. It is above all about security and peace.
How do you find the time to train for marathons?
I run one every year, so I only train hard when the time approaches. In 2004 I intend to enter the Boston Marathon.
AUTO INDUSTRY
Gearing up
Nothing better illustrates Slovakia’s emergence as the leading magnet for foreign investment in Central Europe than the explosive growth of its automotive industry over the past five years. Little Slovakia has outdueled the former East Germany as the site for a Volkswagen factory. It convinced French carmaker PSA Peugeot Citroën to manufacture vehicles in western Slovakia instead of expanding an existing facility in Hungary. And after pushing aside a bid by the Czech Republic, it has managed to get short-listed along with Poland as the potential recipient of South Korean automaker Hyundai Motor Co.'s first assembly plant in Europe. Whether or not Hyundai’s final decision favors Slovakia, says Economy Minister Pavol Rusko, “we have every chance to become the industrial tiger of Central Europe.”
U.S. Ambassador Ronald Weiser, who as a former businessman from Michigan ought to know something about the auto industry, envisions a new Detroit rising on the Danube. “Autos will be a major focus of this country’s economy,” he says. Volkswagen, which has invested more than $1 billion in Slovakia, is already producing 300,000 cars a year there. Virtually all are sold abroad, largely accounting for the explosive 44 percent jump in overall Slovak export revenues in 2002. Peugeot is planning an initial output of 300,000 cars when its $800 million factory opens in 2006. By the ambassador’s estimate, even if Hyundai doesn’t build its $820 million plant, Slovakia will be manufacturing a million autos a year by 2010, making the country the 12th-biggest car producer in the world.
Tailgating the auto manufacturers are the car-parts makers. Volkswagen had at first intended to supply its factory with components from Germany but soon decided that it made more economic sense to buy those parts locally -- and induced its main suppliers to set up plants. There are already five American auto-parts companies in Slovakia. The largest, Delphi Corp., opened for business in 2002 with 1,100 workers and almost tripled its labor force by the end of 2003. Johnson Controls has 1,800 Slovak employees and is expected to double its job rolls when Peugeot begins production.
Slovakia’s flat tax rate, set at a low 19 percent, will enhance its appeal. But for the foreseeable future, the country’s special attraction for the auto industry will remain its cheap, skilled labor force. Heavy industry in the region dates back to the first half of the 20th century, and after World War II, the Communists made Slovakia an Iron Curtain showcase for quality blue-collar education. Wages are one-seventh the norm for the European Union. “It will take decades before that differential disappears,” says Weiser.
The spanner in the works is Slovakia’s woefully inadequate infrastructure. Industrial boosters like to point out that the country’s location in the very center of Europe places its factories within a day’s truck drive of 300 million consumers. But much of the driving time can be spent just getting to a decent superhighway beyond Slovakia’s borders. It can take five hours to motor from Bratislava to the second-largest city, Kosice, only 140 miles to the east. “They really need to develop their highway system,” says Jake Slegers, executive director of the American Chamber of Commerce in the Slovak Republic. “It is especially hard on companies that rely on just-in-time shipments for their operations.” And lest anybody forget, “just-in-time” was a concept invented by the auto industry. -- J.K.
NIGHTLIFE
What to do in Bratislava
Bratislava has lagged behind the revival of cuisine in Central Europe’s other capitals. Locals often claim that the only good Slovak cooking to be had is at home. One notable exception is Koliba, a restaurant set on a wooded mountain overlooking Bratislava. A cynic might be put off by the animal pelts on the walls, the waiters garbed in folkloric vests and breeches and the strolling gypsy musicians. But the ambience seems as authentic as the food. Begin with a bean soup (with smoked meat, noodles, onion and parsley); then have a sheep cheese fried in flour and eggs and topped with a sour cucumber sauce. For a fish course there is carp baked in beer dough; the Pressburg chicken is sautéed and ladled with a garlicky mushroom cream sauce. For dessert try the pierogi (dumplings stuffed with walnuts, poppy seeds and jellied plums). The wine selection includes light, fruity cabernet sauvignons from the nearby Small Carpathian Mountains and a full-bodied white Tokay from southeastern Slovakia that is almost sweet enough to pass for a dessert wine. Koliba is located at Kamzikov vrch, a 15-minute drive from downtown Bratislava; telephone: 4212-5477-1764; hours: Monday-Saturday, noon to midnight, and Sunday, noon to 10:00 p.m.; dinner for two, including wine, about $80.
After a meal at Koliba, you deserve a luxury hotel like the Radisson SAS Carlton, a recently restored landmark that was featured in Architectural Digest magazine. Until World War II the Carlton was the vortex of social life in Bratislava, with a guest list that included Hans Christian Andersen, Jules Verne and Alfred Nobel. Nowadays the Mirror Bar and the Grand Ballroom have been returned to their pre-Communist splendor, with furniture, fabrics and molding that recall the 1920s. But the 168 guest rooms and suites are done in contemporary design, with all the paraphernalia that a business executive requires. Radisson SAS Carlton Hotel is located at Hviezdoslavovo nam 3; telephone: 4212-5939-0000; Web site: www.radissonsas.com; $200 to $250 for a standard single.
Diagonally across the square from the hotel is the Slovak National Theatre, a jewel box of an opera and ballet house built in neo-Renaissance style in 1886. Its quality performances and low prices ($40 for a front-row seat) draw hundreds of enthusiasts nightly from Vienna, an hour’s drive away. -- J.K.
