Proposal for a COUNCIL DECISION providing macro-financial assistance for the Slovak Republic
Date: 1994-10-04
Institutions: European Commission
Subjects: Community loan, Czechoslovakia, EU aid, European Commission, International Monetary Fund, economic development

COMMISSION  OF  THE EUROPEAN  COMMUNITIES 

C0M(94) 410 final 
Brussels, 04.10.1994 

94/0219  (CNS) 

Proposal  for a 

COUNCIL DECISION 

providing macro-financial  assistance 

for the Slovak Republic 

(presented  by the Commission) 

A 

EXPLANATORY  MEMORANDUM 

1. 

SLOVAKIA'S REQUEST FOR COMMUNITY MACRO-FINANCIAL SUPPORT 

On  13  June  1994,  the  Deputy  Prime  Minister  and  the  Minister  of  Finance  of  the 
Slovak Republic, on behalf of the Slovak government,  addressed  to the Commission 
a formal request for  complementary macro-financial  assistance from the EU/G-24 in 
the amount of US$ 300 million. This additional financing is requested to complement 
the new resources that the IMF and the World Bank intend to provide to  Slovakia in 
1994 and 1995. 

The  Slovak  authorities  and the management  of the  IMF  agreed  in late May  on  the 
main elements of an economic policy programme to be implemented in the remainder 
of  1994 and in  1995. In support of this programme, the IMF Board  approved  on 22 
July  1994  a  20-month  stand-by  arrangement  in  the  amount  of  SDR  115.8  million 
(about  US$  160  million).  The  programme  will  also  be  supported  by  a  second 
purchase under the IMF's Systemic Transformation  Facility  (STF)  in the  amount  of 
SDR  64.35  million  (about  US$  89 million)  following  a first purchase  of  the  same 
amount in July  1993. 

The  World  Bank,  for  its  part,  approved  in  November  1993  a  US$  80  million 
Economic  Recovery  Loan  to  support  Slovakia's  structural  reforms  and  to  help  the 
country  overcome  the  disruptions  associated  with  the  split  of  the  CSFR.  Of  this 
amount,  US$  16 million  were  effectively  disbursed  in  May  1994.  In  addition,  the 
Slovak  authorities  are  currently  negotiating  with  the World  Bank  on  an  Enterprise 
and Financial  Sector Adjustment  Loan (EFSAL) to  assist  Slovakia  in the reform  of 
the banking sector and the restructuring of enterprises. 

The  amount  of  complementary  macro-financial  assistance  being  requested 
corresponds to the residual balance of payments "financing-gap" for the remainder of 
1994 and  1995, as estimated by the IMF staff after taking into account  existing loan 
commitments  (including  the  IMF  and  the  World  Bank  funds)  and  the  envisaged 
recourse  to  the  international  capital  markets  by  the  National  Bank  of  Slovakia 
(NBS). 

The present  proposal  of the Commission  is made as a follow  up  to  the  decision  in 
principle taken by the ECOFIN Council on  11 July  1994 to  provide  complementary 
macro-financial  assistance  to  Slovakia  in the  amount  of up  to  ECU  130  million  in 
1994/95. The Community assistance is part of an overall EU/G-24 financing  package 
in which  non-EU/G-24  countries  (mainly  Japan,  Austria  and  Switzerland)  are  also 
expected to provide some US$ 88 million in support of Slovakia. 

2.  MACRO-ECONOMIC  PERFORMANCE  AND  POLICIES  AFTER  THE  DISSOLUTION  OF 

THE CSFR 

The split of Czechoslovakia (CSFR) has so far had a worse impact on Slovakia than 
on the Czech Republic. First, the dissolution  of the federation  has put  an end to  the 
very  considerable  fiscal  transfers  that  Slovakia  used  to  receive  from  the  Czech 
Republic  through  the  federal  budget,  which  the  IMF tentatively  estimates  at  about 

7.5%  of  Slovak  GDP  in  1992.  Second,  with  the  separation  Slovakia  has  also  lost 
much  of  the  federal  government's  solid  reputation  for  orthodox  macro-economic 
policies and market-oriented reforms. This has, in turn, restricted  Slovakia's access to 
the international  capital markets. Third,  with most  federal  institutions  being  located 
in the Czech Republic and many of the better qualified  professionals  remaining in the 
newly-created  Czech  institutions,  Slovakia's  economic  policy  has  been  impaired  by 
the lack cf proper institutions and human capital. 

The termination  of the  fiscal  transfers  from  the  Czech  Republic  and  the  vulnerable 
balance of payments position that  resulted  from  the dissolution  of the CSFR  obliged 
the Slovak authorities to pursue rather restrictive macroeconomic policies.  Together 
with the série ^  disruptions in inter-republican trade caused by the split  of the CSFR 
and  weak  economic  activity  in  the  main  Western  and  Eastern  markets,  these  tight 
macroeconomic  policies  have  contributed  to  the  prolongation  of  the  Slovak 
recession.  Slovak real GDP is estimated to have declined by 4.1% in  1993, implying 
a fourth  consecutive year of recession. The unemployment  rate, for  its part,  reached 
14.2% in April  1994, up from  10.4% at end-1992. 

A restrictive fiscal policy was necessary to reduce the important general government 
deficit  that  emerged  as a result of both the loss of the Czech fiscal transfers  and the 
further  weakening  of economic  activity. Despite the adoption by  the government  in 
the  summer  of  a tough  package  of fiscal measures,  the  general  government  deficit 
reached  7,5% of GDP in  1993. Monetary policy  also had to be tight  in the first half 
and  at  the  end  of  1993  in  order  to  defend  the  country's  reserves  amid  speculation 
about a devaluation of the Slovak crown. 

Regarding exchange rate policy,  the  Slovak  authorities  devalued  the  Slovak  crown 
by  10% against  convertible  currencies last July. Furthermore, the  Slovak  crown  has 
been  devalued  by  5% within  the clearing  system established  in February  1993 with 
the Czech Republic to settle inter-republican transactions. 

The introduction and subsequent increase of the VAT in 1993 and the devaluation of 
the crown resulted  in an increase in CPI inflation from a year-on-year  rate of  12.7% 
at  end-1992  to  25.1%  at  end-1993.  Since  the  final  months  of  1993,  however, 
inflation  has  been  showing  a  decelerating  trend,  with  the  average  monthly  rate  of 
inflation falling slightly below 1%. 

Despite the weakness of domestic demand and the devaluation of the Slovak crown, 
the Slovak current account showed a deficit  of US$ 434 million (or 4.2% of GDP) in 
1993.  Slovakia is having difficulties  to finance this deficit  through inflows of private 
capital.  At  an  estimated  US$  134  million  in  1993,  net  foreign  direct  investment 
continues  to  be  of  little  significance,  and  Slovak  borrowers  have  issued  only  two 
international  bonds  since the  split  of the federation.  All this  has been  reflected  in a 
very vulnerable international reserves position. Although official  reserves have been 
increasing  in recent  months, they  still  represented  at  end-June  1994 little more than 
one month of imports. 

The  delicate  foreign  exchange  reserves  position  led  the  Slovak  authorities  to 
introduce  restrictions  on  current account  convertibility in  February  1993.  While 
these  restrictions  were  lifted  in  December  1993,  Slovakia  introduced  a  10% 
surch;  |e on imports of consumer goods in early March 1994. 

Regarding structural reforms,  after the completion  of the first wave  of large-scale 
privatization,  the  privatization  process  slowed  down  considerably.  An  increased 
emphasis on traditional privatization methods such as direct sales to foreign investors 
or  management  buy-outs  (as  opposed  to  mass-privatization  methods  such  as  the 
voucher  scheme)  was  announced  but the actual  implementation  of the programme 
was disappointing and suffered from a lack of transparency. A bankruptcy law  finally 
came  into  effect  in  June  1993,  under  which  a board  of  creditor  will  have  three 
months to work out a rehabilitation plan. In the area of financial  sector reform, the 
authorities  have  until  now  failed  to  put  into  practice  a  well-articulated  set  of 
measures to strengthen the Slovak banks' balance-sheets while increasing the degree 
of private ownership and competition within the banking sector. 

3. 

THE ECONOMIC POLICY PROGRAMME FOR THE REMAINDER  OF 1994  AND  1995 

The  major goals  of  the  programme  agreed  with  the  IMF are  a  sharp  reduction  of 
inflation,  the strengthening of the fiscal and external positions (including a substantial 
rebuilding  of foreign  exchange reserves) and  the acceleration  of the restructuring  of 
the economy. Also, the authorities are committed to removing the  10% surcharge on 
consumer  imports  introduced  in  March  1994  and  to  make  progress  towards 
achieving full  current account convertibility  so as to reach Article VIII status at the 
IMF by  1  January  1996. The exchange rate is intended to  serve as a nominal anchor 
supporting the fight  against inflation, with no devaluations being envisaged under the 
programme. 

The programme  targets  a decline  in inflation to  12% at  end-1994  and 8%  at  end-
1995. Real  GDP is expected  to  remain  roughly  unchanged  this year  and to rise by 
2% next year.  The deficit of the general government is set to decline to 4% this year 
and to  3% in  1995.  The current account deficit is projected  to  decline to  US$  300 
million  (2.5% of  GDP)  in  1994  and  to  remain  at  a  similar  level  in  1995.  Official 
foreign  exchange  reserves  are  targeted  to  increase  from  US$  650  million  (1.2 
months of imports) in mid-June to about  US$ 0.9  on (1.7 months of imports) and to 
about US$  1.4 bn (2.4 months of imports) by end~1995. 

Slovakia has complied, with the two  "prior actions" required  before  the IMF Board 
could consider the approval of the stand-by and the STF purchase. These are  1) the 
approval  by  the  Slovak  Parliament  of  amendments  to  the  laws  on  the  VAT  and 
excise taxes (the two major elements of a supplementary fiscal package designed to 
cut the  1994 budget  deficit  by  1.5  of GDP )  and 2)  the  introduction  of restrictive 
wage  regulations affecting  loss-making  enterprises  in which the  state  or holders  of 
voucher shares hold a majority stake. 

In the area of structural reform,  the government  intends to accelerate privatization 
by  supplementing  conventional  methods  with  a  second  wave  of  voucher 
privatization, to proceed with financial  sector reform and the restructuring of state-
owned enterprises and to encourage the development of the emerging private sector. 

The  second  wave  of  large-scale privatization, affecting  over  500  state  enterprises 
with an equity book value of about US$ 6.6 billion, has already been initiated. About 
40%  of  the  shares  will  be  sold  through  the  voucher  method  and  the  remainder 

through standard methods. The distribution of vouchers to citizens will be completed 
by end-September  1994 and the voucher auctions will take place in early 1995. 

Several measures are being contemplated  to strengthen the balance-sheets  of Slovak 
banks and  to  reduce  their  degree  of  state-ownership.  First,  the  National  Bank  of 
Slovakia (NBS) will introduce  in the  coming months bad  loan  classification  criteria 
and compulsory provisioning rules and provisions by commercial banks will be made 
tax-deductible.  Second,  banking supervision and regulation will be improved  on the 
basis  of the  two-year  plan  adopted  by the  NBS  in February  1994.  Third,  with  the 
financial  and technical assistance of the World Bank (in the framework of the EFSAL 
currently  under  discussion)  and  the  PHARE  programme,  the  Slovak  authorities 
intend  to  develop  restructuring  and  privatization  plans  for  the  three  largest 
commercial  banks  (VUB,  the  Slovak  Savings  Bank  and  the  Investment  and 
Development  Bank),  which  remain  under  state  control  and  together  account  for 
about  70% of all commercial loans and for  about 90% of all the deposits of Slovak 
banks. The restructuring of banks will focus on their need for recapitalization  and on 
addressing the problem of bad loans in their portfolios.  Special attention will also be 
given to  the  appropriate  restructuring  of the loss-making  enterprises  (mostly  state-
owned) against which non-performing loans are held. 

4. 

PREVIOUS MACRO-FINANCIAL ASSISTANCE TO THE CSFR 

In February  1991, the Council  (Decision  91/106/EEC) granted  an ECU  375 million 
balance of payments loan to the former  CSFR.  This assistance was also granted  in 
the context of an initiative by the G-24 to provide financial assistance  supplementary 
to that  offered  by the IMF and the World Bank.  The EC loan was disbursed  in two 
tranches, respectively in August of  1991 and February of  1992.  Commitments from 
the  non-Community  members  of  the  G-24  reached  US$  387  million  out  of  which 
US$ 362 million have been effectively  disbursed. 

Following the dissolution  of the CSFR on January  1,  1993, the Council  adopted  on 
24  January  1994  a  Decision  (94/61/EC)  allowing  for  the  division  of  the  liabilities 
related to the  1991 EC loan. The Decision  empowers the Commission  to  negotiate, 
in consultation with the Monetary Committee, the amendments to the  original Loan 
Agreements necessary to establish the separate liability of the Czech and the  Slovak 
Republic for, respectively, two thirds and one third of the loan. This operation will be 
formally concluded shortly. 

5.  THE PROPOSED NEW MACRO-FINANCIAL ASSISTANCE 

The  dissolution  of  the  CSFR  has  meant  a  new  negative  shock  for  the  Slovak 
economy  at  a time  when  it  was  still  suffering  from  the  shock  associated  with  the 
collapse of the CMEA trade system and the difficulties  accompanying the process of 
systemic transformation.  In the circumstances, and following the decision in principle 
on  the  matter  taken  by  the  ECOFIN  Council  on  11 July  1994, the  Commission  is 
proposing that  the Community grants  Slovakia  a balance  of payments  loan  of ECU 
130 million with a maximum maturity of seven years. 

By  contributing  to  ease  Slovaki;  balance  of  payments  constraint,  such  assistance 
, new  situation  created  by the  dissolution  of the 
should  help  Slovakia  adjust  to  t 

CSFR  while  putting  an  end  to  the  contraction  of  output  and  employment,  a 
contraction that would risk weakening the  support  of the  Slovak  population for  the 
macroeconomic stabilization efforts  and the structural reforms. 

The Community loan, which would complement resources made available by the IFIs 
and  other  G-24  bilateral  donors,  should  help strengthen  the official  foreign  reserves 
position to the extent  envisaged  under  the IMF programme.  As a demonstration  of 
confidence by the international community, this financial  assistance would also act as 
a catalyst for private capital inflows, including foreign direct investment. 

The  Community  loan would  be disbursed  in two  tranches,  subject  to  a  satisfactory 
track  record  of  Slovakia's  macro-economic  programme  agreed  with  the  IMF  and 
progress with respect to structural reforms,  including the observance of a number of 
performance criteria. 

As  in  the  case  of  similar  operations  in  favour  of  Central  and  Eastern  European 
countries, the Community would provide the funds through market borrowing with a 
guarantee  by  the  general  budget.  Slovakia  would  subsequently  borrow  from  the 
Community.  The  borrowing  and  lending  operations  will  be  perfectly  matched  and 
without any commercial risk for the Community. 

On the assumption that the Guarantee Fund mechanism will be in place before the 
end of the year, the budgetary implications of a decision to grant loan assistance of 
up to ECU 130 million to Slovakia would imply an ECU  18 million provisioning of 
the Fund 

é 

Proposal for a 

COUNCIL DECISION 

providing macro-financial  assistance 

for the Slovak Republic 

THE COUNCIL OF THE EUROPEAN UNION, 

Having  regard  to  the  Treaty  establishing  the  European  Community,  and  in  particular 
Article 235 thereof, 

Having  regard  to  the  proposal  of  the  Commission1  submitted  after  consulting  the 
Monetary Committee, 

Having regard to the opinion of the European Parliament2, 

Whereas  the  people  of  the  Slovak  Republic  have  close  historic  relationships  with  the 
peoples  of the  Community; whereas  that  country  has undertaken  fundamental  political 
and economic reforms and is making substantial efforts  to consolidate a market economy 
model; 

Whereas  the  Slovak  Republic  and  the  Community  signed  on  4  October  1993  an 
Association Agreement replacing the one signed between the Czech and Slovak Federal 
Republic on 14 December  1991 ; 

Whereas the  dissolution  of  the  Czech  and  Slovak  Federal  Republic  has  had  negative 
implications  for  the  Slovak  economy  at  a  time  when  it  was  still  suffering  from  the 
external  shock  associated  with  the  dismantlement  of  the  Council  of  Mutual  Economic 
Assistance trade system and from the difficulties  accompanying the transition to a market 
economy; 

Whereas the financial support of the reforms from the Community will strengthen mutual 
confidence and will bring the Slovak Republic closer to the Community; 

Whereas the Slovak Republic has agreed with the International Monetary Fund (IMF) on 
a  "stand-by  arrangement"  and  a  new  purchase  under  the  "systemic  transformation 
facility"  supporting  the  country's  economic  programme  for  1994-95;  whereas  these 
facilities were approved by the IMF Board on 22 July 1994; 

Whereas the authorities of the Slovak Republic have requested financial assistance from 
the  international  financial  institutions,  the  Community  and  other  bilateral  donors; 
whereas, over and above the estimated financing which could be provided by the IMF 
and the World Bank,  a residual financing gap  of some US$  300 million remains to  be 
covered in the remainder of 1994 and 1995 in order to strengthen the Slovak Republic's 

reserve  position  and  support  the  policy  objectives  attached  to  the  government's  reform 
effort; 

Whereas  the grant by the  Community  of  a medium-term  loan to  the  Slovak  Republic  is 
an  appropriate  measure  to  support  the  balance  of  payments  and  to  strengthen  the 
country's reserve position; 

Whereas the Community loan should be managed by the Commission; 

Whereas  the  Treaty  does  not  provide,  for  the  adoption  of  this  Decision,  powers  other 
than those of Article 235, 

HAS DECIDED AS FOLLOWS : 

Article 1 

1.  The Community shall grant to the Slovak Republic a medium-term loan facility  of a 
maximum  amount  of  ECU  130  million  in  principal  with  a  maximum  maturity  of 
seven years, with a view to ensuring a sustainable balance-of-payments situation and 
strengthening the country's reserve position. 

2.  To  this  end,  the  Commission  is  empowered  to  borrow,  on  behalf of  the  European 
Community,  the  necessary  resources  that  will  be  placed  at  the  disposal  of  the 
Slovak Republic in the form of a loan. 

3.  This  loan  will  be  managed  by  the  Commission  in  close  consultation  with  the 
Monetary  Committee  and  in  a  manner  consistent  with  any  agreement  reached 
between the IMF and the Slovak  Republic 

Article  2 

1.  The  Commission  is  empowered  to  negotiate  with  the  Slovak  authorities,  after 
consultation  with  the  Monetary  Committee,  the  economic  policy  conditions 
attached  to  the  loan.  These  conditions  shall  be  consistent  with  the  agreements 
referred to in Article  1(3). 

2.  The Commission shall verify  at regular intervals, in collaboration with the Monetary 
Committee  and in close  coordination with the IMF, that the  economic  policy  in the 
Slovak  Republic  is  in  accordance  with  the  objectives  of  this  loan  and  that  its 
conditions are being  fulfilled. 

Article  3 

1.  The  loan  shall  be  made  available  to  the  Slovak  Republic  in  two  instalments.  The 
first instalment  shall  be  released  on  the  basis  of  the  approval  of  the  the  "stand-by 
arrangement" by the Board of the IMF and subject to the provisions of Ar  "-le 2(1). 

s 
2.  The second instalment shall be released at least two quarters after the release of the 
first  instalment,  on  the  basis  of  a  satisfactory  progress  in  the  Slovak  Republic's 
application  of  the  "stand-by  arrangement"  and  subject  to  the  provisions  of 
Article 2(2). 

3.  The funds shall be paid to the National Bank of Slovakia. 

Article 4 

1.  The borrowing  and  lending operations referred  to  in Article  1 shall be  carried  out 
using  the  same  value  date  and  must  not  involve  the  Community  in  the 
transformation  of maturities, in any exchange  or interest  rate risk,  or  in  any  other 
commercial risk. 

2.  The Commission shall take the necessary steps, if the Slovak Republic so wishes, to 
ensure that  an early repayment  clause is included  in the loan terms  and  conditions 
and that it may be exercised. 

3.  At  the  request  of  the  Slovak  Republic,  and  where  circumstances  permit  an 
improvement in the interest rate on the loans, the Commission may refinance  all or 
part  of its initial borrowings  or restructure  the  corresponding financial conditions. 
Refinancing  or restructuring  operations  shall be carried  out  in accordance with  the 
conditions  set  out  in  paragraph  1 and  shall  not  have  the  effect  of  extending  the 
average maturity  of the borrowing  concerned  or increasing  the  amount,  expressed 
at the current exchange rate, of capital outstanding at the date of the refinancing  or 
restructuring. 

4.  All  related  costs  incurred  by  the  Community  in  concluding  and  carrying  out  the 

operation under this Decision shall be borne by the Slovak Republic. 

5.  The Monetary Committee shall be kept informed  of developments in the operations 

referred to in paragraphs 2 and 3 at least once a year. 

Article 5 

At least  once a year the Commission  shall address to the European  Parliament  and  to 
the  Council  a report,  which will  include  an  evaluation,  on the  implementation  of this 
Decision. 

Done at 

, 

For the Council 

The President 

FINANCIAL RECORD 

1.  Budget line concerned 

Article (...)guarantee for the Community loans to the Slovak Republic (to be created 

through an amending and/or a supplementary budget). 

2.  Referencesdegal  base) 

Article 235 of the Treaty 

3.  Classification  of the Expenditure 

Obligatory 

4.  Description and Justification for the action 

a)  Description of the action 

The  budget  entry  reflects  the  commitment  of  the  budget  guarantee  associated 

with  the  Community  loan  to  the  Slovak  Republic  designed  to  ensure  a 

sustainable  balance-of-payments  position  and  strengthening 

international 

reserves of this country. 

b)  Justification for the action 

The  viability  of  Slovakia's  external  accounts  heavily  depends  on  external  financial 

assistance from official  sources. 

5.  Nature of the expenditure and method of calculation 

a)  Nature of the expenditure 

Guarantee for the Community loan to the Slovak Republic. 

b)  Method of calculation 

A  token  entry  is  proposed  given  that  the  amount  and timing  of  any  call  on  this 

budget  line  cannot  be  calculated  in  advance  and because  it  is  expected  that  this 

budget guarantee will not be called. 

6.  Effect  of the action on intervention credits 

Only in the case of an effective call on the guarantee. 

7.  Financing of intervention expenditure 

-  Endowment  of  the  line  by  transfer,  by  reutilisation  of  reimbursed  amounts 

(Article  27(3)  of  the  Financial  Regulation  of  1977),  or  by  amending  and/or 

supplementary Budget. 

-  In order to fulfil  its obligations, the Commission can provisionally ensure the debt 

service  with  funds  from  its  treasury.  In  that  case,  Article  12  of  the  Council 

Regulation (EEC, Euratom) rto. 1552/89 of 29.5.1989 will apply. 

ANNEX 

BUDGETARY  RESOURCES  NECESSARY  FOR THE PROVISIONING  OF 

THE  GUARANTEE  FUND IN  1994 AND NOTIONAL  MARGIN  UNDER  THE 

RESERVE  FOR  GUARANTEES 

(IN ECU  MILLION) 

Operations 

Basis of the 

Provisioning  of 

Calculation 

The Fund  (I) 

Reserve 

Margin 

Project  related  assistance 

EIB/CEEC 

EIB/MED 

EIB/PVDLA 

EURATOM 

Macro-financial  assistance 

Moldova 

Bulgaria 

Romania 

Algeria 

Slovakia 

765 

100(3) 

500(4) 

150 

45 

40(5) 

125 

200(6) 

130(6) 

107 

14 

70 

21 

6 

6 

18 

28 

18 

318(2) 

211 

197 

127 

106 

100 

94 

76 

48 

30 

(1)  According to the provisioning rules agreed  in the Council's common  position  of  13 

September  1993 

(2)  Reserve  amount  in  1994 under the financial  perspective 
(3) 

Including amounts of estimated  disbursements in  1993 and operations for  Cyprus 
and  Malta 
Including  amounts of estimated  disbursements in  1993 

(4) 
(5)  Commission  proposal  to increase the amount  of assistance (ECU  110 million) 

decided  in  1992 
(6)  Commission  proposal 

ISSN 0254-1475 

COM(94) 410 final 

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ISBN 92-77-80828-4 

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