VZCZCXRO0546
PP RUEHAST
DE RUEHSL #0839/01 2861507
ZNR UUUUU ZZH
P 131507Z OCT 06
FM AMEMBASSY BRATISLAVA
TO RUEHC/SECSTATE WASHDC PRIORITY 0378
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE PRIORITY
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHDC PRIORITY

UNCLAS BRATISLAVA 000839 
 
SIPDIS 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN PGOV LO
SUBJECT: SMER SURPRISES WITH MODERATE ECONOMIC POLICY 
 
REF: A. BRATISLAVA 490 
     ¶B. BRATISLAVA 457 
 
Sensitive but Unclassified 
 
¶1. (SBU) Summary - Prime Minister Robert Fico celebrated his 
first 100 days in office by getting cabinet approval for a 
budget that is in line with the Euro Maastrict criteria and 
does not alter the flat tax regime that was put in place by 
the last government.  Fear of a significant drop in the 
Slovak Crown and strong approval ratings are two of the key 
elements behind what is seen by many as a significant change 
in economic policy direction from the pre-election rhetoric. 
Despite this initial success, doubts remain about Fico's 
commitment to fiscal prudence if it conflicts with 
accomplishing his pre-election promises, the competence of 
his close economic advisors, and his overall commitment to 
maintaining a positive business environment for investors, 
especially with regard to labor policy. End Summary 
 
-- COMPETENT ADVISORS AND A SCARE BY THE CENTRAL BANK -- 
 
¶2. (SBU) Fico's appointment of Jan Pociatek, a 35-year old IT 
businessman with no previous macroeconomic or government 
experience, as Finance Minister was welcomed by the business 
community.  Although Pociatek is close to top Fico advisor 
Robert Kalinak (they are co-owners of several Bratislava 
restaurants), he is not viewed as a Fico crony.  More 
importantly, Pociatek came out as a strong supporter of the 
previous government's economic reforms and made it clear from 
the time he was appointed that he planned to maintain the 
January, 2009 target for Euro adoption.  Pociatek's deputies, 
long-time Finance Ministry official Frantisek Palko and 
businessman Peter Kazimir, are also viewed as capable 
technocrats who support maintaining the status quo in 
economic policy. 
 
¶3. (SBU) PM Fico did not commit to a position on Euro 
adoption in the pre-election campaign and attempted to keep 
all options open in his first weeks in office.  Due to 
concerns about the policy direction of the new Smer-led 
coalition, the central bank intervened by spending Euro two 
billion in the first three weeks after the election to 
support the ailing Slovak Crown.  With Fico and Pociatek 
sending contradictory signals about the governments 
intentions, Central Bank governor Ivan Sramko requested an 
urgent meeting on July 13 with the two top officials to 
advise the new government on "standard communication tools." 
According to officials that participated in this briefing, 
Sramko made careful use of charts and statistics to make a 
strong case that Slovakia faced a severe financial crisis if 
the new government did not come out with a clear and 
unequivocal economic policy.  At the press conference after 
the meeting Fico outlined his strong support for Euro 
adoption, noting that "we want to do all that is necessary, 
and we've informed the central bank governor about our plans 
for ensuring that the Euro adoption timetable is maintained." 
 
 
-- SOUND TAX AND BUDGET POLICIES -- 
 
¶4. (U) Smer marked its first 100 days in office with the 
cabinet approving a budget with a deficit ceiling of 2.9 
percent, which is below the 3 percent Euro target.  This was 
no easy feat considering that the 2007 deficit target 
includes the costs of pension reform (calculated at 1.1 
percent of GDP), which has been excluded in previous years. 
Although the budget still has to be approved by Parliament, 
Fico stated that the coalition would not accept any proposals 
that increased the fiscal deficit.  Projected deficit targets 
for 2008 and 2009 are 2.9 percent and 1.9 percent, 
respectively. 
 
¶5. (U) In order to achieve this result, Fico had to step back 
from his pre-election promises of increased social spending 
and an overhaul of the previous government's flat tax reform. 
 On the spending side, the state budget expenditure increased 
by SKK 17 billion (USD 580 million) to SKK 347 billion (USD 
11.8 billion) with only a few ministries achieving an 
increase in their budgets.  The biggest increases are for 
pensioners, healthcare, education and agriculture, while the 
ministries of defense and transportation have seen the 
sharpest declines.  The defense ministry received a nominal 
increase of 2.2 percent, which is actually a drop as a 
percentage of GDP from 1.7 percent to 1.6 percent. 
 
¶6. (U) The budget projects revenues of SKK 308 billion (USD 
10.5 billion) for 2007, an increase of SKK 35 billion (USD 
1.2 billion) over 2006.  This increase is based on strong 
economic growth, which is forecast at 7.1 percent for next 
year, a 10 percent across-the-board cut in adjusted state 
expeditures, a new excise tax on tobacco, and dividends from 
state-owned companies.  Prior to the election Fico had spoken 
about several possible changes to the tax code including the 
introduction of a dividends tax, launching of a special tax 
on natural monopolies and highly profitable companies, and 
reintroduction of a progressive income tax.  These would have 
helped offset decreased revenues from a reduction in the 
value-added tax (VAT) for medicines, medical supplies, food 
and books (See Reftel A.) 
 
-- MISMATCH BETWEEN PROMISES AND REALITY -- 
 
¶7. In the end there is little is common between what was 
promised and the government's final tax proposal. The 
government has maintained the flat tax model and none of the 
proposed "new taxes" have been included at this time. 
Instead of introducing new taxes, the government worked 
around the margins or the current system and reigned in their 
ambitions on the VAT.  In fact, with the elimination of 
deductions for those earning more than SKK 88,500 (USD 3000) 
a month, the income tax is now more flat than it was before. 
Other changes include a reduction in the amount of the tax 
bill that corporations can assign to NGOs from two percent to 
0.5 percent, and a reduction in the amount that self-employed 
craftsman can deduct for business expenditures.  For the time 
being the VAT will be reduced to 10 percent (from 19 percent) 
for drugs and medical supplies.  To make up for the lack of 
new sources of revenue, the government has requested all 
ministries to cut administrative costs (minus costs for 
wages, energy and insurance) by 10 percent, although the 
savings from this reform will not be realized until 2008. 
 
-- BUDGET RAISES FICO'S CREDIBILITY -- 
 
¶8. (SBU) Long before the election it was clear that the fall 
budget debate would be the first true indicator of any new 
government's ability to manage the economy.  To say that Fico 
has passed this first test is an understatement.  The 
concensus among financial analysts, who generally take a 
skeptical view of Fico on economic issues, has been quite 
positive.  As an example, ING's chief economist Jan Toth 
changed his forecast of Slovakia's likelihood of adopting the 
Euro by 2009 from 35 percent to 65 percent based on the 
cabinet's approval of the budget.  Although he continued to 
encourage the government to further cut spending to help cut 
inflation, Central Bank Governor Ivan Sramko gave a positive 
assessment of the budget both in public and privately with 
the Ambassador in a meeting earlier in the week. Likewise, 
the business community has been pleasantly surprised with the 
budget developments. 
 
¶9. (U) Even the opposition recognizes that there is very 
little to criticize.  Finance State Secretary Palko was 
scheduled to participate in two separate televised debates of 
the budget in the evening on October 11th, but both were 
canceled because the opposition parties did not want to 
participate.  Former Prime Minister Dzurinda found little to 
criticize in the budget, and instead focused his attack on 
Fico's inability to fulfill his election promises. 
 
-- BUT WILL INVESTORS KEEP COMING? -- 
 
¶10. (SBU) Staying on track for Euro adoption and maintaining 
the flat tax regime are important elements for foreign 
investors.  An informal survey of companies, however, 
indicates that the key issue that companies are watching is 
what changes will be made to the labor code.  An increase in 
minimum wage by 10.1 percent to SKK 7,600 (USD 260) a month 
was generally non-controversial, but other possible changes 
that would reduce the flexibility of the labor code, 
especially the ability to hire part-time workers and to use 
employment agencies, are of greater concern.  The Labor 
Minister, Viera Tomanova, has had detailed discussions with 
trade unions and is broadly promoting a strengthening in the 
position of labor unions and contract workers, but detailed 
proposals are not expected until the spring.  The American 
Chamber of Commerce has had its requests to meet with the 
labor minister turned down.  Even the finance State 
Secretary, Peter Kazimir, has told us that he is concerned 
 
SIPDIS 
about what proposals may come from the labor ministry because 
of the lack of transparency at the ministry. 
 
¶11. (U) The economy ministry's negotiations with energy 
distributors and producers has also caused some concern about 
the risks that companies operating in Slovakia could face. 
Although it is generally agreed that final prices paid by 
consumers are relatively high compared with production costs 
in the nuclear-dominated energy sector, Economy Minister 
Jahnatek's heavy-handed approach in setting new prices is not 
seen as the ideal solution.  After failing to encourage 
energy distribution companies to accept across-the-board cuts 
of six percent, which would have been inconsistent with 
current regulatory statutes, Jahnatek submitted a legislative 
amendment to the cabinet in early October that would increase 
MOE's supervisory authority (and thereby decrease the 
regulator's independence) and expand the powers of the 
regulatory authority to include natural gas for companies and 
production prices for electricity.  Together with the 
continued rhetoric by Fico against natural monopolies and the 
cancellation of the privatization of Bratislava airport, 
these moves illustrate a trend of greater state control in 
the economy. 
 
-- COMMENT -- 
 
¶12. (SBU) Fico has shown that he can put forward a 
responsible budget proposal, but questions remain about 
whether he is a true believer in fiscal responsibility and 
Euro adoption in 2009.  So far he has been dealt a very good 
hand with strong macroeconomic fundamentals and growing 
approval ratings.  Fico's sensitivity to criticisms that his 
program does not fulfill his socialist campaign promises 
creates the greatest risk that he will not stay the course 
over the coming months and years.  What remains clear is that 
Prime Minister has the final say on key policy decisions, 
whether economic or otherwise, and that his cabinet continues 
to speak with one voice, even in budget decisions where there 
were clear winners and losers among the ministries.  End 
Comment. 
VALLEE