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Republic of Slovenia

Author(s):
International Monetary Fund
Published Date:
May 2009
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I. Context

1. The economy overheated following the adoption of the euro in 2007. After a decade of solid economic growth, Slovenia's per capita income rose to 90.8 percent of the EU average in 2008. With the adoption of the euro, inflation rose to the highest level in the Euro area, wage growth eroded competitiveness, the real exchange rate appreciated, and the current account deficit widened significantly.

Real GDP

(Annual percent change)

Source: Statistical Office.

2. The global crisis hit Slovenia in the fall of 2008 (Table 1, Figures 1 and 2). Following 5.4 percent in the first half of 2008, growth slowed to 1.4 percent in the second half of the year, with a sharp decline in the last quarter. Manufacturing and trade, and later investment, decelerated sharply. Private consumption growth moderated from the high level in 2007.

Table 1.Slovenia: Selected Economic Indicators, 2005–10(Annual percentage change, unless noted otherwise)
Projections
200520062007200820092010
Real GDP4.35.96.83.5−2.71.4
Domestic demand2.15.78.03.7−2.01.6
Private consumption2.62.95.02.20.51.2
Public consumption3.34.12.53.75.72.8
Gross capital formation0.412.517.26.1−10.81.4
Net exports (contribution to growth)2.20.1−1.5−0.2−0.2−0.2
Exports of goods and services10.612.513.83.3−4.31.5
Imports of goods and services6.612.215.73.5−3.91.8
Output gap (in percent of potential GDP)−1.21.04.24.4−1.5−3.2
Prices
GDP deflator1.62.04.14.03.00.9
Consumer prices (national definition, period average)2.52.53.65.70.51.5
HICP (period average)2.52.53.85.50.31.3
Differential with euro area average0.30.31.62.2
Core inflation (period average) 1/1.51.32.73.8
Employment and wages
Unemployment rate (in percent, ILO definition)6.56.04.94.46.26.1
Employment (Full employment basis, National accounts)−0.11.53.02.9−2.50.0
Nominal wages (all sectors)4.94.85.98.32.33.5
Real wages (all sectors)2.32.32.22.51.82.0
Unit labor cost (all sectors)0.40.42.27.62.62.1
Public finance (percent of GDP)
General government balance−1.0−0.80.3−0.3−4.2−3.7
Primary balance0.10.31.20.5−3.3−2.7
Structural balance−0.5−1.2−1.4−2.1−3.6−2.4
General government debt27.026.723.422.726.930.0
Monetary and financial indicators
Credit to the private sector23.726.534.118.0
Lending rates 2/4.94.65.26.2
Deposit rates 3/3.33.03.44.3
Government bond yield (3-year, average)3.13.74.34.2
Balance of payments (percent of GDP)
Trade balance (goods)−3.6−3.7−4.8−7.2−5.6−6.4
Current account balance−1.7−2.5−4.2−5.9−4.0−5.0
Gross official reserves (EUR billions)6,894.55,418.5723.8702.8
Gross external debt (percent of GDP, end-period)71.477.6100.8105.0112.6118.5
Nominal effective exchange rate (1995=100)65.065.166.268.2
Real effective exchange rate (1995=100, CPI-based)100.7100.8103.0113.2
Real effective exchange rate (1995=100, ULC-based)97.196.797.9100.5
Sources: Data provided by the Slovenian authorities; and IMF staff calculations and projections.

HICP: Total excl Energy, Food, Alcohol, Tobacco (NSA, 2005=100), period average.

Floating or up to one year fixed rate for new loans to enterprises over an amount of 1 million euro.

For household time deposits with maturity up to one year.

Sources: Data provided by the Slovenian authorities; and IMF staff calculations and projections.

HICP: Total excl Energy, Food, Alcohol, Tobacco (NSA, 2005=100), period average.

Floating or up to one year fixed rate for new loans to enterprises over an amount of 1 million euro.

For household time deposits with maturity up to one year.

Figure 1.Slovenia: Economic Indicators

Sources: Bank of Slovenia; Ministry of Finance; Statistical Office; and IMF staff projections.

Figure 2.Slovenia: Short-term Indicators

(Year-on-year percent change, seasonally adjusted, unless otherwise indicated)

Sources: Statistical Office of the Republic of Slovenia; European Commission; and IMF staff estimates.

Real GDP Growth

Sources: Statistical Office; Eurostat; and IMF staff projections.

Investment and Export Growth

3. The labor market lost momentum at the end of 2008 (Figure 3). Until fall 2008, employment creation was strong, especially in construction and services, with full-time employment increasing 3 percent. Nominal wage growth also accelerated to 8.3 percent in 2008, as wage agreements were implemented. However, the labor market cooled in the fall, with unemployment increasing to 4.3 percent in the last quarter.

Figure 3.Slovenia: Labor Market Indicators

Sources: Statistical Office of the Republic of Slovenia; Eurostat; WEO; and IMF staff estimates.

4. Inflation has dropped sharply since the summer (Figure 4). Reflecting a strong pass-through of fuel and food prices, inflation stood at 5.5 percent in 2008, 2.2 percentage points above Euro-area inflation. In addition, second-round effects led to a pickup in core inflation to 3.8 percent in 2008. After reaching a peak of 6.9 percent in July, inflation came down to 2.1 percent in February 2009, owing to the decline in fuel and food prices and the slowing economic activity.1

Figure 4.Slovenia: CPI Inflation and Components

(Year-on-year percent change)

Sources: Eurostat; and IMF staff estimates.

1/ Core CPI is defined as total HCPI excluding energy, food, alcohol, and tobacco.

Inflation

Sources: Eurostat; and IMF staff projections.

5. The government's budget was broadly balanced in 2008, with a positive fiscal impulse (Table 2, Figure 5). The fiscal deficit was 0.3 percent of GDP in 2008, slightly better than budgeted owing to strong revenues from direct taxes. The fiscal impulse was 0.7 percent of GDP, reflecting a deterioration in the structural balance. Public debt stayed broadly unchanged at 23 percent of GDP.

Table 2.Slovenia: Consolidated General Government Operations (cash basis), 2004–2010(Percent of GDP)
2004200520062007200820092010
AuthoritiesIMFIMF
OutturnOutturnOutturnOutturnEst.Proj.Proj.
Total revenues41.441.741.840.641.340.841.2
Tax revenues37.737.937.937.037.536.737.0
Personal income tax5.95.75.85.25.95.55.7
Corporate income tax1.92.13.03.23.42.72.7
Social security contributions13.913.913.613.313.713.713.9
Taxes on payroll and workforce1.81.81.51.20.70.10.0
Domestic taxes on goods and services13.213.613.113.112.913.713.8
VAT8.38.88.88.48.58.68.7
Excise taxes3.43.33.13.43.34.04.0
Other1.51.51.31.31.21.11.2
Taxes on international trade0.30.10.20.30.30.30.3
Taxes on property0.60.60.60.60.60.60.6
Other taxes0.10.00.00.00.00.00.0
Nontax revenues2.52.22.02.12.32.12.1
Capital revenues and grants0.50.50.70.60.50.40.4
Receipts from the EU budget0.71.11.11.01.01.61.7
Total expenditures42.742.842.640.441.645.044.9
Current expenditures38.939.238.436.137.040.140.0
Wages and social security contributions10.810.510.39.59.610.410.8
Central and local government3.73.73.63.43.63.83.9
Other public institutions7.16.86.66.16.16.76.9
Expenditure on goods and services6.66.76.76.46.87.07.0
Central and local government3.13.03.23.13.23.33.3
Other public institutions3.53.63.53.33.63.73.7
Interest payments1.41.31.21.00.91.01.2
Transfers to individuals and households5.85.85.55.05.25.75.5
Pensions10.410.410.29.79.910.410.7
Subsidies1.21.31.31.21.32.21.6
Other current transfers2.02.22.32.12.12.02.0
Capital expenditures and transfers3.83.64.24.24.65.04.9
Acquisition of capital assets2.32.32.93.33.43.63.6
Capital transfers1.41.31.31.01.21.41.3
Transfers to the EU budget0.61.00.91.01.21.21.2
General government balance−1.3−1.0−0.80.3−0.3−4.2−3.7
Primary balance−0.10.10.31.20.5−3.3−2.7
Memorandum items:
General government balance (ESA 95)−2.2−1.4−1.20.5−0.7−4.5−4.0
Structural budget balance−0.5−0.5−1.2−1.4−2.1−3.6−2.4
Structural primary balance0.80.7−0.1−0.5−1.3−2.6−1.3
General government debt27.227.026.723.422.726.930.0
Nominal GDP (millions of euro)27,07328,70431,00834,47137,12637,20338,045
Sources: Ministry of Finance; and IMF staff calculations.
Sources: Ministry of Finance; and IMF staff calculations.

Figure 5.Slovenia: Fiscal Sector

(Percent of GDP)

Sources: Ministry of Finance of the Republic of Slovenia; and IMF staff estimates.

6. Monetary conditions tightened in the fall 2008 (Figure 6). Until then, monetary conditions were loose as the decline in real interest rates more than offset the real exchange rate appreciation. However, monetary conditions tightened in the fall when the rapid decline in inflation led to an increase in real interest rates. Private credit growth also decelerated sharply.

Figure 6.Slovenia: Monetary Conditions

(Percent, unless otherwise indicated)

Sources: Bank of Slovenia; and IMF staff estimates.

1/ SITIBOR / EURIBOR three-month interest rate.

2/ Nominal three-month interest rate deflated by HCPI year-on-year percent change.

3/ Floating and up to one year initial rate fixation on loans over 1 million euro.

7. The financial sector is increasingly affected by the global crisis (Figure 7). Banks weathered relatively well the first impact of the crisis, thanks to their limited exposure to the U.S. financial system, the low level of households' indebtedness, and the financial stability measures promptly put in place by the authorities. However, equity prices have fallen sharply, following international trends, and banks' funding costs have risen with a soaring sovereign risk spread. In response to tight international liquidity, banks have partly substituted foreign financing with other sources including ECB funds and government deposits. Loans to the nonfinancial private sector have decelerated sharply and banks' profits have fallen.

Figure 7.Slovenia: High-Frequency Financial Indicators 1/

Sources: Thomson Financial/DataStream; and Bloomberg.

1/ The latest observation is as of March 18, 2009.

8. The current account deficit continued to rise, reaching 5.9 percent of GDP in 2008 (Table 3, Figure 8). The main driver was a weakening of the goods balance by about 2.4 percentage points of GDP. Export growth declined starting in the fourth quarter of 2007 in line with the deceleration of activity in trading partners. Import volumes continued to grow faster than exports because of the overheating of the economy. The current account has been financed by banks' foreign borrowing and deposits from nonresidents. Consequently, Slovenia's net external debt rose to 25.4 percent of GDP by the end of 2008.

Table 3.Slovenia: Balance of Payments, 2005–11(Millions of euros, unless otherwise noted)
Projections
2005200620072008200920102011
Current account−498−771−1,455−2,180−1,482−1,890−2,158
Trade balance, goods and services−106−158−473−959−373−687−873
Goods−1,026−1,151−1,666−2,662−2,072−2,428−2,760
Exports f.o.b.14,59917,02819,79920,27819,35919,98421,413
Imports f.o.b.−15,625−18,179−21,464−22,940−21,431−22,411−24,173
Services9209931,1931,7031,7001,7411,887
Exports3,2143,5724,2915,0645,2565,3835,811
Imports−2,294−2,580−3,098−3,362−3,556−3,642−3,924
Income, net−295−440−709−1,008−886−975−1,043
Current transfers, net−97−173−274−212−223−228−242
Capital account−114−132−52−93−33−38−29
Financial account, excl. reserves1,273−581,6252,3431,5141,9282,188
Direct investment, net−43−174−269257235252323
In Slovenia4735131,0501,2359309511,008
Abroad−516−687−1,319−978−695−699−685
Portfolio investment, net−1,313−1,443−2,265606372571564
Equity securities−560−590−717−55306965
Debt securities−754−853−1,547661342501499
Financial derivatives−10−13−216000
Other investment, net2,6401,5714,1801,4749071,1041,301
Government−27−115−43−28−34−39−45
Bank of Slovenia−2−1−45−6000
Commercial banks2,8471,9605,5541,4061,2561,3541,464
Nonbank private sector−179−273−413−382−579−522−492
Loans188479346599407486576
Household currency and deposits−263−805−802−767−781−799−847
Trade credits6636109−54−37−38−40
Other−17017−66−161−167−171−181
Net errors and omissions−473−321−258−92000
Overall balance189−1,281−140−21000
Change in official reserves (-: increase)−1891,28114021000
Memorandum items:
Current account balance (percent of GDP)−1.7−2.5−4.2−5.9−4.0−5.0−5.4
Export of goods (percent change in value)13.216.616.32.5−4.63.27.2
Import of goods (percent change in value)12.416.418.17.0−6.84.67.9
Terms of trade (percent change)−2.4−0.40.2−2.03.2−1.10.1
Gross external debt20,49624,06734,75238,99741,87645,07348,559
(percent of GDP)71.477.6100.8105.0112.6118.5120.5
Net external debt (liabilities - assets) 1/922.03394.06198.09442.010690.812296.814096.6
(percent of GDP)3.210.918.025.428.732.335.0

A negative number indicates net creditor position.

A negative number indicates net creditor position.

Figure 8.Slovenia: External Sector Developments

Sources: Bank of Slovenia; European Central Bank; Direction of Trade Statistics; and IMF staff estimates.

Current Account Balance

(Percent of GDP)

Sources: Statistical Office; and IMF staff projections.

9. Slovenia's competitive position has deteriorated in the past two years. Fundamental determinants of saving and investment suggest that the equilibrium current account deficit for Slovenia is around 2–2.5 percent, the actual level observed in 2004–06.2 While the significant deterioration in the current account since 2006 included some temporary components (the oil price hikes), the overheating of the economy led to second-round effects and a deterioration of competitiveness. Unit labor costs grew by 2.2 percent in 2007 and 7.6 percent in 2008. Hence, both the CPI-based and ULC-based real effective exchange rates have undergone an appreciation in the order of 5 percent. Using the three CGER methodologies, staff estimates that the competitiveness gap is 6 to 9 percent. The lagging competitiveness also reflects a lack of technological upgrading and the catch-up of regional competitors with resulting stagnating market shares over the past few years.3

II. Policy Discussions

10. The policy discussion focused on the outlook, the policy responses to the crisis, the medium-term challenges of competitiveness and structural reforms, and the sustainability of the pension system. In the past, the authorities have broadly followed staff's recommendations, although less so in the areas of fiscal policy and structural reforms (Box 1).

Box 1:Effectiveness of Fund Surveillance

Past Policy AdvicePolicy Outcomes
Fiscal Policy
  • Fiscal stance in 2008-09 should be neutral to reduce overheating risk

  • Front-loaded consolidation with cuts in non-discretionary spending and pension reform when times are still good

  • Improve expenditure efficiency with performance budgeting

  • Undertake up-front substantive pension reform to increase retirement age and/or cut benefits

  • Thanks to buoyant growth, the fiscal outcomes in 2007-08 over-performed the budget but fiscal stance was positive, contributing to the overheating.

  • Some consolidation happened but political support for reducing mandatory expenditures was limited.

  • The MoF is making some progress toward performance budgeting.

  • The authorities are considering options to improve retirement incentives without, however, changing the basic parameters.

  • The authorities regard more systemic reforms to be politically infeasible.

Monetary Policy and Financial Sector
  • Rapid implementation of the government's plans for bank privatization and support the listing of large banks and insurance companies in the stock exchange

  • Reinforce risk assessments with stress tests and cooperation with foreign supervisors

  • State control of the largest bank has been maintained as there were no good opportunities for privatization.

  • Partial privatization of the second largest bank.

  • Bank specific stress tests were implemented under the Capital Requirements Directives (CRD). The BoS signed Memoranda of Understanding with foreign banking supervisors.

Labor and Product Markets
  • Increase labor market flexibility by reducing high costs of hiring and firing

  • Improve the business climate by a “one-stop shop”

  • Continue to privatize state companies

  • Unemployment benefits have been tied to active labor market policies.

  • Increased work incentives for high income earners by elimination of payroll tax.

  • “One-stop shop” has been implemented.

  • The privatization program has slowed down.

A. Outlook

11. The authorities and staff concurred that the economy will experience a recession in 2009. Staff projects that output will contract by 2.7 percent in 2009 following the sharp decline in the last quarter of 2008 (Table 6). The main factors driving the downturn are the deceleration of exports, as the Euro zone is in recession, and of investment, as credit conditions tighten and exports decelerate. Through production linkages, Slovenia's export industry is particularly sensitive to the cycle of the automotive industry. Private consumption should be more resilient because of the recent wage increases and the strong net asset position of the households (Box 2). Staff revised sharply downward the projections during the mission as the negative news on the last quarter of 2008 became known. In light of the new data, the authorities also revised their projections with the Bank of Slovenia (BoS) forecasting a contraction of 2 percent and the Ministry of Finance (MoF) expecting a more pessimistic contraction of 4 percent, on the account of lower employment, consumption, and investment.

Table 4.Slovenia: Banking Sector Soundness Indicators, 2004–08(Percent, end of period)
20042005200620072008
Capital adequacy
Regulatory capital to risk-weighted assets11.810.511.111.210.5 1/
Regulatory Tier 1 capital to risk-weighted assets9.08.99.48.98.5 1/
Capital (net worth) to assets8.18.58.48.48.4
Asset quality
Nonperforming assets to classified claims3.02.92.51.81.6 1/
Large exposures to capital196.2226.2222.9217.4201.6 1/
Earnings and profitability
Net interest margin to average interest bearing assets2.92.62.42.32.2
Operating expenses to average assets2.72.52.22.01.7
Return on average assets (before tax)1.01.01.31.40.7
Return on average equity (before tax)12.513.815.116.39.0
Liquidity
Average liquid assets to average total assets5.34.84.53.63.0
Average liquid assets to average short-term deposits9.689.519.728.47.4
Foreign exchange risk
Foreign currency-denominated loans to total loans38.648.755.96.46.4
Foreign currency-denominated liabilities to total liabilities44.549.453.35.96.1
Market risk
Assets with maturity of more than 1 year (percent of total loans to non-bank sector)34.132.333.435.137.0
Liabilities with maturity of less than 3 months (percent of total liabilities to non-bank sector)64.566.968.266.357.1
Memorandum item:
Ownership of banking sector (percent of equity capital)
Nonresidents32.334.937.737.738.1
Central government19.118.217.415.117.7
Other domestic entities48.646.944.647.244.2
Source: Bank of Slovenia.

Figures refer to Q3.

Source: Bank of Slovenia.

Figures refer to Q3.

Table 5.Slovenia: Vulnerability Indicators, 2003–08(Percent of GDP, unless otherwise indicated)
200320042005200620072008
Financial Indicators (end of period)
General government debt28.527.227.026.723.421.9
Domestic credit52.559.868.176.687.892.0
Private sector credit (percent change) 1/2/15.420.323.726.534.118.0
Foreign exchange deposits (in billions of euros) 2/4.35.05.35.70.50.4
Banks' nonperforming loans (percent of total gross loans)3.73.02.92.51.81.6
Capital adequacy ratio11.511.810.511.111.210.5
Financial Market Indicators (end of period)
Stock market index3,9324,9044,6306,38311,3703,696
Stock market capitalization28.532.734.250.057.322.8
Foreign currency debt rating (S&P, long-term)A+AA-AA-AAAAAA
External Indicators
Exports of goods and services (percent change, value in euros)2.713.213.315.716.95.2
Imports of goods and services (percent change, value in euros)5.515.511.715.918.37.1
Current account balance−0.8−2.7−1.7−2.5−4.2−5.9
Capital and financial account balance, excl. reserve assets1.21.64.0−0.64.66.1
Of which: Inward portfolio investment−0.10.10.22.23.11.7
Inward foreign direct investment1.12.51.61.73.03.3
Other investment, net3.43.59.25.112.14.0
Net foreign assets of commercial banks (in billions of euros) 2/−1.6−2.7−5.1−6.1−6.5−8.6
Short-term foreign assets of commercial banks (in billions of euros)1.31.31.82.04.23.5
Short-term foreign liabilities of commercial banks (in billions of euros)0.60.61.51.63.13.6
Foreign currency exposure of commercial banks (in billions of euros) 2/−8.0−9.9−13.9−16.8−16.7−18.3
Gross official reserves (in billions of euros)6.96.56.95.40.70.7
Gross official reserves (in months of imports of goods and services)5.94.94.63.10.40.3
Net international reserves (in billions of euros)4.44.25.34.90.70.6
Total external debt51.456.571.477.6100.8105.0
Of which: Public and publicly guaranteed14.113.813.214.023.524.6
Total external debt (in percent of exports of goods and services)95.397.6115.1116.8144.3153.9
Total external debt service payments (in percent of exports of goods and services)14.612.714.417.4
External interest payment (in percent of exports of goods and services)2.92.62.73.14.25.3
External amortization payments (in percent of exports of goods and services)12.610.912.514.9
REER (CPI-based, period-average basis, an increase indicates appreciation)3.60.1−0.90.12.12.5
Sources: Data provided by the Slovene authorities; Bloomberg; and IMF staff calculations.

Credit including loans and other claims.

Series present a structural break in 2004.

Sources: Data provided by the Slovene authorities; Bloomberg; and IMF staff calculations.

Credit including loans and other claims.

Series present a structural break in 2004.

Table 6.Slovenia: Macroeconomic Framework, 2006–14
Projections
200620072008200920102011201220132014
Real GDP (percent change)5.96.83.5−2.71.43.73.73.73.5
Contribution
Domestic demand5.78.23.8−2.41.64.14.04.03.9
Private consumption1.62.71.10.20.61.61.71.71.6
Government consumption0.70.50.61.00.50.70.50.50.4
Gross investment3.55.12.0−3.60.41.81.81.81.9
Net foreign demand0.1−1.5−0.2−0.2−0.2−0.4−0.3−0.3−0.3
Exports of goods and services8.29.62.5−3.21.13.64.64.94.9
Imports of goods and services−8.1−11.1−2.73.0−1.3−4.0−4.9−5.2−5.2
Output gap (in percent of potential)1.04.24.4−1.5−3.2−2.5−1.7−0.9−0.2
Growth rates
Domestic demand5.78.03.7−2.01.64.03.93.83.7
Consumption3.24.42.61.81.63.23.13.02.8
Government4.12.53.75.72.83.92.42.42.4
Non-government2.95.02.20.51.23.03.33.23.0
Gross capital formation12.517.26.1−10.81.45.85.85.75.8
Fixed investment10.311.96.2−12.21.66.76.66.56.5
Change in stocks (contribution to GDP growth)0.81.80.20.00.00.00.00.00.0
Exports of goods and services12.513.83.3−4.31.54.96.26.56.3
Imports of goods and services12.215.73.5−3.91.85.26.36.66.4
Savings and investment (percent of GDP)
National saving26.227.226.424.924.124.325.025.726.3
Government3.44.54.30.71.21.41.82.12.3
Non-government22.822.722.024.222.923.023.123.524.1
Gross capital formation28.731.432.228.929.129.730.330.931.5
Government 1/2.93.33.43.63.63.63.53.53.4
Non-government25.828.228.925.325.426.126.727.428.1
Foreign saving−2.5−4.2−5.9−4.0−5.0−5.4−5.3−5.2−5.2
Prices
Consumer price inflation2.53.65.70.51.52.32.52.73.0
GDP deflator2.04.14.03.00.92.12.42.73.0
Employment (percent change)1.53.02.9−2.50.01.00.90.70.5
Unemployment rate (ILO, percent)6.04.94.46.26.15.95.75.65.5
Real wages (percent change)2.32.22.51.82.02.92.72.82.8
Government budget (percent of GDP)
Revenue41.840.641.340.841.241.441.541.641.6
Expenditure42.640.441.645.044.944.944.544.244.1
General government balance−0.80.3−0.3−4.2−3.7−3.5−3.0−2.6−2.4
Structural government balance−1.2−1.4−2.1−3.6−2.4−2.4−2.2−2.2−2.4
Merchandise trade (percent change)
Export volume13.413.11.0−5.31.74.75.86.15.8
Import volume12.715.13.4−4.61.95.36.46.76.5
Export value16.616.32.5−4.63.27.28.58.98.9
Import value16.318.17.0−6.84.67.99.19.49.6
External balances (in billions of euros)
Trade balance−1.2−1.7−2.7−2.1−2.4−2.8−3.1−3.6−4.1
In percent of GDP−3.7−4.8−7.2−5.6−6.4−6.8−7.3−7.8−8.3
Exports of goods17.019.820.319.420.021.423.225.327.6
Imports of goods18.221.522.921.422.424.226.428.931.6
Current account−0.8−1.5−2.2−1.5−1.9−2.2−2.3−2.4−2.5
In percent of GDP−2.5−4.2−5.9−4.0−5.0−5.4−5.3−5.2−5.2
Sources: Data provided by the authorities; and IMF staff projections.

Government capital transfers are not included in government investment.

Sources: Data provided by the authorities; and IMF staff projections.

Government capital transfers are not included in government investment.

Table 7.Slovenia: External Debt Sustainability Framework, 2004–2014(In percent of GDP, unless otherwise indicated)
ActualProjections
20042005200620072008200920102011201220132014Debt-stabilizing non-interest current account 6/
1Baseline: Gross External debt56.571.477.6100.8105.0112.6118.5120.5121.3121.9122.3−4.9
2Change in external debt5.114.96.223.24.27.55.92.00.90.60.4
3Identified external debt-creating flows (4+8+9)0.00.8−0.4−0.7−1.93.01.6−2.3−3.2−3.5−3.8
4Current account deficit, excluding interest payments1.10.10.41.32.20.41.11.41.31.11.0
5Deficit in balance of goods and services1.20.40.51.42.61.01.82.22.32.52.6
6Exports57.962.166.469.968.366.266.767.569.271.173.1
7Imports59.062.466.971.370.867.268.569.771.573.675.7
8Net non-debt creating capital inflows (negative)0.02.12.52.9−0.5−0.7−0.8−1.0−1.4−1.4−1.4
9Automatic debt dynamics 1/−1.2−1.4−3.3−4.9−3.63.31.3−2.7−3.1−3.2−3.4
10Contribution from nominal interest rate1.51.72.12.93.63.63.83.94.04.14.2
11Contribution from real GDP growth−2.1−2.3−3.9−4.7−3.32.8−1.5−4.2−4.2−4.2−4.1
12Contribution from price and exchange rate changes 2/−0.6−0.7−1.4−3.1
13Residual, incl. change in gross foreign assets (2-3) 3/5.114.16.623.96.14.54.34.34.14.24.2
External debt-to-exports ratio (in percent)97.6115.1116.8144.3153.9170.1177.7178.4175.3171.4167.3
Gross external financing need (in billions of Euros) 4/4.95.48.410.317.518.315.917.218.319.520.8
in percent of GDP18.018.727.029.847.149.141.942.642.842.842.7
Scenario with key variables at their historical averages 5/112.6113.7114.8115.7116.6117.5−3.4
Baseline: Net external debt−3.23.210.918.025.428.732.335.037.038.840.5
Key Macroeconomic Assumptions Underlying Baseline
Real GDP growth (in percent)4.34.35.96.83.5−2.71.43.73.73.73.5
GDP deflator in Euros (change in percent)1.11.32.04.14.03.00.92.12.42.73.0
Nominal external interest rate (in percent)3.13.13.14.23.93.43.53.53.63.63.6
Growth of exports (Euro terms, in percent)13.213.315.716.95.2−2.93.17.38.99.49.5
Growth of imports (Euro terms, in percent)15.511.715.918.37.1−5.04.37.89.19.59.7
Current account balance, excluding interest payments−1.1−0.1−0.4−1.3−2.2−0.4−1.1−1.4−1.3−1.1−1.0
Net non-debt creating capital inflows0.0−2.1−2.5−2.90.50.70.81.01.41.41.4

Derived as [r - g - (1+g) + (1+r)]/(1+g++g) times previous period debt stock, with r = nominal effective interest rate on external debt; = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, = nominal appreciation (increase in dollar value of domestic currency), and = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-(1+g) + (1+r)]/(1+g++g) times previous period debt stock. increases with an appreciating domestic currency (0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; Euro deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, Euro deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Derived as [r - g - (1+g) + (1+r)]/(1+g++g) times previous period debt stock, with r = nominal effective interest rate on external debt; = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, = nominal appreciation (increase in dollar value of domestic currency), and = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-(1+g) + (1+r)]/(1+g++g) times previous period debt stock. increases with an appreciating domestic currency (0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; Euro deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, Euro deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Table 8.Slovenia: Public Sector Debt Sustainability Framework, 2004–2014(Percent of GDP, unless otherwise indicated)
ActualProjections
20042005200620072008200920102011201220132014Debt-stabilizing primary balance 9/
Baseline: Public sector debt 1/27.227.026.723.422.726.930.031.732.733.233.5−0.7
o/w foreign-currency denominated12.19.38.30.10.10.10.10.10.10.10.1
Change in public sector debt−0.3−0.2−0.3−3.3−0.74.23.11.71.00.50.2
Identified debt-creating flows (4+7+12)0.20.1−0.7−3.1−1.44.23.21.81.10.60.4
Primary deficit−0.1−0.3−0.4−1.3−0.63.22.62.31.71.31.1
Revenue and grants41.441.741.840.641.340.841.241.441.541.641.6
Primary (noninterest) expenditure41.341.541.439.340.744.043.843.743.242.942.7
Automatic debt dynamics 2/−0.3−0.2−0.8−2.3−0.81.00.6−0.5−0.6−0.7−0.7
Contribution from interest rate/growth differential 3/−0.6−0.2−0.8−1.6−0.81.00.6−0.5−0.6−0.7−0.7
Of which contribution from real interest rate0.50.90.70.00.00.30.90.60.50.50.4
Of which contribution from real GDP growth−1.1−1.1−1.5−1.6−0.80.6−0.4−1.1−1.1−1.1−1.1
Contribution from exchange rate depreciation 4/0.30.00.0−0.60.0
Other identified debt-creating flows0.60.60.50.40.00.00.00.00.00.00.0
Privatization receipts (negative)−0.10.00.00.00.00.00.00.00.00.00.0
Recognition of implicit or contingent liabilities0.10.00.10.00.00.00.00.00.00.00.0
Other (specify, e.g. bank recapitalization)0.60.60.40.40.00.00.00.00.00.00.0
Residual, including asset changes (2-3) 5/−0.5−0.30.4−0.20.70.00.0−0.1−0.1−0.1−0.1
Public sector debt-to-revenue ratio 1/65.764.864.057.655.065.972.976.678.879.980.4
Gross financing need 6/5.58.25.83.85.47.19.07.45.06.96.6
in billions of U.S. dollars1.92.92.21.83.03.54.53.92.84.24.3
Scenario with key variables at their historical averages 7/26.925.524.122.721.320.0−0.7
Scenario with no policy change (constant primary balance) in 2009-201426.930.733.335.838.240.5−0.9
Key Macroeconomic and Fiscal Assumptions Underlying Baseline
Real GDP growth (in percent)4.34.35.96.83.5−2.71.43.73.73.73.5
Average nominal interest rate on public debt (in percent) 8/5.65.14.94.34.24.44.44.44.34.34.3
Average real interest rate (nominal rate minus change in GDP deflator, in percent)2.23.52.80.20.11.43.52.21.91.61.3
Nominal appreciation (increase in US dollar value of local currency, in percent)−2.2−0.30.09.27.4
Inflation rate (GDP deflator, in percent)3.41.62.04.14.03.00.92.12.42.73.0
Growth of real primary spending (deflated by GDP deflator, in percent)5.14.95.71.57.15.40.83.52.63.03.1
Primary deficit−0.1−0.3−0.4−1.3−0.63.22.62.31.71.31.1

Gross debt of the general government.

Derived as [(r - 8(1+g)8 - g + 8(1+r8]/(1+g+8+g8)) times previous period debt ratio, with r = interest rate; 8 = growth rate of GDP deflator; g = real GDP growth rate; 8 = share of foreign-currency denominated debt; and 8 = nominal exchange rate depreciation (measured by increase in local currency value of Euro before 2007 and of U.S. dollar in 2007 and beyond).

The real interest rate contribution is derived from the denominator in footnote 2/ as r - π (1+g) and the real growth contribution as - g.

The exchange rate contribution is derived from the numerator in footnote 2/ as 8(1+r).

For projections, this line includes exchange rate changes.

Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.

Derived as nominal interest expenditure divided by previous period debt stock.

Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

Gross debt of the general government.

Derived as [(r - 8(1+g)8 - g + 8(1+r8]/(1+g+8+g8)) times previous period debt ratio, with r = interest rate; 8 = growth rate of GDP deflator; g = real GDP growth rate; 8 = share of foreign-currency denominated debt; and 8 = nominal exchange rate depreciation (measured by increase in local currency value of Euro before 2007 and of U.S. dollar in 2007 and beyond).

The real interest rate contribution is derived from the denominator in footnote 2/ as r - π (1+g) and the real growth contribution as - g.

The exchange rate contribution is derived from the numerator in footnote 2/ as 8(1+r).

For projections, this line includes exchange rate changes.

Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.

Derived as nominal interest expenditure divided by previous period debt stock.

Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

Box 2:Sectoral Balance Sheets

Sectoral balance sheet analysis suggests that Slovenian corporates have large net financial liabilities. Moreover, domestic banks' exposure to the rest of world is significant and increasing, exposing them to contagion in the international financial market. However, households are in a strong position with small liabilities vis-à-vis the other sectors of the economy.

Inter-Sector Financial Claims and Liabilities 1/(% of GDP, end of September 2008)
Claims
Domestic sectorsRest of the worldTotal Liabilities
LiabilitiesCorporatesFinancial sectorGovernmentHouseholdsTotal
Corporates72.873.524.230.3200.842.2243.0
Of which:
Loans9.063.30.82.275.312.4
Equity39.07.818.923.589.116.1
Financial sector18.926.412.653.1111.077.2188.1
Government6.010.814.12.032.911.544.4
Households3.725.50.80.030.00.030.0
Total101.5136.351.985.4375.0130.9505.9
Rest of the world28.154.82.116.0101.1101.1
Total claims129.6191.154.0101.4476.1130.9606.9
Source: Bank of Slovenia.

The columns refer to creditors.

Source: Bank of Slovenia.

The columns refer to creditors.

12. Inflation and the current account deficit are projected to moderate. With the output gap projected to turn negative and world commodity prices declining, inflation is expected to slow to about 0.5 percent in 2009 and 1.5 in 2010. The current account will benefit from the decline in commodity prices and the slowdown in imports as aggregate demand decelerates. However, recent devaluation in neighboring countries will increase competition in the Slovenia's traditional export markets. Debt sustainability analysis suggests that Slovenia's external debt will continue to rise in the medium term. To prevent the current account deficit from staying above 5 percent of GDP in the medium term, wage moderation and strong productivity gains are necessary.

Exports, 2008

(percent of total)

Sources: Bank of Slovenia; and Direction of Trade Statistics.

Net International Investment Position, 2007

(percent of GDP)

13. The authorities and staff agreed that risks to growth and the current account are on the downside, while risks to inflation are on the upside. International spillovers will transmit through Slovenia's tight trade integration with Europe, as well as the banking system. The main downward risks to growth are lower-than-projected growth in Europe, and a credit crunch in the event that foreign financing dries up. Private consumption could prove to be less resilient than projected as a consequence of a weaker labor market. Finally, a failure to stem the fast wage growth observed in 2008 would lead to a persistent inflation differential with Euro-area countries, and a further deterioration in competitiveness and the current account.

B. Financial Sector

14. Slovenia's banks have so far withstood the global crisis relatively well. The banks are well capitalized, the level of nonperforming loans is still low, and banks are well provisioned owing to prudent regulation (Figure 9, Table 4). Foreign ownership is relatively low. Acting together with other European countries, the authorities responded promptly to the turmoil with a set of financial measures (Box 3).

Figure 9.Slovenia: Financial Soundness Indicators, 2007 1/

(Percent)

Sources: IMF, Global Financial Stability Report; and Bank of Slovenia.

1/ NMS includes: Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, and Slovak Republic.

Box 3:Financial Measures in Response to the Crisis

  • Unlimited guarantee for all deposits by individuals and small enterprises until end-2010;

  • the provision of up to €12 billion in guarantees on new debt issuance by financial institutions until end-2010, which is estimated to cover all banks' foreign refinancing needs for the next two years;

  • amendments to the Public Finance Act to empower the government to lend and provide guarantees to financial institutions, recapitalize banks, and purchase bank assets;

  • the issuance of treasury bonds in the amount of €1 billion in January, which were temporarily deposited with the domestic banking system; and

  • the announcement of €1.2 billion government guarantees for loans to nonfinancial companies.

15. The international credit squeeze has considerably increased the banks' vulnerability on the liability side. Foreign financing, at about one third of banks' total liabilities, of which almost one third is short term, is much higher than in other EU banks. However, the BoS and staff agreed that banks have maintained adequate liquid assets to cover their liabilities and could borrow more from the ECB. More pressing is a shortage of longer-term funding for the financing of loans. The authorities have put in place a contingency plan, including providing government guarantees for interbank loans, increasing government deposits in the banking system, and possibly repatriating part of BoS's foreign assets. The staff assessed these measures to be adequate to cover the banks' immediate funding needs but cautioned that additional public resources may be necessary if the international liquidity squeeze continues.

16. On the asset side, rapid credit growth in the past few years and the severe economic downturn have also increased banks' credit risk. Household debt, at around 30 percent of GDP, is much lower than the Euro-area average, and there is little sign of a housing price bubble (Figure 10).4 However, the level of corporate debt (87.5 percent of GDP in 2008) has approached the Euro-area average. Loan concentration is high. Corporate vulnerability indicators do not compare well with peers (see table).

Figure 10.Bank Credit to Households and Nonfinancial Corporations in European Emerging Markets, 2007

Sources: Eurostat; European Central Bank; and IMF staff estimates.

1/ Credit figures include domestic and foreign loans. For EMU, loans to enterprises include loans to domestic and (other) Euro area countries.

Indicators of Corporate Vulnerabilities, 2007
CzechEuro zoneGreeceHungaryPortugalSlovenia
Debt-to-assets ratio, in percent14.024.427.717.041.229.6
Interest coverage ratio65.019.021.935.43.76.6
Return on assets5.95.06.68.55.28.0
Price to earning ratio13.814.912.914.716.823.2
Source: Corporate Vulnerabilities Database.
Source: Corporate Vulnerabilities Database.

So far, the debt service burden is low but nonperforming loans are likely to increase as the recession deepens. In addition:

  • Some recent leveraged management buyouts could result in defaults as the value of the collateral has plummeted. The largest group in trouble owes about €800 million (2.5 percent of total private sector loans). According to the BoS's stress tests, the banking system's capital adequacy is not at risk. As a precautionary measure, the BoS has raised the provision requirement for such exposures. However, a failure to restructure quickly the liabilities of this group could result in the largest bankruptcy in Slovenia in recent history. While no formal rule appears to have been violated, enhanced supervisory practices are called for.

  • Possible deterioration of credit made abroad, especially to the Balkans, is another source of vulnerability. Loans abroad expanded rapidly in recent years but decelerated sharply in 2008, reaching close to 9 percent of total loans to the nonbanking sector by end-2008.

17. The authorities and staff agreed on the need to strengthen the monitoring of credit risk. In the staff's view, updated bank-by-bank stress tests are necessary to gauge the impact of potentially higher nonperforming loans on banks' capital needs, and the government should maintain a contingency plan for bank recapitalization. Banks should be encouraged to maintain precautionary capital buffers against worsening of the portfolio quality. The authorities should step up coordination with foreign supervisors to monitor potential regional spillovers. The BoS concurred with staff on the vulnerabilities and stressed that many of these measures are being taken, including the recommendation of retaining profits and raising provisions against risky exposures. The authorities also noted that their experience in recapitalizing banks and restructuring nonperforming assets during the transition is valuable in dealing with present challenges.

18. The authorities are considering measures to increase lending to nonfinancial companies. A second anti-crisis package, which includes auctioning partial state guarantees on new loans to nonfinancial enterprises of up to €1.2 billion, was announced in February. In addition, the publicly owned and recently recapitalized Slovene Export and Development Bank has expanded considerably its portfolio since September. The authorities stressed the need of ensuring credit to healthy companies. While staff appreciated the benefits of providing support to viable companies during difficult times, it stressed the need for the allocation of state guarantees to be transparent and to limit banks' moral hazard.

C. Fiscal Policy

19. The authorities and staff concurred that a fiscal stimulus is necessary. The unprecedented crisis calls for a bold fiscal response to attenuate the drop in aggregate demand and to alleviate distress of the most vulnerable groups. Staff supported the size of the fiscal stimulus package (2.1 percent of GDP, Box 4) and projected the fiscal deficit to deteriorate to 4.2 percent of GDP in 2009, reflecting both automatic stabilizers and a fiscal stimulus package. The MoF indicated their intention to contain the fiscal deficit to 4 percent of GDP in 2009, possibly cutting public investment in case the deficit exceeds this threshold. Staff endorsed this prudent position in light of the necessity to keep fiscal sustainability and rising borrowing costs.

Box 4:Fiscal Stimulus Package

The government announced a €806 million fiscal stimulus package (equivalent to 2.1 percent of GDP, of which 1.8 percent will be spent in 2009, 0.2 percent in 2010, and 0.1 percent in 2011) in December 2008 and passed a supplementary budget in March 2009. The main components of the stimulus package are as follows:

  • 0.6 percent of GDP in wage subsidies to companies for shorter labor hours;

  • 0.5 percent of GDP in other subsidies to companies, including for R&D;

  • 0.6 percent of GDP for the elimination of the payroll tax; and

  • 0.5 percent of GDP in reduction of corporate taxation.

20. Views differed on the wage subsidies to shorten working hours included in the package. The authorities stressed that this measure was targeted at preserving jobs and could save the payment of unemployment benefits. According to staff, these measures might provide some relief to workers and medium and large-sized enterprises but were not sufficiently targeted to the most vulnerable groups; they might entail a risk of abuse and would be hard to reverse if the crisis continues, causing large fiscal costs. Staff recommended not to renew these measures and to use the funds for more targeted interventions in case the crisis continues.

21. Staff recommended increasing public investment. Public investment could be leveraged with EU funding and has a direct effect on demand. Moreover, investment is key to upgrading infrastructure and to increasing potential growth and is, by nature, temporary. The authorities agreed but noted that institutional bottlenecks had limited absorptive capacity in the past.

22. Looking forward, staff stressed that the fiscal position should be reverted to a more conservative stance as the crisis subsides. Fiscal policy should be tightened as soon as possible considering the cost of public debt, the fiscal implication of the aging population, and the contingent liabilities deriving from the financial stability measures. The authorities aim to reduce the fiscal deficit to below 3 percent of GDP in 2010; however, no plan has been presented on how to achieve this objective.

23. The authorities and staff concurred that fiscal adjustment should mainly come through the consolidation of expenditure. The recent public sector wage agreement will raise the wage bill substantially over 2009 and 2010. Future increases need to be contained. Staff welcomed the authorities' goal of reducing by attrition public employment by 2 percent a year over the next two years and suggested that the government should link the employment reduction measures to a comprehensive strategy to improve the efficiency of public expenditure, which would include the introduction of performance budgeting.

24. The authorities agreed that a rapidly aging population and current policies pose a challenge for long-term fiscal sustainability, but there is no political consensus for systemic reforms. The authorities also noted their goal of increasing minimum pension. With the lowest birth rate in Europe and an aging population, the elderly dependency ratio will increase to 60 percent in 2030, one of the highest in Europe. In the absence of reforms, age-related expenditures are projected to increase by 8 to 10 percentage points of GDP and reach almost 30 percent of GDP by 2050.5 As a solution, the government is considering greater incentives for a longer working life and private pension savings and active aging policies aimed at increasing labor participation especially among older workers. In staff's view, these measures go in the right direction but are insufficient to ensure long-term sustainability. Fiscal viability requires systemic reforms, including (partially) de-linking pensions from wages and increasing the retirement age. A prompt introduction of the pension reform would also anchor expectations for fiscal consolidation after the crisis.

Elderly Dependency Ratio

(percent)

Employment rate of 55-64 years old, 2007

(percent)

D. Structural Issues

25. Staff emphasized that successful competition in the Euro zone requires greater labor market flexibility. As a consequence of large devaluations in neighboring countries, Slovenia will face tougher competition, especially in labor-intensive sectors. Labor markets need to be flexible to facilitate the reallocation of workers from sectors no longer competitive to new sectors and to contain the wage pressures that were observed after the euro adoption. To this end, further liberalization of employment protection legislation is necessary in the medium term and could be implemented in the context of a “flexicurity” approach. The authorities stressed that the “flexicurity” model of labor market implies large fiscal costs and requires further analysis.

26. Improvements in the product and financial markets are needed to enhance competitiveness (Figure 11). Slovenian banks are among the least efficient in Europe (Box 5); Slovenia ranks low among European economies in the World Bank's Ease of Doing Business indicators, and has attracted little FDI in the past few years. Among possible causes are the high government ownership and involvement in the economy, the extent of red tape and regulations, shortfalls in competition laws and their enforcement, and the lagging regulation of network industries. To ease business and property registration, the authorities have adopted several measures, including the introduction of the “one-stop shop” for companies' registration. Staff endorsed the government's program to simplify the regulatory burden and strengthen judicial enforcement. In staff's view, further reforms should focus on enhancing competition in the product and financial markets, including by increasing the independence of the Competition Protection Office and continuing the privatization process once the crisis is over.

Figure 11.Structural Indicators of the Product Market

Sources: World Bank, Doing Business; EBRD; European Comission, European Innovation Scoreboard, 2008.

1/ A lower value indicates a better performance.

Box 5.Efficiency of Slovenian Banks

The financial sector remains dominated by domestic, largely state-controlled banks. How well are they prepared for increasing competition in the integrated European financial markets? A recent paper by IMF staff finds that Slovenian banks are among the least efficient in Europe, which may reflect the low contestability compared to EU peers.1

Slovenia tends to lag behind the New Member States (NMS) in cost efficiency, owning to high labor costs. Profitability is also lower than regional peers, driven by declining net interest margins. The analysis of scores for bank efficiency and indices for market contestability for Slovenia and its EU peers shows that Slovenian banks are, on average, less cost efficient than those in the EMU, and among the least contested in Europe. The Slovenian banking sector is characterized by higher-than-average market concentration and state ownership, which could have resulted in low efficiency and contestability, as suggested by larger cross-country studies.

Average Bank Efficiency Scores by Country, 2007

Index of Market Contestability

1/Rudolfs Bems and Piritta Sorsa, “Efficiency of the Slovenian Banking Sector in the EU Context,” Slovene Banking Journal, November 2008.

III. Staff Appraisal

27. To date, the fiscal and financial policy responses have been broadly appropriate. Going forward, it is essential that these measures be complemented by broad-ranging reforms aimed at raising the economy's growth potential and ensuring fiscal sustainability.

28. Short-term actions are needed to counter the effects of the global crisis. Policies should focus on attenuating the consequences of the crisis, taking into consideration that the slowdown may be protracted and the following recovery sluggish. Tight credit markets also limit the ability to finance fiscal deficits.

29. In the medium term, the economy needs to emerge from the global crisis on a sustainable growth path. As the crisis subsides, Slovenia will face new challenges from tighter international credit conditions, lower potential growth, and neighboring countries with competitive exchange rates. To address these challenges, reforms in labor, product, and financial markets are required.

30. The main long-term challenge comes from the fiscal implications of a rapidly aging population. The current pension system needs to be reformed to address the imbalance between the means available and commitments deriving from the current pension provisions and an aging population.

31. Vulnerabilities in the banking system have increased and further preventive actions are in order. Efforts should continue ensuring that the banks have enough funding in case of further international credit squeeze, especially at longer maturities. Bank-by-bank stress tests should be performed to gauge the liquidity and capital needs of the banks. The BoS should encourage vulnerable banks to raise their capital levels. If banks come under stress, the authorities should be ready to inject public capital into undercapitalized banks, accompanied by measures to restructure the nonperforming assets and the operation of the affected banks.

32. The authorities' priority should be maintaining banks' stability rather than expanding further their portfolios given the protracted nature of the crisis. Given the potential tightness in banks' capital, there is a trade-off between expanding further banks' portfolios during the crisis and keeping additional lending capacity for the future. The authorities announced measures to increase lending to nonfinancial enterprises, including auctioning partial state guarantees on new loans to nonfinancial enterprises. While staff appreciates the benefits of providing support to viable companies during difficult times, caution should be taken to maintain loan quality. The allocation of state guarantees needs to be transparent, to limit banks' moral hazard, and to avoid sector picking.

33. The magnitude of the planned fiscal deficit is appropriate. The severe economic downturn called for a bold fiscal response, which the authorities have implemented. Looking forward, the large spread on Slovenian sovereign bonds reminds of the necessity to keep a low level of borrowing. Staff endorses the authorities' commitment to keep the fiscal deficit at or below 4 percent and to bring it down further as soon as the crisis subsides.

34. The composition of the fiscal package could be improved by allocating relatively more resources to public investment. Public investment increases directly aggregate demand and can be leveraged with EU funds; public investment is also key to upgrading infrastructure and increasing potential growth. The authorities should act swiftly to remove the legal and institutional bottlenecks, which previously hindered the use of EU funds. To this end, a task force to coordinate the use of EU funds among ministries should be considered.

35. The fiscal position should be reverted back to a more conservative stance as soon as a recovery takes hold. The short-term fiscal measures should be embedded into a long-term fiscal strategy, which highlights the future fiscal liabilities of the pension system and contingent liabilities owing to the extensive guarantees that the government may issue. Having a clear deficit reduction strategy coupled with an effective communication framework will also help in financing the budget.

36. Systemic changes to the pension system are necessary to ensure longer-term fiscal sustainability. The measures the government is considering, including greater incentives for a longer working life and private pension savings, are insufficient to ensure long-term sustainability and to generate resources to increase minimum pensions. Fiscal sustainability requires a systemic reform that raises retirement age and/or moderates the indexation mechanism of the pension benefits. Pensions should not increase to reflect the one-off rise in wages following the recent public wage agreement.

37. Structural reforms in the labor, product, and financial markets are imperative to improve competitiveness. Greater labor participation and flexibility are essential to succeed in the Euro-area and to face competition from neighboring countries, which have recently devalued. Staff endorsed the government's program to simplify the regulatory burden and strengthen judicial enforcement. Improving the business climate, as well as reviving the privatization program once the crisis subdues, will boost productivity growth.

38. It is recommended that Slovenia moves to a 24-month consultation cycle. Slovenia, being a non-systemic country, with stable economic and financial conditions, and without outstanding Fund credit or pressing policy issues of broad interest to the Fund membership, meets the criteria for the 24-month consultation cycle. The authorities agreed to move the consultations to a 24-month cycle, with an interim staff visit.

The strong pass-through and the wage-setting mechanism suggest that inflation could increase again when the economy picks up. A Selected Issue Paper analyzes the lessons of the inflation surge in 2007–08.

See “Exchange Rate Assessments: CGER Methodologies,” by Lee and others (2008) for more details on the methodology.

See IMF Country Report No. 06/250.

See Financial Stability Report (2008).

See IMF Country Report No. 06/250.

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