On May 20, 2011, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Slovenia.1
Slovenia’s economy is gradually recovering following one of the sharpest GDP declines in the euro area during the crisis. Real GDP declined over 10 percent from peak to trough owing to: a sharp decline in external demand; a significant tightening in external credit conditions forcing banks to curtail domestic credit supply; and an abrupt end of a construction and housing price boom. Real GDP growth reached 1.2 percent in 2010, led by rising exports. Weak domestic demand led to negative core inflation and greatly reduced the current account deficit. The current account deficit shrank from 6.7 percent of GDP in 2008 to 1.2 in 2010, reflecting mainly the end of the construction boom. Average CPI inflation was 1.8 percent in 2010, mainly because of rising fuel and energy prices. The average unemployment rate increased to 7.2 percent in 2010 up from 4.8 percent at end 2008.
GDP growth is projected at 2 percent in 2011. The pick-up in growth reflects mainly a recovery in the manufacturing sector and inventory rebuilding. However, investment will likely be low due to deleveraging in the highly indebted corporate sector. High unemployment and fiscal retrenchment will weigh on consumption growth. Average inflation is projected to gradually pick up on the back of high commodity prices. The current account deficit is expected to widen again as the economy recovers, but not as much as in pre-crisis times. The main risks to the outlook are the near-term dependence of the recovery on external demand and significant contingent public liabilities from entitlement spending and banks. The postponement of pension and labor market reforms could also lead to further deterioration in competitiveness and potential output growth.
The general government fiscal deficit narrowed in 2010. After widening considerably during the crisis, the general government deficit declined to 5.2 percent in 2010. The main factors were one-off revenue gains, cuts in capital transfers, and containment of the wage bill. The deficit is expected to continue narrowing in 2011 primarily through further wage bill rationalizations, reduced indexation of pensions and other entitlements, and capital expenditure and capital transfer cuts. The authorities aim to reduce the fiscal deficit to below 3 percent by 2013. In the long term, pension expenditure poses a challenge to fiscal sustainability. Slovenia is projected to have one of the largest pension expenditures in the EU by 2050 if no reform is implemented. The authorities started addressing the challenge with the pension reform that will increase the effective retirement age and lower the replacement rate. But additional reforms will be needed to ensure sustainability of the system in the long run.
The crisis exposed vulnerabilities in the financial sector. The rapidly expanding credit growth financed with short–term external bank borrowing came to a sudden stop in 2008. Banks’ profitability and asset quality deteriorated with aggregate profits turning negative in 2010 due to high loan losses to the highly indebted corporate sector. Total assets declined and corporate credit growth remained anemic. Slovenian banks are among the most thinly capitalized in the EU, particularly the systemic domestic banks. Publicly announced recapitalizations are sufficient to offset the accumulated losses of the last two years. But, given the thin capitalization at the eve of the crisis, they will not be sufficient to create new lending capacity.
Executive Board Assessment
Executive Directors noted that, inspite of the authorities’ commendable policy response, Slovenia experienced one of the largest drops in output in the euro area. The domestic boom, fueled by easy external financing conditions and an expansionary fiscal policy, came abruptly to an end with the global financial crisis. While a gradual recovery is underway, important challenges remain. Directors emphasized the need to keep the recovery on track, safeguard the sustainability of public finances, enhance financial sector resilience, and strengthen competitiveness.
Directors supported the authorities’ fiscal consolidation targets, but stressed the importance of specifying and implementing additional and durable consolidation measures. Social programs should be better targeted, and the planned reduction in public sector employment should be implemented.
Directors emphasized the crucial role of pension reform. While the current reform is a step in the right direction, it will likely fall short in generating the needed savings in the long run. Directors considered that additional measures should include a more rapid increase in the effective retirement age and moving indexation gradually toward full-price indexation. Directors stressed the importance of a strengthened communication strategy to help build social consensus for reform. They also encouraged the authorities to prepare contingency measures in case of rejection of the pension reform.
Directors highlighted the risks associated with the thinly capitalized banking sector. The near-term priority should be on further increasing banks’ capital buffers, along with strengthened supervision. The recently completed recapitalizations for the systemic banks are a good start, but probably insufficient. Directors also encouraged further tightening of capital requirements to reinforce the recapitalizations. They considered expanding ownership to include private and foreign investors as a key measure to help address governance and risk management weaknesses, as well as to acquire additional capital. Directors encouraged the authorities to set out and implement clear divestment strategies for their ownership stakes in domestic banks.
Directors cautioned that lending activity should be monitored carefully, but not distorted with ad-hoc measures, such as the recently taken measure of taxing banks’ balance sheets to incentivize borrowing by the over-indebted corporate sector. They encouraged the authorities to monitor housing price developments closely to prevent recent surges in mortgage lending from creating new imbalances. Directors welcomed the authorities’ willingness to tighten prudential regulations if necessary.
To address the slowdown in the economy’s growth potential and to boost competitiveness, Directors agreed that structural reforms in labor and product markets will play a crucial role. They viewed the loosening of labor market restrictions, phasing-out of wage indexation schemes, and eliminating of pay increases unrelated to productivity gains as key in helping reduce unemployment. Directors also encouraged the authorities to enhance competition in product and financial markets to foster foreign direct investment (FDI) inflows.
It is expected that the next Article IV consultation with Slovenia will be held on a 12-month cycle.
Public Information Notices (PINs) form part of the IMF’s efforts to promote transparency of the IMF’s views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case. The
|(Annual percentage change)|
|Real wages (all sectors)||2.2||2.5||2.6||2.0||2.3||1.9|
|Average unemployment rate (in percent, ILO definition||4.9||4.4||5.9||7.2||7.5||7.2|
|(In percent of GDP)|
|General government balance 1/||0.3||-0.3||-5.5||-5.2||-4.8||-4.3|
|General government debt||23.4||22.5||35.4||37.2||42.3||44.9|
|(Percentage change, end-period)|
|Money and credit|
|Credit to Private Sector||34.1||17.2||3.2||2.0||…||…|
|Government bond yield (10 year, in percent) 2/||4.5||4.7||4.4||3.8||…||…|
|Balance of payments||(In percent of GDP)|
|Trade balance (goods)||-4.8||-7.1||-2.0||-2.7||-3.1||-3.2|
|Current account balance||-4.8||-6.7||-1.5||-1.2||-2.0||-2.1|
|External debt (percent of GDP, end-period)||100.6||105.2||113.8||113.3||114.4||112.8|
|Exchange regime||Member of EMU|
|Nominal effective exchange rate (2000=100)|
|Real effective exchange rate|
|(CPI based, 2000=100, period average)||101.8||104.0||106.8||101.9||…||…|
Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country’s authorities. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm