Statement by Johann Prader, Alternate Executive Director and Borut Repanšek, Assistant for Republic of Slovenia

The Republic of Slovenia, being the most successful transition economy in Central and Eastern Europe, has achieved significant economic convergence with the European Union, and has built up an impressive record of sustained, broad-based growth, reflecting strong competitiveness and investment. However, Executive Directors emphasized the need to maintain strong monetary and fiscal policies, and accelerate structural reforms. They commended the comprehensive action plan prepared by the authorities to strengthen prudential standards, improve liquidity management, and deepen the money market.

Abstract

The Republic of Slovenia, being the most successful transition economy in Central and Eastern Europe, has achieved significant economic convergence with the European Union, and has built up an impressive record of sustained, broad-based growth, reflecting strong competitiveness and investment. However, Executive Directors emphasized the need to maintain strong monetary and fiscal policies, and accelerate structural reforms. They commended the comprehensive action plan prepared by the authorities to strengthen prudential standards, improve liquidity management, and deepen the money market.

May 11, 2001

1. In 1991 Slovenia became an independent state and introduced its own currency. Ten years later Slovenes expect that their country will be ready to join the EU at the end of 2002. From that point of view Slovenia's transformation has been rapid.

2. Slovenia has never needed the Fund’s financial support, contributes to the Fund’s finances and complies with the SDDS standard. Since the last Article IV consultations there have been three characteristics of Slovenia’s cooperation with the Fund:

  • The exchange of views intensified because of the complex final macroeconomic and structural adjustments before EU membership. This resulted in comprehensive Article IV and FSAP reports. The authorities thank the staff for their dedicated, highly professional, and beneficial work.

  • The staff and the authorities broadly agree on the pursued policies. They assess monetary policy in 2000 from somewhat different angles, as explained in paragraphs 14 and 15 of the Article IV Staff Report. But they both see the recent tightening of the policy and changing instruments as appropriate steps towards price stability.

  • The Slovene authorities have been very active in implementing several policy measures discussed with the staff.

3. Last year the Slovene economy remained macroeconomically stable and vibrant. Growth was high, unemployment fell to 6.6 percent in November 2000, and investment reached the highest level ever. This was supported by a sound combination of a further increase in domestic savings and foreign borrowing. The current account deficit shrank, while the fiscal deficit increased somewhat. However, inflation has been hovering between 8 and 9 percent. We will comment on fiscal policy, monetary and exchange rate developments, structural reforms and the FSSA report.

Fiscal policy

4.1 In view of the huge fiscal policy challenges in recent years—establishing the new state, three major bank rehabilitations, transition reforms, and the EU harmonization—the burden on the Slovene taxpayers in the form of general government debt of 25 percent of GDP is reasonable. However, the general government deficit rose from 0.8 in 1999 to 1.3 percent of GDP in 2000. It was on the one hand a consequence of more specific developments in 2000 (a larger shift in composition of demand towards export, and spending increases due to higher indexation and public sector wage increases granted in the election year), and on the other hand longer-term factors (aging population; EU harmonization). The authorities are aware that public finances are under severe pressure. To offset it, they are combining short-term measures (freezing most expenditures after last fall’s elections, using revenues from bandwidth concessions) and others which bring results more gradually; all in order to at least balance the budget by 2004.

4.2 In addition to what is explained in paragraphs 19 and 20 of the staff report, the following four budgetary developments are relevant:

First, in April the Parliament approved the 2001 budget. The deficit of one percent of GDP is 0.3 percent lower than a year before, although it includes correction of the inherited election-year slippage.

Second, the Government is closing down the Slovene Development Corporation, which acted as the channel for subsidizing the enterprise sector.

Third, the reform of direct and indirect taxes will be adopted by the end of this year. Draft laws on personal income tax, corporate income tax, and a tax on immovable property are being prepared. Legislation changes are also being introduced for the alignment of the value-added tax, excise duties and customs procedures with the EU legislation.

Fourth, a two-year budget for 2002/03 is under preparation and planned for adoption in fall. The medium-term fiscal policy orientation is consistent with last year’s Board recommendation and the recent paper “Balancing Fiscal Priorities - Challenges for the Central European Countries on the Road to EU Accession”.Unfortunately, medium-term fiscal planning will become more complex and even impossible if a clear decision on the timing of EU accession is not made soon. We would like to encourage continuation of the dialogue between the Fund and the EU on how to decrease the fiscal costs of EU enlargement.

Monetary and exchange rate policy

5.1 Monetary policy has been crucial for macroeconomic stabilization by lowering the inflation rate, managing the exchange rate float, and gradually opening the capital account. Some observers noted that it was not focused enough on price stability as its ultimate goal. However, the results are striking: inflation was reduced from 207 percent in 1992 to 4.3 percent in June 1999. In 2000, the effects of the VAT introduction, the increase in oil prices and liberalization of controlled prices pushed inflation back to around 8 percent. The authorities consider bringing down inflation significantly an immediate task. For that, moderate wage agreements will be crucial.

5.2 The central bank’s intermediate target is M3, which moves within the band announced a year in advance. For reaching the money target, the central bank cannot rely only on price instruments; they are not developed enough and appropriate responsiveness of the money market is not assured. But more importantly, raising interest rates, and consequently increasing interest rate differentials, would attract more capital inflows that would adversely affect the money supply and endanger the intermediate monetary target. Therefore the central bank is also using exchange rate interventions to close the gap between foreign and domestic interest rates in a way that supports achieving the money target.

5.3 In an external environment conducive to disinflation, the central bank policy remains tight. The central bank is intensively preparing changes of its instruments in order to deepen the money market and prepare it for an increased use of price instruments. It is also working on a medium term monetary framework. A few remaining steps towards full capital account liberalization will be taken as planned. Slovenia has closed negotiations with the EU on the chapter on freedom of capital movements. The abolition of indexation is a major step for Slovenian economic policy considered possible when inflation falls to 5-6 percent In preparation, a non-indexed one-month Treasury bill was issued this Wednesday, while the Slovene Institute of Auditors is preparing the adjustment of accounting standards to the deindexed environment.

Structural policies

6.In 2000, the Government changed twice: in June after the Parliament’s non-confidence vote and in November after the regular elections. Still, the key reforms and EU harmonization under implementation continued without significant interruptions.

7. With respect to privatization, it is useful to keep things in perspective. First, privatization was prepared in the early’90s according to the model that the society could agree upon, and partly also under the influence of external advice. Certain drawbacks of voucher privatization are largely unavoidable, and corporate governance can be among them. However, taking into account the size and growth of Slovene exports, corporate governance is not a major problem. Second, privatization of the two largest banks is technically prepared and will begin before summer. Third, the privatization of the largest insurance company has been delayed by court proceedings rather than by economic policy.

Financial Sector Stability Assessment

8.In line with the views of the staff and taking advantage of an excellent FSAP, the Slovene authorities responded vigorously by preparing and executing a comprehensive action plan.

9. The FSSA Report reveals a number of strengths of the Slovene financial system, and also notes areas where further improvement is needed. It also sends somewhat contradictory messages about banking sector developments. One presents banks that were strongly shielded from competition, the other states that banks in Slovenia are now sound, well capitalized and their performance compares favorably with those in selected EU and Central European countries. The two state-owned banks, that went through costly rehabilitation in the early’90s that arguably should have been sold years ago, are performing very well and score the highest rating that Moody’s assigned to banks in Central and Eastern Europe.

10. Although all factors mentioned that worked against higher competition in banking were relevant, we should also note that foreign banks could and have been entering the market since the early’90s. Foreign-owned banks have been competing with the Slovene owned banks on the same basis. Later, allowing foreign bank branches to open led to the one symbolic application ever submitted and granted. With capital account liberalization allowing the private sector to raise in 2000 almost half of the new loans abroad, competition has obviously increased substantially. The banking industry continues to change–the sale of the third largest bank in the country to Societe Generale is only the most recent proof of that.