Republic of Slovenia: Staff Report for the 2003 Article IV Consultation

This 2003 Article IV Consultation highlights that economic growth in the Republic of Slovenia slowed during 2001–02 to about 3 percent, owing to a weak external environment and subdued domestic demand. Export growth slowed as demand from the European Union weakened, but the impact was cushioned by a rapid expansion of exports to southeastern Europe and Russia. With imports growing more slowly than exports and the terms of trade improving, the external current account swung into surplus in 2001 and strengthened further in 2002, reflecting a satisfactory competitive position.

Abstract

This 2003 Article IV Consultation highlights that economic growth in the Republic of Slovenia slowed during 2001–02 to about 3 percent, owing to a weak external environment and subdued domestic demand. Export growth slowed as demand from the European Union weakened, but the impact was cushioned by a rapid expansion of exports to southeastern Europe and Russia. With imports growing more slowly than exports and the terms of trade improving, the external current account swung into surplus in 2001 and strengthened further in 2002, reflecting a satisfactory competitive position.

I. Background

1. Slovenia’s road to European Union (EU) accession, scheduled for May 2004, has been marked by sustained real convergence in per capita income, but progress in nominal convergence has stalled and its resumption represents the main policy challenge in the period ahead. Adjusted for differences in purchasing power, Slovenia’s per capita GDP and labor productivity are currently around 70 percent of the EU average, and well above the level in other Central European accession countries (Table 1) and above some EU members. The sectoral composition of GDP also is broadly similar to the EU average. Inflation has got stuck at about 8 percent since 1997, in part owing to the persistence of indexation of wages and financial contracts and continued adjustments in administered prices.

Table 1.

Selected Indicators of Central European EU Accession Candidates, 1993-2002

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Sources: World Economic Outlook; Balance of Payments database; and Eurostat.

2. For most of the 1990s, Slovenia experienced sustained rapid growth, against a backdrop of prudent macroeconomic policies and a gradualist approach to structural reform. The general government deficit averaged below 1 percent of GDP in the second half of the decade, after a surplus in the earlier years. This sound fiscal position coupled with a high private saving ratio helped keep external imbalances at bay (Table 2 and Figure 1). Until they began to be liberalized in 1999, capital controls played a key role in the authorities’ strategy of avoiding liquidity growth fueled by capital inflows. With privatization taking place mostly through a voucher scheme and insider buyouts, Slovenia attracted little foreign direct investment (FDI) until 2000. However, this did not impede the manufacturing sector from restructuring, raising productivity, and maintaining its export orientation. The pace of structural reforms accelerated toward the end of the 1990s. Since then, capital account transactions have been fully liberalized and significant strides have been made in reforms of the tax and pension systems and the financial sector, but important challenges remain. Slovenia has closed all the negotiation chapters of the acquis communautaire.

Table 2.

Slovenia: Selected Economic Indicators, 1999-2004

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

IMF staff projections for real GDP and components, inflation, employment, balance of payments, and external debt. Figures for general govt finances for 2003-04 refer to the budget approved by Parliament.

Average of the first three quarters of 2002.

Figures reflect a shift in the budget accounting to a pure cash basis entailing 11 months of VAT and excise tax revenues. Adjusted for this.ie 42.3 percent of GDP and the general government deficit would be 1.4 percent of GDP.

For deposits with maturity between 31 days and 1 year.

Figure 1.
Figure 1.

Slovenia: Economic Indicators, 1993—2004

Citation: IMF Staff Country Reports 2003, 108; 10.5089/9781451835656.002.A001

Sources: Data provided by the Slovene authorities; and IMF staff projections.1/Figures for 2002 have been adjusted for the shift in the budget accounting to a pure cash basis. The general government balance for 2003-04 refers to the budget approved by parliament.

3. In concluding the last consultation on March 20, 2002 (EBM/02/29), Executive Directors emphasized the need to pursue disinflation, and considered that exchange rate policy should be subordinated to this goal. They endorsed the authorities’ medium-term goal of a balanced budget. Directors welcomed the progress in strengthening financial sector supervision, and encouraged the authorities to press ahead with bank privatization. The authorities have received considerable technical assistance from the Fund in institution building and have generally heeded the Fund staffs policy advice. They have taken prompt steps to implement the recommendations of the 2001 Financial Sector Assessment Program (FSAP). However, the authorities have pursued a more gradual approach to tackling inflation than advocated by the staff (see ¶15-19), and foreign investment in the banking sector has met with some resistance.

4. Economic growth slowed during 2001-02 to around 3 percent, owing to a weak external environment and subdued domestic demand, opening up a small output gap. Investment fell in 2001 with the erosion of business confidence, but recovered modestly in 2002 with the revival of construction activity. Private consumption growth moderated, as households’ propensity to spend was restrained by the jump in indebtedness in 1999 arising from credit-financed pre-VAT purchases, layoffs in many sectors in manufacturing and a general slowdown in employment growth, and the introduction of attractive long-term savings schemes. Export growth slowed as demand from the EU weakened, but the impact was cushioned by a rapid expansion of exports to southeastern Europe and Russia. With imports growing more slowly than exports and the terms of trade improving, the external current account swung into a small surplus in 2001 that widened to 1¾ percent of GDP in 2002.

GDP and its Components

(Real growth rates in percent, unless otherwise noted)

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Sources: Statistical Office; and IMF staff projections.

5. Progress with disinflation was less than envisaged. Inflation at end-2002 (7.2 percent) remained above the Bank of Slovenia’s (BoS) original projection of 5.8 percent and its revised mid-year projection of 7.0 percent. Thus, although down from the highs observed in 2000, inflation has remained in the 7-8 percent range that has prevailed since 1997. In 2002, increases in indirect taxes, oil prices, municipal services charges, and non-oil administered prices accounted for about two-fifths (or 3 percentage points) of inflation, and were larger than anticipated by the BoS. The slippage in disinflation translated into higher wages on account of catch-up clauses in the wage indexation mechanism. However, real wage increases were smaller in 2002, and receded below national productivity growth. Real wage increases in public administration were sharply curtailed, but increases in some public services (e.g., education and health) continued to outpace economy-wide real wage increases and productivity gains by a wide margin (Figure 2).

Figure 2.
Figure 2.

Slovenia: Wages and Productivity, 1995-2002

Citation: IMF Staff Country Reports 2003, 108; 10.5089/9781451835656.002.A001

Source: Statistical Office ofthe Republic of Slovenia.1/ Wages in respective sector divided by wages in the manufacturing seclor.2/ Includes public administration, education, health, and other social services.

Factors Contributing to Inflation

(Percentage points)

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Source: Institute of Macroeconomic Analysis and Development.

A proxy for underlying inllation.

Productivity and Real Wages

(Percent change)

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Sources; Statistical Office; and Ministiy of Finance.

6. Monetary conditions have varied over time. In real terms, the key policy rate has exhibited periodic sharp increases and decreases, including turning negative during much of 1999-2000 and in the later part of 2001 (when large deposits of euro-legacy currencies were made with banks). Real interest rates on 60-day tolar bills rose in 2002, but remained below the peak reached in October 2001. Because of indexation, the changes in policy rates did not induce significant adjustments in real lending rates of commercial banks during the period through mid-2002. Following the de-indexation of short-term financial instruments in July 2002, lending rates of banks became more sensitive to movements in the interest rate on foreign currency-denominated credit and declined in real terms; the relationship with developments in policy rates remained weak. The exchange rate of the tolar vis-à-vis the euro has depreciated at varying rates, around a decelerating trend path. As a result, there have been alternating swings in the exchange rate-adjusted interest differential with abroad (Figure 3). While this did not trigger interest-sensitive capital inflows, foreign direct investment increased sharply in 2002 to the equivalent of about 9 percent of GDP, particularly in the pharmaceutical and banking sectors. The privatization receipts of the government were deposited in the BoS, and the rest of the inflows were largely sterilized through open market operations. Thus, base money growth in 2002 was limited to 8½ percent, compared with 21 percent in 2001. Domestic credit growth to the private sector slowed significantly, reflecting weak demand (Table 3 and Figure 4).

Figure 3.
Figure 3.

Slovenia: Inflation, Interest Rates, and Depreciation, 1999-2002 1/

(In percent)

Citation: IMF Staff Country Reports 2003, 108; 10.5089/9781451835656.002.A001

Sources: Bank of Slovenia; Eurostat; and Statistical Office of the Republic of Slovenia1/ Depreciation vis-à-vis the euro.2/ Difference between short-termlending rates in Slovenia and Germany.3/ Vis-à-vis the Euro zone.
Table 3.

Slovenia: Monetary Survey, 1998-2002

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Source: Bank of Slovenia, Monthly Bulletin.
Figure 4.
Figure 4.

Slovenia: Selected Monetary Developments, 1999-2002

Citation: IMF Staff Country Reports 2003, 108; 10.5089/9781451835656.002.A001

Source: Bank of Slovenia.

7. Competitiveness indicators have been broadly stable. The real effective exchange rate (REER) indicators and relative profitability index have remained broadly unchanged since early 1998 (Figures 5 and 6). During the past two years, Slovenia has regained the loss in export market share experienced during 1999-2000, mainly through market penetration in non-EU countries. Beginning in 2000, Slovene exporters have progressively increased their presence in the former Yugoslav republics and other non-EU countries, and are consolidating their footholds by investing in local distribution companies and production facilities. This trade diversification has been facilitated by improved political and macroeconomic stability in the destination countries, brand recognition by local consumers, and past business connections. The role of trade credits in supporting exports has been modest: nonetheless, the proportion of trade credit-financed exports to the former Yugoslav republics (11 ½ percent) has been higher than to the EU (6½ percent). However, Slovenia’s share in EU imports has fallen slightly, while those of the Czech Republic, Hungary, Poland, and Slovak Republic have been rising, despite Slovenia’s REER having depreciated vis-à-vis these countries. (Figure 7). The better export performance of the other Central European accession candidates to the EU is likely to reflect higher foreign direct investment from EU countries and the associated beneficial market linkages.

uA01fig01

Exports Market Shares, 1998-2002

(1998Q1=100)

Citation: IMF Staff Country Reports 2003, 108; 10.5089/9781451835656.002.A001

Figure 5.
Figure 5.

Slovenia: Exchange Rate Indicators, 1998-2002

(1998Q1=100) 1/

Citation: IMF Staff Country Reports 2003, 108; 10.5089/9781451835656.002.A001

Sources: Bank of Slovenia Bulletin: Eurostat; IFS; and IMF staff calculations.1/ Trade weights based on 1998-2000 data for exports of goods. Partner countries comprise: Austria, Croatia, France, Gsrmany, Italy, Poland, United Kingdom, and United States.2/ Unit labor costs in Slovenia relative to those in trading partner countries, adjusted for manufacturing producer price inflation-a rough indicator of developments in profitability.
Figure 6.
Figure 6.

Slovenia: Wages, Productivity, and Product ULC in Manufacturing, 1997-2002

(1998Q1=100)

Citation: IMF Staff Country Reports 2003, 108; 10.5089/9781451835656.002.A001

Sources: Statistical Office of the Republic of Slovenia; and IMF staff calculations.1/ Defined as the ratio of nominal wages to producer price index.2/ Defined as the ratio of real product wages to productivity.
Figure 7.
Figure 7.

Slovenia: Competitiveness Indicators and Export Market Shares of Slovenia and EU Accession Candidates, 1997-2002

(1998Q1=100)

Citation: IMF Staff Country Reports 2003, 108; 10.5089/9781451835656.002.A001

Sources: IMF Direction of Trade Statistics; and IMF staff calculations based on data from national authorities.1/ ULC in manufacturing in national currencies. ULC in industry for Hungary and the Slovak Republic.2/ Ratio of U.S. dollar ULC between Slovenia and EU accession candidates. An increase indicates appreciation.3/ Calculated as the share of exports of each individual country in the combined imports of the following countries: Austria, France, Germany, Italy, United Kingdom, and United States.

8. Other external vulnerability indicators also were satisfactory. With a widening of the current account surplus and large inflows of foreign direct investment, gross official reserves at end-2002 rose to more than five times the level of base money as well as of short-term debt on a residual maturity basis. Total external debt remained moderate (42 percent of GDP), and external debt service payments in 2002 were about 14 percent of exports of goods and services (Table 4).

Table 4.

Slovenia: Vulnerability Indicators, 1998-2002

(In percent of GDP, unless otherwise indicated)

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

Decemher, unless otherwise indicated.

NFS denotes nonfactor services.

Yield differential on a seven-year DEM-denominated Slovene government bond, maturing in 2004.

9. The general government deficit has remained slightly below 1½ percent of GDP since 2000.1 With output growing below estimated potential (4 percent), this stable ratio implies discretionary withdrawals of about ½ percentage point of GDP a year in 2001-02. In contrast to 2001 when there were expenditure overruns, the budget came under pressure in 2002 because of revenue shortfalls that are not well understood. The revenue-to-GDP ratio, corrected for the shift in budget accounting, fell by ¾ percentage point, notwithstanding increases in VAT and excise tax rates introduced in the original budget to align them with EU standards. The government responded through a combination of expenditure cuts and upward revision of the fiscal deficit target.

General Government Operations, 2000-02

(In percent of GDP)

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Source: Ministry of Finance.

Adjusted for the one-off shortfall in recorded revenue as a result of a shift in accounting practice to full cash basis.

10. Some key structural measures were implemented in 2002, but a backlog developed on the privatization front. As of July, financial contracts with maturity of less than one year ceased to be indexed to inflation, as a partial step toward enhancing the interest rate transmission channel of monetary policy. Thirty-nine percent of the shares of Nova Ljubljanska Banka (NLB, the largest bank) were sold to foreign investors. However, the privatization of Nova Kreditna Banka Maribor (NKBM, the second largest bank) stalled because no offer met the guidelines. Telecom privatization was postponed owing to unfavorable market conditions. Ownership transformation of insurance companies remained held up on account of a court challenge.

II. Report on the Discussions

11. The authorities plan to enter ERM2 by end-2004 and to adopt the euro at the earliest possible date. Thus, in addition to the macroeconomic outlook, the discussions focused on the main policy priorities for achieving these objectives. The major challenges for Slovenia are to bring inflation down to 3-4 percent level,2 while entering ERM2 at a viable exchange rate; address the institutional factors that have contributed to inflation inertia and real wage rigidity; consolidate public expenditure within a clear medium-term framework in order to secure the government’s fiscal goal specified in the updated 2002 Pre-Accession Economic Programme (PEP); and complete the remaining agenda for financial sector reform. Slovenia already meets the Maastricht criteria for the fiscal deficit and debt ratio.3

A. Macroeconomic Outlook

12. During the December mission, the authorities were upbeat about the prospect of real GDP growth climbing back to the growth rate of potential output by 2004, but have subsequently revised downward their near-term forecast. The rolling two-year budget for 2003-04, prepared in mid-autumn 2002, projected real GDP growth to rise to 3.7 percent in 2003 and 4.1 percent in 2004, premised on a strong recovery of both domestic and foreign demand. The staff argued that expectations indicators pointed to a slow pickup in both private consumption and private investment. There also were uncertainties about the strength of the EU’s expected recovery and the drag from higher international oil prices. The authorities acknowledged the downside risks to their growth projections, and have subsequently lowered their GDP forecast for 2003 to a range of 3-3.4 percent, overlapping with the staffs current projection of 3.2 percent. Updated official projections for 2004 are not available; the staff projects real GDP growth to climb to 3¾ percent, on the basis of a continued recovery in Europe, and the expectation of a strong pickup in private consumption driven by the release of funds from the housing savings scheme.

13. There was consensus that the external current account would likely remain in sizable surplus in 2003-04 by about 1¾-2 percent of GDP, but that the evolution thereafter was uncertain. Export growth should remain robust, with demand from the EU strengthening but the scope for gains in market share in non-EU countries tapering off. Imports should be boosted by the pickup in domestic demand and overtake export growth in due course. BoS officials cautioned that uncertainties surrounding the likely evolution of the external current account beyond 2004 were greater than usual, given the risk of a demand boom brought about by a convergence-related decline in interest rates. Assuming strong private consumption growth based on a decline in the private saving ratio toward its historical average, and taking into account domestic investment plans of Slovene enterprises, the staff projects the current account surplus to fade away over the medium term. BoS officials expected a modest increase in the reliance of enterprises and households on foreign financing upon EU accession.4 Thus, the external debt ratio is anticipated to decline to about 33 percent over the medium term. Gross official reserves are projected to exceed external debt by 2007 (Tables 5 and 6). Stress tests point to modest risks to the staffs baseline external projections, but sustainability is not a serious concern (see Appendix III).

Table 5.

Slovenia: Balance of Payments, 1998-2004

(In millions of U.S. dollars, unless noted otherwise)

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Sources: Bank of Slovenia; and IMF staff projections.

Stocks and flows may not reconcile due to valuation changes.

Table 6.

Slovenia: Medium-Term Macroeconomic Scenario, 1999-2008

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Sources: Information provided by the Slovene authorities; and IMF staff estimates and projections.

14. The BoS has revised upward its inflation projection for 2003. Inflation is now officially projected to fall to 5.3 percent at end-2003—compared with a forecast of 4 percent established when the BoS adopted the new monetary framework in January 2002—and to decline further to 3.5 percent at end-2004. BoS officials were concerned about the risks to disinflation arising from higher oil prices.5 Subsequent to the discussions, in order to avoid higher inflation that could get locked in because of wage indexation, the government lowered the excise tax on gasoline in response to higher international oil prices, and decided to offset the decrease in tax revenue by cuts in expenditure. The staff considered the BoS’s revised end-2003 inflation goal to be feasible, given the authorities’ plans for administered price adjustments (see ¶22), but was skeptical that the current policy setting would yield the disinflation path envisaged in 2004. Taking into account the price impact (estimated at ½ percentage point) of a further increase in excise duty on tobacco to progressively align it to the EU average, the staff projects inflation to fall to around 4¾ percent at end-2004.

B. Monetary and Exchange Rate Policy

15. The authorities viewed the partial shift toward an inflation-targeting framework in early 2002 as a useful adaptation to a changed environment. With capital account liberalization reducing the central bank’s control over broad money, the BoS shifted at the beginning of 2002 from monetary targeting to a discretionary approach bearing some hallmarks of inflation targeting.6 The main innovations of the new approach were the announcement of a medium-term inflation objective and publication of BoS inflation forecasts twice a year. However, the authorities explained that the operational mechanisms of policy had not greatly changed. The focus still was on trying to control inflation primarily by keeping a grip on liquidity, though over a longer horizon. Toward this end, efforts continued to be directed toward adjusting interest rates while also managing the exchange rate with the aim of discouraging interest-sensitive capital inflows. The BoS conducts its exchange rate policy through temporary swaps (rather than outright purchases) of foreign currency from banks, while restricting the growth of base money by means of sterilization operations. Because of the reliance on swaps and an associated swap fee paid by banks to the BoS, the cost of sterilized intervention is reduced.

16. The authorities agreed that the main challenge facing monetary policy was how to disinflate while entering ERM2 at a viable exchange rate. In this regard, the staff noted that the record of the past several years pointed to broad stability for the real exchange rate (see Figure 3 and 5) but also for the inflation rate. Even after discounting the impact of changes in administered prices and indirect taxes, there had been little progress in disinflation (see text table next to ¶5). While the reasons for this record were complex and included institutional rigidities (see below), one aspect seemed to be that periodic steps toward policy tightening were not sustained long enough. The series of missed and revised inflation forecasts may also have adversely affected the entrenchment of disinflationary expectations. In this light, the mission asked about the relative role of competitiveness and other considerations in shaping monetary policy.

17. The BoS officials indicated that while their primary focus was on disinflation, the policy stance was also influenced by concerns that the burden of disinflation not fall unduly upon the tradable sector and that short-term gains in disinflation through a stronger tolar might not prove sustainable. They explained that the observed broadly stable real exchange rate was not a policy objective, but an outcome of the attempt to equalize the domestic and foreign costs of finance (in order to discourage capital inflows) and the prevailing dynamics of domestic and foreign interest rates. Nevertheless, competitiveness also was a consideration in the policy stance, given its importance for a small open economy. Also, the BoS had accommodated the first- and second-round effects of price shocks originating from increases in taxes and administrative prices out of concerns that a more restrictive monetary policy would hurt the tradable sector and further dampen economic activity. BoS officials further argued that efforts to lower inflation more rapidly through a stronger tolar entailed risks of capital inflows or, if the expected interest differential with abroad was maintained by a reduction of interest rates, an expenditure boom that could lead to external imbalances as well as undermine the disinflation efforts. They were also wary of large exchange rate fluctuations as experienced by some EU accession candidates in the region.

18. Given the aim of nominal convergence with the euro area and the likely significant costs to the real economy of bringing down inflation once a central exchange rate with the euro had been adopted, the staff called for a greater and more sustained effort to bring inflation down in the period immediately ahead. In this regard, the mission observed that there seemed to be scope for further "testing the waters" through a stronger tolar without unduly exposing the economy to risks, especially given the strong external current account position. BoS officials did not dispute this assessment, but emphasized that complementary efforts from the government and social partners were necessary. They explained that in the past when the BoS had pressed ahead with disinflation, these entities had felt less constrained and created additional price pressures that offset the disinflation gains achieved through monetary policy.

19. The staff also stressed the importance of the BoS investing greater credibility and accountability in its inflation objectives, which should become cast as targets rather than projections. In this respect, the staff recommended that the BoS also forecast and monitor a measure of inflation that excluded administered prices and indirect taxes, to help it better assess underlying price pressures, assume accountability, and shape public expectations.

20. The BoS is aiming to formally eliminate indexation of all financial contracts by mid-2003, based on the recent initiative taken by the banking sector. As de-indexation of short-term financial contracts in July 2002 did not show any adverse impact on banks’ balance sheets, the leading commercial bank began to offer in November 2002 long-term deposits and loans at nominal interest rates linked to the 60-day BoS tolar bill rate, and other banks followed suit quickly. The government also issued a small amount of three-year securities with nominal interest rates in the second half of 2002, though longer-term public debt issues mainly remained indexed. Against this background, BoS officials agreed that there was little to be gained from delaying nominalization of all financial instruments, even though conditions for a first-best reference rate were not yet in place, and indicated that steps would be initiated to repeal the relevant law.

C. Price and Wage Policies

21. The authorities’ disinflation strategy also entails addressing the cost-push factors that have contributed substantially to inflation inertia over the past years. Efforts are being geared mainly toward reducing the pressures from changes in administered prices and indirect taxes, moderating public sector wage growth, and making wage indexation weaker.

22. In this regard, the authorities pointed to the decision to defer increases in taxes on water supply and environmental discharges, and to cap increases in administered and regulated prices in 2003 at the projected inflation rate. Unlike in previous years, the size and timing of the price increases were being coordinated with the BoS, a development welcomed by the staff. The authorities argued that many of the recent increases in administered and regulated prices did not reflect legitimate cost recovery, and that the price cap imposed by the government would not result in losses for the service providers. They agreed with the staffs observation that administered and regulated price adjustments needed to be approached from a medium-term perspective—in order to eliminate uncertainties for service providers and encourage them to generate internal savings through efficiency gains—and indicated that they would take steps to prepare and coordinate a multiyear program.

23. The authorities’ goal is to have public sector wages rise at a slower pace than private sector wages. Toward this end, the government has already taken steps to restrict extraordinary promotions. Also, a new wage setting system for the public sector (including education and health workers) will be introduced in 2004 under which collective agreements would be centralized, and bonus payments would be performance-based and subject to an upper limit.

24. Changes are envisaged in the wage indexation mechanism in 2004, with the aim of making it weaker. The existing indexation mechanism for economy-wide basic wages is forward-looking with respect to the CPI, and has a clause for almost full catch-up for higher inflation by year-end. Social partners in the private sector have agreed to move to a wage indexation formula in 2004 that will take into account inflation in Slovenia and in the main EU trading partner countries, and changes in the tolar/euro exchange rate; the details will be worked out in the coming months. In the public sector, individual-level indexation would be reduced in 2004, as one-half of the budgetary funds earmarked for wage bill indexation would be applied toward implementation of a new wage structure aimed at reducing wage dispersion.7 Negotiations on job grading and the allocation principles for set-aside funds between job categories are expected to start in May 2003. The authorities anticipated pressure from the social partners for additional resources for implementing the new wage structure, and indicated that if collective bargaining stretched into 2004, an election year, a successful resolution would be at risk.

25. The staff encouraged the authorities to work toward ensuring that wage indexation was not formalized in the 2004 collective agreements for the public sector. Recognizing that wage flexibility in both the public and private sectors was essential in the context of ERM2 entry and the eventual adoption of the euro, the authorities indicated that efforts would be initiated with the social partners to achieve full understanding of the need to eliminate wage indexation. However, in the meetings with the mission, labor union representatives emphatically stated that they would not consider elimination of wage indexation until inflation came down to EU levels.

D. Fiscal Policy

26. The authorities explained that the rolling two-year budget for 2003-04 had been formulated consistent with Slovenia’s medium-term goal of attaining close to structural balance before adopting the euro. The budget targets a modest reduction of the general government deficit to 1.2 percent of GDP in 2003 and 0.9 percent of GDP in 2004, implying a small structural withdrawal in both years. The budget authorizes additional borrowing of up to SIT 15 billion (¼ percent of GDP) each year in the event of revenue shortfalls. No new revenue measures are planned, except for increases of excise duties on tobacco in line with EU accession commitments. Large increases have been budgeted for border policing and defense, in line with EU and NATO requirements, and for investment. However, efforts would be also directed toward restraining spending on goods and services of most direct users of the state budget, keeping wage increases moderate, obtaining a saving in pension expenditure in 2003 from a change in the indexation formula, and avoiding additional entitlements for social transfers beginning in 2004 (Table 7). Because negotiations were still ongoing at the time of budget preparation, the full fiscal effects of EU accession had not been incorporated in the budget proposal.

Table 7.

Slovenia: Summary of General Government Operations, 1999-2004

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Sources: Ministry of Finance; and IMF staff calculations.

Due to a shift in the budget accounting to a pure cash basis, there were only 11 months of VAT and excise tax revenues. Adjusted for this shift, the revenue ratio would be 42.3 percent of GDP and Ihe general government deficit would be 1.4 percent of GDP.

IMF staff projections.