Statement by Johann Prader, Alternate Executive Director for the Republic of Slovenia, and Ksenija Maver, Assistant to the Executive Director

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.


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.

April 16, 2003

The Slovenian authorities would like to thank the staff for its excellent report, and for the constructive, stimulating discussions during the consultation process. The authorities broadly agree with the staffs view of Slovenia’s economic situation.

Prudent macroeconomic management has help smooth the way toward EU accession. Slovenia’s successful EU accession negotiations, concluded in December 2002, were followed in March 2003 by a strong referendum vote in favor of EU membership, and the signing of the Treaty and Act of Accession on April 16, the very day when this Article IV consultations is to reach the Board, will mark the next major milestone. Slovenia will officially join the EU in May 2004. The next major priority on Slovenia’s policy agenda is to achieve early entry into ERM 2.

Slovenia’s retention of its resilience despite the slowdown in neighboring countries resulted mainly from its sound fundamentals and vigorous export sector. Slovenia’s growth in 2002 was a solid 3.2 percent, up from 3 percent in 2001. Following the downward adjustments reflecting recent global developments, growth of 3.1 percent is still expected for 2003, down from the 3.7 percent projected last fall. This trend was supported in 2002 by a comfortable current account surplus of 1.8 percent, a moderate fiscal deficit of 1.4 percent of GDP, and a general government debt ratio of 28 percent of GDP. Despite a slowdown in its major trading partners, in 2002 Slovenia maintained its market shares and in some cases even increased them by 0.5 to 1 percentage points.

The first months of 2003 have seen a resumption of the disinflation interrupted by the introduction of the VAT in 1999. In 2002 the original target of 5.8 percent was missed due mainly to cost-push factors, and the year ended with inflation still slightly above 7 percent. In January 2003, the authorities reacted by adjusting the excise duties on oil, and by taking a coordinated approach to administered prices. By the end of February 2003 the annualized inflation rate had been reduced to 6.2 percent. In early March the central bank followed up reducing the policy rate and the pace of depreciation. If there are no external surprises, inflation targets of 5.3 percent for end-2003 and of 3.5 percent for end-2004 are within reach, and are consistent with the stability required for ERM-2 entry in January 2005.

Smooth and balanced progress towards ERM-2 and the euro, with minimal costs and disruptions, is now the core objective of fiscal and monetary policy. This will involve a number of complex challenges, such as maintaining the momentum of disinflation, achieving a structurally balanced budget, abolishing indexation, deepening the money market, and further reinforcing the financial sector. One of the most important tasks at present, both for Slovenia and other ERM-2 candidates, is to have a viable central exchange rate with an appropriate band by the time of ERM-2 accession. Slovenia looks to the Fund for an active dialog on its policy options and continuing advice.

Monetary Policy

The central bank’s main goal is to maintain price stability by controlling the money supply. Given the free flow of capital, the money supply must be controlled by adjusting both interest rate and the exchange rate dynamics.

To achieve its inflation targets, the central bank must depend on the Government to support its monetary policies by adhering to the planned restraints on public spending and public sector wage growth, and direct or indirect price curbs to keep prices in line with underlying trends.

The Bank of Slovenia’s monetary policy under an exchange rate regime consisting of a managed float is tailored to Slovenia’s specific circumstances. It has attracted some academic discussion and deserves a brief explanation here. The managed float was chosen to permit some monetary flexibility even in a context of unrestrained capital flows. The central bank’s ability to sterilize net foreign exchange inflows is an important aspect of the monetary framework.

The central bank has two levers for controlling the money supply: interest rates and the exchange rate. Interest rates must be adjusted in response to inflation dynamics and inflation expectations. Exchange rate adjustments, expressed as annual growth rates, must minimize differentials between domestic and foreign interest rates (except those caused by country risk) in order to discourage short-term speculative flows. In effect, the central bank uses its exchange and money market interventions to ensure an appropriate supply of base money.

In conditions of strong, unrestricted capital flows, foreign exchange interventions are an important way of managing the exchange rate. In Slovenia’s case this is based on an agreement between the central bank and the commercial banks to cooperate in the foreign exchange market which enables the central bank to set the range of rates for the commercial bank’s dealings with other parties.

This special agreement serves the interests of both the central bank and the commercial banks, and ensures the transparency of monetary policy. Practically all of Slovenia’s commercial banks have signed on. These commercial banks have a standing facility for the temporary sale of foreign currency to the Bank of Slovenia, with a compulsory repurchase after seven days; and in some cases for the temporary sale of foreign currency with the option of an outright sale after 270 days. This swap facility enables the central banks to adjust supply and demand in the foreign exchange market. It gives the commercial bank a way of managing their foreign exchange positions, as well as a major source of liquidity. The commercial banks pay interest on this liquidity, based on the swap rate set by the central bank. This swap rate, added to the Euro interest rate, represents the central bank’s main policy rate. To sterilize excess liquidity caused by the extensive monetization of foreign exchange inflows, the Bank of Slovenia issues tolar-denominated central bank bills. It is important to understand that the swap rate and the tolar bill rate are such as to make these monetary operations financially viable for the central bank.

The Bank of Slovenia’s monetary policy is aimed at bringing down inflation to the established target in time for ERM-2 accession. So far, monetary policy has also succeeded in supporting the external account. And the relatively stable real effective exchange rate was the welcome result—but not a target—of the monetary policy interventions.

During 2002, monetary policy was complicated by two major factors, high inflation and record investments inflows. These high inflows, amounting to 8.8 percent of GDP were mostly caused by sales of equity shares in Lek, a big pharmaceutical company, and Nova Ljubljanska Banka d.d., the largest Slovenian bank. The central bank’s policies just described succeeded in sterilizing liquidity in the banking sector and preventing an excessive increase in the money supply and a sudden unsustainable appreciation of the nominal exchange rate.

The higher inflation rates at the beginning of 2002 caused the central bank to make several increases in its main policy rate and the interest rates of other monetary instruments. These adjustments, together with a decreasing trend in foreign interest rates, interrupted the desired slowing of the tolar’s depreciation. The ECB’s cut in its main refinancing rate was followed, in December 2002, by the Slovenian central bank’s policy rate cut of 0.5 percentage points. This would not have been possible without the successful coordination of policies that had been established between the government and the central bank. A second cut, last month, of 0.75 percentage points, was a response both to the decline in inflation, and to the ECB’s rate cut. Declining inflation was also the reason for the slowing of the nominal depreciation of the tolar. The real appreciation of the tolar in the 12 months preceding February 2003 amounted to 5.3 percent.

For 2003, the Bank of Slovenia foresees no major changes in its conduct of monetary policy. The lowering of interest rates will go hand in hand with the expected decline in inflationary expectations, subject to the influence of movements in foreign interest rates. The central bank will also continue to slow the rate of tolar depreciation in order to support the disinflation. In addition, the central bank has already begun to reduce its presence in the foreign exchange market. Its various policy options will be weighed with due regard to their effects on capital flows and on the behavior of investors and domestic consumers.

Fiscal Policy

Slovenia’s public finances ran small surpluses until the mid-1990s, and have since registered deficits of less than 1.5 percent of GDP. The 2003-2004 budget, which targets deficits of 1.2 percent of GDP in 2003 and 0.9 percent of GDP in 2004, sets the stage for a gradual fiscal consolidation, with emphasis on expenditure, in preparation for the adoption of the euro.

The fiscal situation became difficult in early 2003, with revenue shortfalls and weaker growth prospects due to the weakening global environment. The figures for the first two months pointed to a possible slippage of as much as 1 percent of GDP for the year, in place of the planned structural withdrawal of 0.3 percent of GDP.

On April 3, 2003, the authorities quickly tightened the fiscal stance by restricting capital expenditures, by limiting discretionary spending on goods and services and freezing new hiring in the public sector. These fiscal measures will remain in place until the supplementary budget for 2003 is in place. A draft will be discussed on April 17. This supplementary budget will increase, by about 0.3 percentage points of GDP, the original budget deficit target of 1.2 percent of GDP, and will include savings resulting from revised spending priorities. The 2004 budget will be reviewed next fall in the course of the regular budgetary procedure. By taking early action, the authorities hope to ensure the credibility of Slovenia’s path toward ERM-2 and euro zone accession, and to support the disinflation process.


Indexation of wages and social transfers is seen as the main remaining obstacle to successful disinflation. De-indexation began in early April 2003, after a social agreement had been reached on private and public sector wages for the period 2003-2005. This agreement will link wages to the average EU inflation rate, and will be adjusted only for the amount by which Slovenia’s actual inflation exceeds targeted inflation. The agreement also provides that wage growth will stay at least 1 percentage point behind productivity growth.

De-indexation of financial contracts began in 2002. The authorities’ efforts to accomplish de-indexation are focused on two areas. The formal elimination of indexation began with banks’ short-term financial contracts in June 2002, and will be extended to banks’ long-term financial contracts. The second area is long-term nominal instruments: the March 2002 fixed-rate three-year government bond issue was complemented in March 2003 by a five- year nominal bond issue. The commercial banks have followed suit by beginning to offer long-term instruments with nominal interest rates.

The nominalization of bonds will be an important boost not only for the de-indexation of the economy, but also to the deepening of the domestic primary and secondary markets. The process will likewise affect the formation of the yield curve and make the cost of borrowing more transparent, and establish a benchmark of progress toward the Maastricht nominal convergence criteria.

Slovenia’s banking sector is sound, despite the recent strain which affected only one small bank. Even though foreign exchange lending increased considerably during 2002, the risk portfolio of the banks’ balance sheets did not change, since regulatory provisions require the open foreign exchange position to remain low. Increased demand for banks’ foreign exchange loans came mostly from exporters seeking to hedge their foreign exchange exposures, which suggests that the banks’ and the exporters’ risks are well covered.

The authorities have requested an FSAP Update mission to provide a final test of financial system strength before EU entry and complete the Action Plan implemented on the recommendation of the 2000 FSAP mission. The valuable advice of the Fund and the World Bank during that mission was helpful to the process of strengthening the financial market and preparing it for the competitive pressures of the EU. It is expected that the FSAP Update mission will take place in early autumn.

The above steps, and many others not described here, show the strength of the authorities’ commitment to keep the forward momentum based on macroeconomic stability, and to carefully navigate the remaining tasks to be completed to reach Slovenia’s ambitious goals.