Republic of Slovenia
2006 Article IV Consultation: Staff Report; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for the Republic of Slovenia
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International Monetary Fund
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Publication Date:
10 Jul 2006
eISBN:
9781451835779
Language:
English
Keywords:
ISCR; CR; EMU convergence price index; euro adoption; Maastricht convergence criteria; inflation criterion; fiscal policy; exchange rate; labor market; productivity growth; Europe
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Slovenia is set to become the first among the new European Union member states to adopt the euro. Executive Directors emphasized the need to implement policies that increase productivity, create an efficient business environment and a flexible labor market, and improve sustainability of public finances in the face of population aging. Labor participation is also relatively low among the older and younger working-age population. To deal with these challenges, the authorities should speed up efforts to raise labor utilization by lowering marginal tax rates, improving the target of social benefits and reducing incentives for early retirement.

Abstract

Slovenia is set to become the first among the new European Union member states to adopt the euro. Executive Directors emphasized the need to implement policies that increase productivity, create an efficient business environment and a flexible labor market, and improve sustainability of public finances in the face of population aging. Labor participation is also relatively low among the older and younger working-age population. To deal with these challenges, the authorities should speed up efforts to raise labor utilization by lowering marginal tax rates, improving the target of social benefits and reducing incentives for early retirement.

I. Introduction

1. Slovenia is set to become the first among the new EU member states to adopt the euro. Aided by broadly favorable initial conditions and generally sound macroeconomic and incomes policies, Slovenia has over the past decade sustained robust growth with small external imbalances, while gradually lowering inflation to euro–area levels. Long–term interest rates, the fiscal deficit, the public debt ratio, and inflation were all within the Maastricht Treaty limits at end–2005. This, combined with the tolar’s two successful years within the ERM2, has set the stage for euro adoption in January 2007.

A01ufig01

Growth has been strong over the past decade.

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Source: World Economic Outlook.

2. The achievements notwithstanding, Slovenia faces structural challenges that need to be addressed to ensure success in the euro zone. Although Slovenia’s gradualist approach to reform has contributed to macroeconomic stability, it has left the country with many structural rigidities—notably an inflexible budget, a welfare system that discourages labor participation, and a restrictive business environment. The loss of the exchange rate instrument puts a premium on softening these rigidities. Over the longer horizon, Slovenia’s population aging is expected to be among the most rapid in Europe, creating strong fiscal pressure through higher pension and health spending. Combined with a productivity growth lagging behind that of the other new Central European EU members (NM–8), this demographic trend could also weaken the growth potential. With the near–term outlook largely benign, the Article IV consultation focused on how to deal with these medium– and longer–term challenges.

A01ufig02

Slovenia has lowered inflation to euro area levels.

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Source: World Economic Outlook, IMF.1/ Average for Czech, Estonia, Hungary, Latvia, Lithuania, Poland, and Slovakia.
A01ufig03

But progress in implementing structural reforms has been less impressive.

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Source: EBRD Transition Report, 2005.1/ Simple average across all categories surveyed. The closer the average is to 4 the closer the economy is to “the standards of an industrialized market economy.”

II. Background

3. Strong growth continued in 2005, bringing output close to potential (Table 1, Figures 1 and 2). In 2004, GDP growth reached a five–year peak of 4¼ percent, fueled by EU–accession–related investment, including inventory accumulation. Although the subsequent unwinding of inventories slowed domestic demand, growth in 2005 at 3.9 percent remained above the estimated potential of 3¾ percent, driven by strong exports. Consumption continued to contribute to growth, buoyed by real wage increases (of around 2 percent) and booming consumer loans. The strong activity boosted job creation, especially in services, and unemployment remained low at 6½ percent even as participation rates improved slightly. These trends, and the increase of the capacity utilization rate to the highest level in a decade, suggest that the output gap has been closed almost fully.

Table 1.

Slovenia: Selected Economic Indicators, 2000–08

article image
Sources: Data provided by the Slovene authorities; and Fund staff calculations and projections.

For 2006–08, Spring 2006 forecasts of the Slovene Insitute of Macroeconomic Analysis and developments.

Revenue and expenditure exclude social security contributions paid for government employees.

Figures reflect a shift in the budget accounting to a pure cash basis entailing only 11 months of VAT and excise tax revenues.

Adjusted for the methodological change, the general government deficit would be 1.5 percent of GDP.

For deposits with maturity between 31 days and 1 year.

Figure 1.
Figure 1.

Slovenia: Economic Indicators, 1999–2007

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Sources: Bank of Slovenia; Ministry of Finance; Statistical Office; and IMF staff projections.1/ Fiscal deficit and public debt as of end–2005; interest rate as of February 2006; inflation rate as of March 2006.
Figure 2.
Figure 2.

Slovenia: Labor Market Indicators, 2000–05

(y–o–y percent change, unless otherwise indicated)

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Sources: Employment Service of Slovenia; Monthly Bulletin, Bank of Slovenia; WEO; and IMF staff estimates.1/ 2005 LFS data refers to third quarter.2/ For 2005, data refer to the second quarter.

4. In keeping with its record of fiscal prudence, Slovenia maintained a tight fiscal stance in 2005 (Table 2). In a performance setting it apart from its Central European peers, Slovenia has maintained low fiscal deficits, with public debt below 30 percent of GDP. In 2005, the general government deficit, at 1.1 percent of GDP, was below target, due to one-off municipal revenues and lags in spending EU transfers.1 Tax revenues were buoyant, reflecting the recovery of indirect taxes from a temporary drop following EU accession. Adjusting for cyclical effects, the deficit implied a neutral fiscal stance for the year.

A01ufig04

Slovenia has maintained a conservative fiscal policy with low deficits and debt.

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Source: World Economic Outlook.1/ Net debt for Hungary.
Table 2.

Slovenia: Summary of General Government Operations, 2003–08 1/

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Sources: Ministry of Finance; and Fund staff calculations and estimates.

Based on GSF 1986, unless otherwise indicated.

5. With limited scope for independent central bank action, monetary conditions tightened only marginally in 2005(Table 3 and Figures 3). Having set its key policy interest rate at 4 percent upon entering ERM2 in 2004, the BoS maintained the rate at that level through 2005. However, a surge in short–term capital inflows prompted reductions in February and March 2006 by 25 basis points each. Together with the recent increases in European Central Bank (ECB) rates, this narrowed the tolar–euro interest rate differential from 2 to 1 percent. Yet, the tolar–euro exchange rate has remained stable, aided by BoS swap operations.2 With a broadly unchanged REER and lower inflation, the BoS stance implied a slight tightening of monetary conditions in 2005.

Table 3.

Slovenia: Monetary Survey, 2000–05

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Source: Bank of Slovenia, Monthly Bulletin.
Figure 3.
Figure 3.

Slovenia: Monetary Conditions, 2000–06

(In percent)

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Sources: Bank of Slovenia; Eurostat; and Statistical Office of the Republic of Slovenia.1/ Vis–à–vis the euro.

6. In the context of broadly neutral macroeconomic policies, wage discipline has supported disinflation (Figures 4 and 5). Despite the diminished slack in activity, core inflation more than halved—to less than 1 percent—during 2005, owing to lower tolar depreciation expectations, increased competition following EU accession, and prudent macroeconomic and incomes policies. In particular, guidelines setting wage growth below that of productivity helped minimize second–round effects of energy price shocks. The benign core inflation led headline inflation to a historical low of 2½ percent during the year.

Figure 4.
Figure 4.

Slovenia: CPI Inflation and Components, 2000–06

(Year–on–year change, in percent)

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Sources: Statistical Office of the Republic of Slovenia; Eurostat; and IMF staff calculations.
Figure 5.
Figure 5.

Slovenia: Wages and Productivity, 1998–2005

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Source: Statistical Office of the Republic of Slovenia.1/ Wages in respective sector divided by wages in the manufacturing sector.2/ Includes public administration; education; health; and other social services.3/ Includes distributive trade; hotels and restaurants; transport, storage, and communications; financial intermediation; and real estate.

7. The current account moved to near balance in 2005, with strong export performance more than offsetting the impact of a terms–of–trade deterioration (Table 4 and Figures 6). The growing importance of Slovenia as a gateway to, and investor in, Southeastern Europe (SEE) boosted exports of services, especially tourism, transport, and construction. Despite the higher oil prices, moderation in domestic demand slowed nominal merchandise import growth to 11½ percent from over 16 percent in the previous year, while merchandise exports, led by cars, continued to grow by 12 percent. On balance, the current account deficit narrowed to about 1 percent of GDP from 2.1 percent in 2004.

Table 4.

Slovenia: Balance of Payments, 2000–10

(In millions of euros, unless otherwise noted)

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Sources: Bank of Slovenia; and IMF staff prorections.

A negative number indicates net creditor position.

Stocks and flows may not reconcile due to valuation changes.

Figure 6.
Figure 6.

Slovenia: External Sector Developments, 2001–05

(In percent of GDP, unless otherwise indicated)

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Sources: Monthly Bulletin, Bank of Slovenia; and IMF staff calculations.
A01ufig05

Inflation declined in 2005 despite an increase in administered prices.

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Strong net service exports were the main determinant of the narrowing of the current account.

8. Despite the favorable external performance, indicators of competitiveness show a mixed picture (Figures 7–9). Measures of price competitiveness appear satisfactory, as evidenced by a stable real effective exchange rate and flat unit labor costs. Also, estimates of the equilibrium real exchange rate do not indicate a misalignment (see, for example, IMF Working Paper 05/27). However, in recent years Slovenia has underperformed regional competitors in gaining markets in EU–15 and world markets, and total factor productivity growth has lagged the NM–8, as has the pace of upgrading the quality and skill content of exports (Box 1 and SIP). Indeed, in 2005 manufacturing wages in Slovenia, adjusted for productivity, remained the highest among the NM–8.

Figure 7.
Figure 7.

Slovenia: Exchange Rate Indicators, 1998–2005

(1998q1═100) 1/

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.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, Germany, Italy, Poland, United Kingdom, and United States.2/ Unit labor costs in trading partner countries relative to those in Slovenia, adjusted for manufacturing producer price inflation–a rough indicator of developments in profitability.
Figure 8.
Figure 8.

Slovenia: Wages, Productivity, and Product ULC in Manufacturing, 1998–2005

(1998q1═100) 1/

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Sources: Statistical Office of the Republic of Slovenia; and IMF staff calculations.1/ Seasonally adjusted. Trade weights based on 1998–2000 data for exports of goods. Partner countries Comprise: Austria, Croatia, France, Germany, Italy, Poland, United Kingdom, and United States.2/ Defined as the ratio of nominal wages to producer price index.3/ Defined as the ratio of real product wages to productivity.
Figure 9.
Figure 9.

Slovenia: Competitiveness Indicators and Export Market Shares of Slovenia and New Member States

(1998q1═100), 1998–2005

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Sources: IMF Direction of Trade Statistics; and IMF staff calculations based on data from national authorities.1/ ULC in manufacturing in euros.2/ Ratio of Euro ULC between Slovenia and EU accession candidates. An increase indicates appreciation.3/ Calculated as the share of nominal exports of each individual country in the combined nominal imports of the following countries:Austria, France, Germany, Italy, United Kingdom, and United States. The share declines for all countries in 2004 because of higher oil and commodity imports.

Slovenia: Sources of Current Account Improvement, 2005

(Change in millions of euros over the same period of previous year)

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Sources: Bank of Slovenia; and staff estimates. Sources: Bank of Slovenia; and staff estimates.
A01ufig06

Wage growth has been moderating, ensuring lower unit labor cost pressures over the past few years.

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Sources: Statistical Office of the Republic of Slovenia; and staff calculations.
A01ufig07

Total factor productivity trails regional peers.

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Source: World Economic Outlook, IMF.1/ CEE-4 consists of Czech Republic, Hungary, Poland, and Slovak Republic.
A01ufig08

Slovenia’s manufacturing wages, adjusted for productivity, are relatively high.

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Sources:Country authorities; and staff calcualtions.
A01ufig09

Slovene exports have been unable to increase market penetration in the EU–15.

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Source: Direction of Trade Statistics, IMF.Note: Calculated as the share of nominal exports of each individual country in the combined nominal imports of EU 15 and the US.

Trends in the Skill and Technology Content of Exports

Slovenia’s competitive position in the high-tech industries of the EU–15 is eroding as regional competitors gain markets at a faster pace. Revealed comparative advantage indicators—Slovenia’s high–tech export share relative to that of the world—show that, although Slovenia had a strong initial competitive position, other NM–8s are catching up fast.

A01ufig10

Revealed Comparative Advantage of High–Tech Sector, 1994–2004

(Ratio)

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

The pace of quality improvement has also been slower than in the other NM–8s. The change in unit value ratios (UVRs) of Slovene exports—a proxy for quality—has been lagging behind that of NM–8 exports. This is linked to Slovenia’s small gains in market share in EU–15. A possible explanation is Slovenia’s relatively favorable initial position, which reduces the scope for catch–up. But, given the low FDI, Slovenia may have missed opportunities to gain from technological spillovers and market linkages.

A01ufig11

Change in Market Share versus Change in UVR, 1994–2004 (Ratio)

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Source: COMTRADE; and staff calculations.

9. Cross–border flows increased in 2005, signaling closer integration with global financial markets in the run–up to euro adoption (Table 5). With domestic interest rates declining toward EU levels and the local stock market underperforming, investors sought to diversify their portfolios to higher yielding markets abroad. In particular, households’ appetite for foreign–oriented mutual funds and firms’ direct investment abroad increased. Also, as deposits were declining as a source of funding, banks resorted to longer–term foreign borrowing—mostly at variable rates and with higher liquidity risk—to meet the strong demand for credit. Although gross external debt increased rapidly as a result, net debt remains at 20 percent of GDP, which together with the imminent euro adoption and a one–to–one reserve cover of short–term liabilities suggests resilience to sudden changes in market conditions.

Table 5.

Slovenia: Vulnerability Indicators, 2000–06

(In percent of GDP, unless otherwise indicated)

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

Credit including loans and other claims.

Yield differential between 5.38 percent (coupon) Slovene eurobond maturing 2010 and 5.38 percent (coupon) German government bond maturing 2010.

NFS denotes nonfactor services.

Remaining maturity basis.

Banking Sector Soundness Indicators, 2003–05

(In percent; end of period)

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Source: Bank of Slovenia.

For 2005, data as of September.

10. The banking system remains sound and stable, but pressures on profitability and market risks are increasing (Table 6, Figures 10 and 11). On the positive side, bank profitability improved slightly in 2005 despite a drop in interest income and increased competitive pressures. Also, the non–performing loan ratio declined, although this partly reflected a rapid expansion of new credit. But there were also indications of a relaxation of credit standards in the competition for market share, which combined with the increasing recourse to variable rate contracts has increased interest rate risks and the associated credit risks. This is increasingly straining bank profitability, which is already low by regional standards.

Table 6.

Slovenia: Banking Sector Soundness Indicators, 2000–05

(In percent; end of period)

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Source: Bank of Slovenia.

Data as of September 2005.

Table 7.

Slovenia: Macroeconomic Framework, 2000–10

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

Government capital transfers are not included in government investment. In 2002 correcting to move to cash accounting.

Includes the statistical discrepancy.

Figure 10.
Figure 10.

Slovenia: Bank Lending Rates on New Loans, 2003–06

(In percent)

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Sources: Bank of Slovenia; Eurostat.
Figure 11.
Figure 11.

Slovenia: Credit Developments and Capital Inflows, 2000–05

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Source: Bank of Slovenia.
Figure 12.
Figure 12.

Slovenia: Trade Specialization and Quality Indicators, 2000–04

(In percent, unless otherwise noted) 1/

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Source: COMTRADE Database, Staff calculations.1/ Underline data reflects exports to EU–15 market.

11. Structural reform has lagged behind progress with macroeconomic policies, leaving the economy with many rigidities. Generous welfare and retirement benefits have reduced incentives to work, leading to low labor participation rates, especially among low-income and older workers. Slow privatization, inflexible labor markets, and regulatory constraints that impede the business environment have been reflected in FDI flows and productivity performance that compare unfavorably with those in the other Central European countries. These factors, combined with a rigid budget and one of the fastest aging populations in Europe, pose challenges to Slovenia’s long-run fiscal sustainability and growth prospects.

A01ufig12

The projected rise in the elderly dependency ratio is among the fastest in Europe

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Sources: United Nations; and staff calculations.

III. Report on the Discussions

12. With immediate prospects largely favorable but longer–term structural challenges looming, the discussions focused on the policy requirements for maintaining a balanced expansion, increasing the economy’s flexibility, and supporting long–term growth in the face of population aging. The mission also discussed the prospects for the financial sector after euro adoption. In line with previous consultations (Box 2), there was much agreement on the direction of policies, although the authorities stressed that substantive reforms are likely to take time in a consensus–driven society.

Implementation of Past IMF Policy Recommendations

Fiscal policy. Slovenia has maintained an overall prudent fiscal policy, which the staff has supported. The fiscal stance has also been adjusted to cyclical conditions in line with staff recommendations. The authorities have been less successful in undertaking needed expenditure rationalization.

Monetary policy and financial sector issues. Over the years, the BoS followed a gradual approach to disinflation based on declining currency depreciation. While not disagreeing with the strategy, the staff argued for slower nominal depreciation of the currency and slower decline in tolar interest rates to achieve faster disinflation. After entering the ERM2 in June 2004, the BoS kept policy interest rates unchanged as long as possible in a cyclical upswing—as advocated by staff—until a surge in short–term capital inflows recently forced a reduction. Slovenia has also implemented most of the recommendations of the 2001 FSAP and of the 2004 FSSA update.

Structural reforms. Over the years, the authorities have generally resisted staff’s recommendations to deepen and accelerate structural reforms. This reflects the slow decision-making process in a consensus–driven society. The government in power since December 2004 has expressed a strong commitment to reforms, which the staff supports. However, progress since last year has been slow.

A. Outlook

13. The authorities and staff expected the economy to stay close to capacity, with growth around 4 percent in 2006 and 2007, and inflation to remain moderate. Domestic demand would be the main driver, as investment is expected to recover, led by construction activity. Household consumption should remain moderate, provided real wage growth continues to lag behind productivity growth. Although export growth is likely to be sustained given strong external demand, net exports would be flat owing to a pick up in capital imports. This assessment is supported by indicators of consumer and business confidence, and is in line with private sector forecasts. Assuming oil prices of $70 per barrel in 2006 and wages trailing productivity growth, the staff projects average inflation at 2½ and 2¼ percent in 2006 and 2007, respectively, slightly above the authorities’ projections. The government’s Institute for Macroeconomic Analysis and Development (IMAD), in particular, projected inflation at 2.1 percent in both years, mainly because it assumes lower wage, oil price, and domestic demand pressures.

14. The short–term risks to both growth and inflation were jointly seen as mainly on the upside. The staff assumes nominal wage growth to accelerate to 5 percent in 2006–07 from an estimated 4¾ percent in 2005, still consistent with average wage growth lagging productivity growth by ½–1 percentage points. This baseline takes into account the recent reversal of the trend of declining unemployment owing to an increase in participation. But so far there has been no wage agreement for 2006–07, and larger wage settlements than those assumed would have knock–on effects on pensions and household demand. Furthermore, higher energy prices would result in second–round effects in the absence of countervailing policies that had helped offset the impact of oil prices in recent years. On the downside, a sharp appreciation of the euro, or a sluggish euro–area recovery could slow demand.

15. Turning to the medium term, the authorities concurred that a loss of competitiveness following euro adoption was a key risk facing Slovenia. In particular, strong wage growth could lead to real exchange rate appreciation and loss of export competitiveness. To mitigate this risk, the authorities saw the need to focus structural reforms on productivity–enhancing measures to reduce the rigidities that remained an obstacle to growth. Greater flexibility was also needed to deal with possible external shocks from changes in international interest rates and euro appreciation in the context of unwinding global imbalances. The DSA (Appendices 3 and 4) indicates that a combination of these factors would also affect external debt dynamics. Under a baseline that assumes continued strong appetite for foreign loans by banks, the gross external debt–to–GDP ratio would rise to over 90 percent by 2010. Despite this increase, risks are contained as net debt remains resilient to standard shocks to interest rates, growth, or exchange rate changes, owing to the large shares of long–term debt and gross foreign assets.

B. Near–Term Policies: How to Maintain a Balanced Expansion?

16. While recognizing the limited scope for independent monetary policy, the staff agreed with the authorities that policy rates should be kept unchanged as long as market conditions permit. With the economy in no need for additional stimulus, policy rates should ideally be equalized with the ECB just ahead of euro adoption in January 2007. But the authorities recognized that if Slovenia’s risk premium falls rapidly and capital inflows surge, they may be forced to equalize rates earlier than that. Moreover, the remaining interest rate differential may narrow even faster if the ECB continues to raise interest rates. The authorities and staff therefore concurred that the onus of moderating domestic demand and inflationary pressures fell largely on fiscal policy.

17. While agreeing that a neutral fiscal stance would be appropriate in 2006, the authorities saw this challenging to achieve, given existing commitments and overperformance in 2005. Implementing the approved 2006 budget would imply a fiscal impulse of ½ percent of GDP (text table). Additional expenditure for highway construction by a public enterprise could boost it further by ⅓ percent of GDP, while election–year spending by municipalities out of their surplus funds provided further risks. Against this background, the authorities agreed to take measures to maintain the deficit at about 1 percent of GDP, but highlighted the difficulties with securing short–term expenditure savings in a rigid budget.

Measures of the Impact of Fiscal Policy, 2003–08

(Consolidated general government)

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Sources: Ministry of Finance; and IMF staff projections.

A negative sign represents a fiscal withdrawal.

18. The staff noted that wage restraint and strong productivity growth were also essential to sustaining non–inflationary growth.The consensus among social partners that has allowed wage growth to lag behind productivity growth has been critical for preventing cost–push pressures. The staff pointed out that inability to contain unit labor costs has often been the distinguishing factor among countries that have underperformed in the Euro zone.3 In this regard, current pent–up wage pressures posed a risk, especially following euro adoption. While acknowledging the risk, officials were confident that prudent wage settlements could be reached, given the social consensus about the need to maintain competitiveness in the euro zone.

A01ufig13

Ability to contain unit labor costs upon euro adoption has been associated with faster growth in the euro area

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Source: World Economic Outlook, IMF.1/ Eurozone–11 refers to the original 11 members.
A01ufig13a
Source: World Economic Outlook, IMF.1/ Eurozone–11 refers to the original 11 members.

C. Containing Financial Vulnerabilities

19. The authorities concurred that, with rising pressures on bank profitability, bank supervision needed to be vigilant to prevent credit standards from weakening and balance sheet vulnerabilities from emerging. Bank profitability is under increasing strain as yield convergence is compressing bank margins, euro adoption will eliminate most income from foreign exchange transactions, and increasing competition is pushing banks toward a riskier credit portfolio. Also, Slovenia’s provisioning is relatively low and the application of the new International Financial Reporting Standards will effectively result in a decrease of required provisioning. The authorities’ transitory measure of classifying the released provisions as reserves will alleviate this impact, but in the longer run the combination of these factors could weaken balance sheets in some banks. The authorities concurred, and noted that they are stepping up risk–based supervision of banks’ credit assessment standards to reduce credit risks. Nevertheless, these risks are contained—the authorities’ stress tests indicate that a one percentage point decline in interest margins leads only to a 0.6 percentage point decline in capital adequacy ratios.

The banking system is sound but less profitable than in comparable countries.

(2005 or most recent data available, in percent)

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Sources: National authorities; Bankscope; ECB; Eurostat; Global Financial Stability Report, IMF; IFS; and IMF staff estimates.

20. Both sides also agreed that while euro adoption will eliminate most exchange rate risks, the banking sector is becoming increasingly susceptible to market risks. A substantial share of new loans carry variable interest rates, exposing borrowers and banks to increases in euro–area interest rates. Also, the increased interest–rate sensitivity of lending can rapidly translate into credit risks. With borrowers having seen interest rates only decline over the past decade, the staff recommended increasing public awareness of interest rate risks, and that supervisors collect more comprehensive data on household indebtedness, including indicators of debt concentration and debt–servicing capacity. The rapid growth of mortgages suggests that the housing market is a related risk, and a database of residential real estate transactions should be established to monitor developments in prices and turnover. BoS officials agreed, but noted that expanding the credit registry to cover households is hampered by the unwillingness of some large banks to share data to protect their market positions. They also noted that the increase in the foreign assets of Slovenian residents has reduced the vulnerability of Slovenian banks to foreign interest rate shocks.

21. The authorities emphasized that, in an environment of strong cross–border financial linkages, they are increasingly cooperating with foreign supervisors to better detect regional vulnerabilities and limit contagion risks. Slovenian banks—about one third of whose equity is foreign owned—rely heavily on borrowing from foreign institutions that have a high exposure to the region (most of the increase in liabilities in 2005 was to Austrian banks, which now account 40 percent of foreign liabilities of Slovenian banks). Moreover, a large share of bank-financed assets are invested in SEE as bank deposits, FDI or in mutual funds, exposing Slovenia to developments in that region. The authorities noted that information exchange and joint supervision of foreign subsidiaries of banks were being enhanced. They argued that foreign banks are discriminating in their country risk assessments, and that parent banks would, if needed, inject capital to Slovene subsidiaries to protect their reputations. Nevertheless, officials acknowledged an increased concentration of risks as foreign banks lent through subsidiaries specializing in the region. They also expressed concern that under the new EU directives national authorities would not have supervisory control over majority foreign owned–banks, but would remain responsible for guaranteeing their deposits. The staff noted that this concern would need to be weighed against the considerable potential for increased profitability and technological upgrading that divestment of the state’s large remaining share in banks would bring.

Foreign ownership of banks is lower than in many comparable countries.

(2005 or most recent data available, in percent)

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Sources: National authorities; Bankscope; ECB; Eurostat; Global Financial Stability Report, IMF; IFS; and IMF staff estimates.

D. Fiscal Policy in the Medium Term: Enhancing Flexibility, Efficiency, and Sustainability

22. The government envisages significant tax and expenditure reforms to achieve structural balance over the medium term. Under the current budget forecast, the authorities aim for a 1 percent of GDP general government deficit in 2008 and structural balance in 2010. To lower the tax wedge and the high marginal tax rates, a gradual elimination of the payroll tax is planned through 2008. To further increase supply–side incentives, the authorities are also considering reducing the progressivity of personal and corporate income taxation, with an increase in indirect taxes as the offset. The most radical of these proposals, a flat tax, is facing opposition from unions and parts of the government, mainly on equity grounds. Expenditure reductions, mainly in the wage bill and discretionary and social outlays, have yet to be identified.

23. While concurring on the need for fiscal consolidation, the staff noted that cyclical and long–term sustainability considerations call for frontloading the adjustment. Under the authorities’ plan, the structural deficit would decline only marginally over the next three years. To contain demand pressures with output close to potential, the staff argued for early achievement of at least structural balance. Specifically, the staff recommended that structural balance, or even a small surplus, should be reached in 2009, implying an annual adjustment of some⅓–½ percent of GDP. While the public debt outlook remains favorable and resilient to shocks, longer–term aging considerations also support the case for faster consolidation. The staff pointed out that, under current policies, the long–run fiscal sustainability gap—the permanent adjustment needed to restore inter–temporal balance—is 10 percent of GDP in net present value terms (SIP). Moreover, each year of delay in reform increases the needed adjustment by ⅛ percent of GDP. Accordingly, the staff urged the authorities to move rapidly from plans to action with the envisaged tax and expenditure measures. The authorities agreed on the economic merits of faster adjustment, but noted that reaching political consensus on any change in social entitlements could be slow and difficult.

24. While supporting the tax reform plans, the staff stressed the importance of focusing expenditure reform to reduce structural rigidities. The planned tax reforms would reduce marginal effective tax rates, which are among the highest in Europe, and improve supply–side incentives to work, especially for high–skilled workers. But these needed to be supplemented by benefit reform, so as to improve incentives for labor participation, remove welfare traps that discourage the unemployed from re–entering the labor market, offset lower tax revenues, and make room for higher spending for an ageing population. The authorities noted that discussions on spending reform were ongoing. The staff welcomed the creation of a central registry of social benefits to prevent abuse and the draft law in parliament linking unemployment benefits to activation policies. Looking forward, the authorities were considering plans to unify various benefit indexation formulae, implement more flexible work arrangements in the public sector, trim public employment by one percent annually over the next three years, and adopt performance–based budgeting on a pilot basis.

25. The authorities agreed on the need for expenditure flexibility in the euro zone. The imminent loss of the exchange rate instrument puts a premium on fiscal flexibility in dealing with shocks. In this regard, the staff noted that Slovenia has a rigid public spending structure, as evidenced by a high share of nondiscretionary spending compared to its NM–8 peers. A cross–country comparison of key expenditures with performance outcomes shows room for improvement in many categories in Slovenia (SIP). For example, a decline in the primary school–age population has not been offset by a corresponding reduction in the number of teachers and schools, leading to high costs per pupil (relative to per capita GDP) compared to regional peers. In this context, efficiency could be enhanced by reviewing rigid social sector funding and institutional arrangements, giving priority to reforms in areas where Slovenia’s performance falls most short of comparator countries (text table). The authorities were well aware of the need for fiscal flexibility in adjusting to shocks, and welcomed the staff’s analysis as a useful input into their expenditure policy discussions.

A01ufig13b

Efficiency of primary education in Slovenia can be substantially improved.

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Public primary spending per student (as a share of GDP/capita)
A01ufig14

Non–discretionary spending in Slovenia is high and rigid compared to the NM–8.

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Source: Staff estimates.

26. The authorities shared staff concerns about longer–term budgetary pressures from population aging. Slovenia’s pension problem is particularly severe: the country has one of the most rapidly aging populations in Europe, one of the lowest average retirement ages in Europe, and one of the highest ratios of pensions to wages among the NM–8 (Box 3 and SIP). The substantial parametric reforms initiated in 2000, which among other things provided for a gradual increase in the retirement age, were subsequently set back by a shift to wage–based indexation. With the reforms therefore insufficient to restore sustainability, pension spending is projected to rise by over 7 percent of GDP by 2050. The authorities were well aware of these challenges and were looking for ways to enhance sustainability of the system, but noted that radical reform in the near term is unlikely. Measures are, however, envisaged to boost private saving for pensions, including the removal of the minimum return requirement on voluntary pensions and the establishment of employer–funded retirement accounts. The authorities are also reviewing the number and indexation methods of the numerous non–contribution based pension benefits. To deal more decisively with the aging pressures, the staff recommended strengthening the link between benefits and contributions; raising the statutory and effective retirement ages; revising the costly wage–based indexation formula; and improving incentives for private saving for retirement.

E. Reducing Structural Obstacles to Growth

27. The staff stressed the need for reforms to improve labor market participation and flexibility. Despite Slovenia’s solid economic performance, productivity growth has not shown the dynamism seen among regional competitors, and labor force participation has fallen in relative terms (Box 4 and SIP). Trailing productivity performance compared with other Central European countries appears closely linked to weak investment, labor market rigidities, and regulatory constraints—factors that are slowing convergence to euro area income levels.

28. The authorities were actively considering ways to improve the functioning of the labor market. Discussions were underway within the government and social partners on further measures to link payment of social benefits with activation policies, in line with the “flexicurity” and “work ability” models applied in the Nordic countries.4 These measures, along with the reduction of marginal effective tax rates, would increase the incentives for labor participation. The source of some youth unemployment may also lie with the education system, which has weak links to private sector skill demands. Measures to ensure that graduates enter the labor market with sufficient and marketable skills, and to create adequate possibilities for life–long learning, would also help improve Slovenia’s competitive edge. Concurrently, relaxing labor market regulations, including through lower costs of hiring and firing and a wage–setting mechanism that allows an opt–out for distressed companies, would be needed to increase labor demand. Labor market regulations have already become more decentralized and flexible, although in practice wages still followed centrally–set guidelines.

The Pension System and Early Retirement

Slovenia has one of the lowest retirement ages in Europe. The statutory retirement age—currently at 61 years and 6 months for men, and 55 years and 4 months for women—will remain among the lowest in Europe even after a recently–approved increase over the next decade for employees with minimum pension–qualifying years. Combined with other generous features of the pension system, Slovenia also has one of the lowest effective retirement ages in Europe.

A01ufig15

Inactivity rates, 2001

(in percent)

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Source: OECD (2005), Statistical Yearbook of the Republic of Slovenia (2004).
A01ufig15a

Age Distribution of New Retirees, 2002

(in years)

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Source: World Bank (2004)1/Full pensionable age varies with mininum years of service.

The current system encourages early retirement, especially for low–income male workers. With the use of the accrual method, even under the newly approved higher compulsory retirement age, the system of penalties and bonuses is not strong enough to provide incentives to delay retirement. For example, a man earning the average wage who qualifies for a pension with 35 years of service at age 58 has an incentive to retire almost two years ahead of the full pensionable age of 63. These incentives are even stronger for low-income earners.

A01ufig16

Statutory Retirement Age

(in years)

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Source: OECD (2004); and Slovene authorities.
A01ufig16a

Implicit Tax

(In percent)

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Source: Staff calculations.

Tax and Welfare Systems and Labor Participation

Staff analysis shows that participation rates among low–income workers (proxied by the level of education attainment) in Slovenia are low in the European context reflecting a combination of generous welfare entitlements and high tax rates:

A01ufig17

Activity Rate by Age Groups

(Labor Force Survey)

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

A01ufig17a

Activity Rates (age group: 15-64) by Level of Education Attained

(Labor Force Survey)

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

The personal income tax is highly progressive (rates ranging from 16 to 50 percent), and in addition wages are affected by a social security contribution of 22.1 percent and a progressive payroll tax (paid by the employer, with rates ranging from 6 to 14.8 percent). The welfare system is among the most generous in the EU (IMF Country Report No. 05/253, Table 8). In particular, net replacement rates exceed or equal OECD averages, leading to high marginal effective tax rates (METRs), particularly for individuals seeking to move from joblessness to work.

A01ufig18

Net Replacement Rates: Initial Phase of Unemployment at Different Earnings Levels, 2004 (OECD), 2005 (Slovenia) 1/

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Sources: OECD, Tax-Benefit Models; and staff calculations.1/ For married couples the percentage of average wage (AW) relates to one spouse only; the second spouse is assumed to have full-time earnings equal to 67% of AW.
A01ufig18a

METRs for a Couple with Two Children where the Principal Earns 67% of Average Wage (AW) and the Secondary Earns the Minimum Wage or 2 AW

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

A simultaneous reform of the tax and welfare systems would boost labor participation. For example, less progressive taxes, such as a flat tax, while improving work incentives for high–income workers, would not on their own reduce METRs for low–income ones. Tax reform should therefore be accompanied by welfare reform to increase participation rates among the latter. In particular, a reform of the unemployment assistance that ensures a smooth transition in terms of lost benefits and increased taxation for lower–income workers would increase their incentives to work.

29. Both sides saw room to improve the regulatory environment so as to reduce the cost of doing business and attract investment. The Slovene economy is still heavily state dominated, as evidenced by the lowest private sector share in the economy among the NM–8. To strengthen entrepreneurship and corporate governance and improve efficiency, the authorities plan to accelerate divestment in strategic companies, including in the banking, telecom, and electricity sectors. Slovenia’s business climate also ranks the worst among NM–8 countries owing to labor market rigidities, lengthy and cumbersome procedures for business registration, and difficulties in acquiring land for business and enforcing contracts. Measures to relax the regulatory environment are a high priority, and an all–in–one system for registration of individual entrepreneurs was already introduced in 2005. Other measures under consideration—such as extending the all–in–one system to corporations, and further reduction of regulatory barriers, particularly by strengthening judicial efficiency—could also help.

A01ufig19

Slovenia has the lowest share of the private sector among NM–8, 2005

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Source: EBRD Transition Report, 2005

Business Climate Indicators, 2005

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Source: World Bank.

30. The relatively slow growth in productivity suggests that Slovenia is not climbing up the technology ladder as fast as its regional peers. While there is evidence of increasing specialization into high–tech sectors, export quality upgrading appears slower than in regional competitors. This could be a factor in Slovenia’s difficulty in increasing export market shares. While noting that Slovenia’s higher initial income level could partly explain its inability to grow at the pace of the other NM–8, the authorities acknowledged that the relatively low level of inward FDI may have limited the technological spillover effects. They also recognized that the efficiency of R&D spending is low when considering the number of patents and marketable research applications produced. It was therefore jointly seen that improving productivity growth would require more internal competition, further divestment of the state share in the economy, higher investment in research and development, innovation—including through a more fluid interaction between research centers and firms—and foreign direct investment to fully benefit from technological spillovers.

A01ufig20

FDI flows to Slovenia have been low over the past few years compared to the region.

Average Foreign Direct Investment, 2001–04 (percent of GDP)

Citation: IMF Staff Country Reports 2006, 249; 10.5089/9781451835779.002.A001

Source: World Economic Outlook, IMF.

IV. StaffAppraisal

31. Slovenia’s imminent entry into the euro area marks the culmination of a successful economic transformation since independence in 1991. A skilled work force and open trade regime have encouraged the development of a manufacturing and service base that has generated solid economic growth. Inflation—after declining sharply in recent years—is low, public and net external debt have stayed at moderate levels, and interest rates are converging rapidly to euro area levels. The banking sector is sound. These achievements testify that years of prudent macroeconomic and incomes policies have paid off. A benign global economic environment should entrench these favorable developments in the near term.

32. The task ahead is to translate these achievements into becoming a success within the euro area. In recent years, the authorities’ policies have been driven mainly by the goals of meeting the Maastricht criteria and a minimum stay in ERM2. To sustain income convergence in the future, more attention will now be needed on improving economic flexibility and long–term growth prospects. This will require policies that raise productivity, improve sustainability of public finances, and create an efficient business environment and a flexible labor market.

33. Fiscal policy in the near term should be geared to containing the deficit to its 2005 level. Interest rate convergence to the lower euro area interest rates provides monetary stimulus to an economy operating near capacity. Support to disinflation from incomes policy, which has been crucial is sustaining balanced growth in the past, is still uncertain as wage negotiations for 2006–07 have yet to be concluded. These factors and the loss of the exchange rate instrument put a premium on prudent fiscal policy. To contain the inflation risks and counterbalance the monetary stimulus, a neutral fiscal stance is called for. This requires achieving expenditure savings to keep the fiscal deficit in 2006 to 1 percent of GDP,½ percent of GDP below the budget.

34. Over the medium term, fiscal policy will need to deal with the challenges of a rapidly aging population, while improving the flexibility and efficiency of public spending. The authorities’ commitment to achieving a structural balance over the medium term is commendable, but the target date of 2010 could be advanced and the consolidation made more front loaded than currently planned. This would both support balanced growth and help address long–term debt sustainability concerns, as the impending growth in age-related outlays provides a limited window of opportunity to create fiscal space. As regards tax reform, implementing the plans to reduce the steeply progressive income taxes should enhance incentives for more work and growth. These measures should be accompanied by expenditure reforms that address fiscal rigidities and deal with age–related spending pressures. Revision of the level and indexation mechanisms of the social benefits, parametric reform of the public pension system, and measures to boost private savings for old–age income are priorities in this regard. Together with better targeting and linking of social benefits to activation policies, these measures should help increase budgetary flexibility, incentives for work, and fiscal sustainability.

35. While competitiveness appears adequate, challenges remain. Market expectations are firmly anchored at the current level of the exchange rate for euro adoption, as was evident when short–term capital inflows surged earlier this year on account of the interest rate differential. Indicators of price competitiveness have been stable, studies on the equilibrium exchange rate do not point to misalignment, and export growth remains strong. Nevertheless, Slovenia trails other new EU member states in gaining export market shares, which could pose a challenge after Slovenia enters the euro zone.

36. To maintain competitiveness and ensure faster convergence, the authorities need to speed up the implementation of policies to boost productivity growth and increase labor flexibility and participation. Slovenia’s productivity growth and technological progress have lagged behind regional peers, and labor participation among older and younger workers is low. Slovenia also remains vulnerable to a persistent increase in unit labor costs. Together with one of the fastest aging population in Europe, these trends pose significant constraints on long–run growth. To address these challenges, Slovenia needs to redouble its efforts toward raising labor utilization and upgrading technology. To increase labor input, lower marginal tax rates, better targeting of social benefits and training, and reduced incentives to retire early are key. Reducing regulatory constraints that hinder the business environment and create labor market rigidities would help improve efficiency and promote FDI. Flexibility in labor markets would also be enhanced by lowering the costs of firing and hiring and establishing wage–setting mechanisms that allow distressed companies to opt out of minimum increases. Enhancing productivity growth will in addition require higher investment and a conducive environment for private–sector led growth, through privatization, simplified business regulations, and R&D promotion.

37. Although the banking system remains sound, supervision should be enhanced to guard against market and credit risks. Borrowers will face higher interest rates in the period ahead as euro–zone rates rise. This could translate into higher credit risk, particularly for those banks that have lent aggressively to riskier borrowers to gain market share. Although banks are expected to be resilient enough to withstand these shocks in the near term, their profitability is coming under increasing stress from competition, yield convergence, and loss of foreign exchange related income upon euro adoption. Supervisory scrutiny of credit assessment standards should be strengthened to ensure that the balance sheet transformation upon euro adoption does not lead to distress for some banks. The BoS has already taken steps to ensure adequate liquidity standards in the euro changeover process. These prudential measures should be complemented by strengthened coordination with foreign supervisors to limit contagion risks deriving from the regional concentration of funding. Surviving in this open, competitive, and rapidly changing international environment will require increasingly efficient and dynamic institutions, which calls for an increased role of the private sector in the banking system.

38. It is recommended that the Article IV consultation with Slovenia remain on the 12– month cycle.

Appendix I

Slovenia: Fund Relations

(As of April 30, 2006)

I. Membership Status: Joined: 12/14/1992; Article VIII status as from September 1, 1995.

II. General Resources Account

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III. SDR Department.

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IV. Outstanding Purchases and Loans: None

V. Financial Arrangements: None

VI. Projected Payments to Fund

(SDR Million; based on existing use of resources and present holdings of SDRs):

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VII. Exchange Rate Arrangement

The currency of Slovenia is the tolar (SIT). On June 28, 2004, Slovenia joined the ERM2 at the central parity of SIT239.64 per euro and the authorities stated that they would aim for a stability of the exchange within a narrow, but unannounced band. Since ERM2 entry, the exchange rate has remained close to the central parity. Slovenia aims to adopt the euro on January 1, 2007.

VIII. Last Article IV Consultation

The last Article IV consultation with Slovenia was concluded on July 20, 2005. It was agreed that Slovenia would remain on the standard 12–month cycle. The Acting Chairman’s summing up of the discussion was circulated as SUR/05/85.

IX. FSAP Participation and ROSCs

An FSAP mission took place during November 6–20, 2000, and follow–up meetings were held with the authorities on February 8–9, 2001 in the context of the 2001 Article IV consultation mission. An FSSA report (Country Report No. 01/161) was prepared on April 24, 2001 and published on September 18, 2001. The report includes assessments of the following standards: banking supervision, securities regulation, insurance regulation, and payments systems.

An FSAP Update mission visited Ljubljana during November 10–21, 2003. An FSSA report (Country Report No. 04/137) was issued on April 26, 2004. The report includes assessments of the following standards: Compliance with Basel Core Principles; insurance regulatory and supervisory system; corporate governance; housing finance; and analyzes options for monetary operations in the transition to EMU.

The fiscal transparency module of the fiscal ROSC was published in June 2002.

X. Technical Assistance

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Appendix II

Slovenia: Statistical Issue

1. Data provision is adequate for surveillance purposes.

2. Special Data Dissemination Standard: Slovenia has subscribed to the Special Data Dissemination Standard (SDDS), meets SDDS specifications, and its metadata are posted on the Fund’s Dissemination Standards Bulletin Board on the Internet. http://dsbb.imf.org/Applications/web/sddscountrycategorylist/?strcode═SVN

3. Real Sector Statistics: The Statistical Office of the Republic of Slovenia (SORS) follows the European System of Accounts 1995 (ESA95). Quarterly GDP estimates by industry and expenditure categories are compiled in both current and constant prices, and are published within 80 days after the reference quarter. In September 2005, the SORS changed the base year for compiling constant prices GDP from 2000 to the previous year’s prices and started using the chain–link index methodology.

4. The SORS compiles the Harmonized Index of Consumer Prices (HICP) for monitoring compliance with the Maastricht inflation criterion. However, price collection is restricted to four cities and their surrounding rural areas. The weights are based on the three-year average of expenditure data for consumer goods from continuous Household Budget Surveys for 2002, 2003, and 2004. It also compiles a retail price index (RPI), which differs from the consumer price index in weights only.

5. Government Finance Statistics Slovenian fiscal statistics are timely and of a high quality. The ministry of finance publishes a comprehensive monthly Bulletin of Government Finance, which presents monthly data on the operations of the “state budget”(Budgetary Central Government), local governments, social security (Pension and Health funds), and the consolidated general government. The coverage of general government excludes the operations of extrabudgetary funds and own revenues of general government agencies (zavods). However, these operations are small in size. Monthly fiscal indicators are reported for publication in IFS on a timely basis and annual statistics covering general government operations, including the operations of the extrabudgetary funds are reported for publication in the Government Finance Statistic Yearbook (GFS Yearbook).

6. The data published in the Bulletin of Government Finance are on a cash basis and broadly use the analytical framework and classification system of the IMF’s 1986 government finance statistics methodology. The data reported for publication in the GFS Yearbook are also on a cash basis but are recast in the analytical framework and classifications of the Manual on Government Finance Statistics 2001(GFSM 2001).

7. The Slovenian authorities wish to adopt the GFSM 2001 methodology, which could then be used as a building block for the compilation of the ESA 95–based data jointly by the Ministry of Finance and the SORS for reporting to the European Commission. To assist the Ministry of Finance resolve several classification issues and develop a migration path, a STA technical assistance mission visited Ljubljana in April 2006. The introduction in 2008 of a new chart of accounts for all public entities based on accrual principles will greatly facilitate the adoption of the new methodology.

8. Money and Banking Statistics: Monetary statistics are timely and of good quality.

9. Balance of Payments Statistics: Balance of payments data are comprehensive and of high quality. The data have been published in the Balance of Payments Statistics Yearbook since 1993 (with estimates of the international investment position published since 1994). In 2002, the Bank of Slovenia revised the balance of payments statistics going back to 1994; the most significant revisions were related to the income component of the current account and to the other investment component of the financial account.

10. External Debt Statistics: External debt statistics were revised and brought in line with the SDDS in August 2003. The main change comprised the inclusion of trade credits in the debt data.

Slovenia: Table OF Common Indicators Required FOR Surveillance

As OF April 28, 2006

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Includes reserve assets pledged or otherwise encumbered as well as net derivative positions.

Both market–based and officially–determined, including discount rates, money market rates, rates on treasury bills, notes and bonds.

Foreign, domestic bank, and domestic nonbank financing.

The general government consists of the central government (budgetary funds, extra budgetary funds, and social security funds) and state and local governments.

Including currency and maturity composition.

Daily (D), Weekly (W), Monthly (M), Quarterly (Q), Annually (A); Irregular (I); Not Available (NA).

Appendix III

Slovenia: Public Debt Sustainability Analysis

1. Slovenia’s general government debt remained at 29 percent of GDP at end–2005, which is well below the Maastricht criterion threshold (60 percent). The debt–to–GDP ratio increased from 18.5 percent in 1994 in spite of fiscal surpluses or moderate deficits since then. The increase was driven mainly from debt assumed as a result of bank and enterprise restructuring and by the inheritance of liabilities from the former Federal Republic of Yugoslavia.1 In addition, until 2000 the central government borrowed mainly through inflation–linked (and to a lesser extent exchange–rate linked) instruments, which also contributed to a rising debt profile despite a strong fiscal position.

2. In the baseline, general government debt would peak at 29.8 percent of GDP in 2007 and decline steadily afterwards. The slight increase over 2006–07 reflects government plans to finance the fiscal deficit more through borrowing and less through running down its reserves. The debt–to–GDP ratio is projected to gradually decline to 27.2 percent by 2010, reflecting fiscal consolidation. In 2000, the government started a gradual transition towards the use of long–term nominal financing instruments. The first ten–year tolar–denominated Treasury bonds were issued in 2003. As a result of this debt management policy, the share of indexed debt is expected to steadily decline in the medium term. This explains why, unlike in the past, the prudent medium–term fiscal policy is expected to translate into a declining debt path.

3. The baseline is relatively resilient to shocks and sustainability is not a problem. The standard stress tests show that Slovenia’s public debt position is relatively resilient to a wide range of shocks. Relative to the baseline, shocks to real interest rates, real GDP growth, the primary balance, or a combination of all three would make the debt–to–GDP ratio rise at most to around 30 percent. A scenario where, compared to the baseline, interest rates are higher by 2 standard deviations (SD), real GDP growth is lower by one SD, and there is an exchange rate appreciation that dissipates over time would lead to an increase in the debt–to– GDP ratio to 37 ½ percent by 2010, a level still lower than the Maastricht criterion level. However, such scenario would set Slovenia on a path of rapid public sector debt increase.

Table A1.

Slovenia: Public Sector Debt Sustainability Framework, 2000–2010

(In percent of GDP, unless otherwise indicated)

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Indicate coverage of public sector, e.g., general government or nonfinancial public sector. Also whether net or gross debt is used.

Derived as [(r - π(1+g)- g + αε(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r ═ interest rate; π ═ growth rate of GDP deflator; g ═ real GDP growth rate; α ═ share of foreign–currency denominated debt; and ε ═ nominal exchange rate depreciation (measured by increase in local currency value of euros).

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 αε(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.

Relative to the baseline, this scenario assumes an increase in interest rates by 2 standard deviation; a decline in real GDP by one STD, and gradual exchange rate appreciation (10, 8, 6, 4, 2 percent from 2006 to 2010).

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.

Table A2.

Slovenia: Public Sector Debt Sustainability Framework––Gross Public Sector Financing Need, 2000–2010

(In percent of GDP, unless otherwise indicated)

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

Gross financing under the stress test scenarios is derived by assuming the same ratio of short–term to total debt as in the baseline scenario and the same average maturity on medium– and long term debt. Interest expenditures are derived by applying the respective interest rate to the previous period debt stock under each alternative scenario.

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

Relative to the baseline, this scenario assumes an increase in interest rates by 2 standard deviation; a decline in real GDP by one STD, and gradual exchange rate appreciation (10, 8, 6, 4, 2 percent from 2006 to 2010).

AppendixIV

Slovenia: External Sustainability Analysis

4. Although Slovenia’s outlook does not raise major concerns regarding external sustainability, the recent deterioration in the external debt situation needs monitoring. Under the baseline scenario, the external debt–to–GDP ratio which jumped by 13.3 percentage points in 2005 to 71.4 percent, will continue to grow, but at a slowing pace until it reaches 92 percent in 2010. With the current account deficit in 2005 at 1.1 percent of GDP, the increase in external debt could principally be attributed to the sharp rise in bank loans from abroad and foreign deposits in the banking system substituting for lower deposit growth. It is expected that the decline in mutual funds’ returns in 2005 would lead to a return of deposits to banks. Although some of banks’ foreign borrowing is from parent companies, as seen in other emerging economies, these loans could still be called back. As the bulk of new borrowing is euro–denominated, barring a major unforeseen shock, the exchange risk is low given the imminent euro adoption (January 2007). However, there are maturity and credit risks arising from banks clients’ balance sheet imbalances. The external debt service, as a ratio to exports of goods and services, is projected to rise from 17.4 percent in 2005 to 19.7 percent in 2008 and stabilize at around 19.5 percent over 2009–2010.

5. Stress tests suggest that the baseline scenario is sensitive to shocks, but Slovenia’s economy appears resilient to such shocks over the medium term. Standard bound tests show a significant jump in the external debt–to–GDP ratio in 2006 by an average of 6 percentage points and further gradual increases to at most 95 percent by 2010 (3 points more than the baseline). A Slovenia–specific scenario assuming, relative to the baseline, a combination of 2–standard deviation higher interest rates, 1–standard deviation lower real GDP growth, and exchange rate appreciation that dissipates over time, would worsen debt trends slightly. The debt–to–GDP ratio would jump by 7 percentage point jump to 79 percent in 2006, and further increase to 96 percent of GDP by 2010. This would further increase the already high external debt–to–export ratio from 105.5 percent in 2005 to 165 percent in 2010. However, with the upcoming euro adoption, generally solid fundamentals and sound macro policies, and the planned privatization of state assets, the medium–term external debt outlook does not raise sustainability concerns at this point.

Table A3.

Slovenia: External Debt Sustainability Framework, 2000–2010

(In percent of GDP, unless otherwise indicated)

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

The contribution from price and exchange rate changes is defined as [-ρ(1+g)+ εα(1+r)]/(1+g+ρ+gρ) times previous period debt stock. ρ increases with an appreciating domestic currency (ε > 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.

Relative to the baseline, this scenario assumes an increase in interest rates by 2 standard deviation; a decline in real GDP by one STD, and gradual exchange rate appreciation (10, 8, 6, 4, 2, percent from 2006 to 2010).

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 A4.

Slovenia: External Sustainability Framework––Gross External Financing Need, 2000–2010

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

Gross external financing under the stress–test scenarios is derived by assuming the same ratio of short–term to total debt as in the baseline scenario and the same average maturity on medium– and long term debt. Interest expenditures are derived by applying the respective interest rate to the previous period debt stock under each alternative scenario.

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.

Relative to the baseline, this scenario assumes an increase in interest rates by 2 standard deviation; a decline in real GDP by one STD, and gradual exchange rate appreciation (10, 8, 6, 4, 2 percent from 2006 to 2010).
1

Debt assumption reached a peak in 1995, when they represented 45 percent of end-of-year outstanding debt.

1

Slovenia is set to receive from the EU annually on average 1.4 percent of GDP during 2004–06 and 2.4 percent of GDP during 2007–13.

2

Since ERM–II entry in June 2004, the tolar has not deviated by more than ±0.2 percent from its central parity of SIT239.64 per euro.

3

A. Ahearne, and A. Pisani–Ferry,“The Euro: Only for the Agile,” Bruegel Policy Brief, Issue 2006/01 Brussels: Bruegel, 2006.

4

H. Jensen–J. Larsen (2005) The Nordic Labor Markets and the Concept of Flexicurity, Economic Policy Center Working Paper No. 20.

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Republic of Slovenia: 2006 Article IV Consultation: Staff Report; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for the Republic of Slovenia
Author:
International Monetary Fund
Volume/Issue:
Volume 2006: Issue 249
Publisher:
International Monetary Fund
ISBN:
9781451835779
ISSN:
1934-7685
Pages:
63
DOI:
https://doi.org/10.5089/9781451835779.002
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    Growth has been strong over the past decade.

  • View in gallery

    Slovenia has lowered inflation to euro area levels.

  • View in gallery

    But progress in implementing structural reforms has been less impressive.

  • Figure 1.
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    Figure 1.

    Slovenia: Economic Indicators, 1999–2007

  • Figure 2.
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    Figure 2.

    Slovenia: Labor Market Indicators, 2000–05

    (y–o–y percent change, unless otherwise indicated)

  • View in gallery

    Slovenia has maintained a conservative fiscal policy with low deficits and debt.

  • Figure 3.
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    Figure 3.

    Slovenia: Monetary Conditions, 2000–06

    (In percent)

  • Figure 4.
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    Figure 4.

    Slovenia: CPI Inflation and Components, 2000–06

    (Year–on–year change, in percent)

  • Figure 5.
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    Figure 5.

    Slovenia: Wages and Productivity, 1998–2005

  • Figure 6.
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    Figure 6.

    Slovenia: External Sector Developments, 2001–05

    (In percent of GDP, unless otherwise indicated)

  • View in gallery

    Inflation declined in 2005 despite an increase in administered prices.

  • Figure 7.
    View in gallery
    Figure 7.

    Slovenia: Exchange Rate Indicators, 1998–2005

    (1998q1═100) 1/

  • Figure 8.
    View in gallery
    Figure 8.

    Slovenia: Wages, Productivity, and Product ULC in Manufacturing, 1998–2005

    (1998q1═100) 1/

  • Figure 9.
    View in gallery
    Figure 9.

    Slovenia: Competitiveness Indicators and Export Market Shares of Slovenia and New Member States

    (1998q1═100), 1998–2005

  • View in gallery

    Wage growth has been moderating, ensuring lower unit labor cost pressures over the past few years.

  • View in gallery

    Total factor productivity trails regional peers.

  • View in gallery

    Slovenia’s manufacturing wages, adjusted for productivity, are relatively high.

  • View in gallery

    Slovene exports have been unable to increase market penetration in the EU–15.

  • View in gallery

    Revealed Comparative Advantage of High–Tech Sector, 1994–2004

    (Ratio)

  • View in gallery

    Change in Market Share versus Change in UVR, 1994–2004 (Ratio)

  • Figure 10.
    View in gallery
    Figure 10.

    Slovenia: Bank Lending Rates on New Loans, 2003–06

    (In percent)

  • Figure 11.
    View in gallery
    Figure 11.

    Slovenia: Credit Developments and Capital Inflows, 2000–05

  • Figure 12.
    View in gallery
    Figure 12.

    Slovenia: Trade Specialization and Quality Indicators, 2000–04

    (In percent, unless otherwise noted) 1/

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    The projected rise in the elderly dependency ratio is among the fastest in Europe

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    Ability to contain unit labor costs upon euro adoption has been associated with faster growth in the euro area

  • View in gallery
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    Efficiency of primary education in Slovenia can be substantially improved.

  • View in gallery

    Non–discretionary spending in Slovenia is high and rigid compared to the NM–8.

  • View in gallery

    Inactivity rates, 2001

    (in percent)

  • View in gallery

    Age Distribution of New Retirees, 2002

    (in years)

  • View in gallery

    Statutory Retirement Age

    (in years)

  • View in gallery

    Implicit Tax

    (In percent)

  • View in gallery

    Activity Rate by Age Groups

    (Labor Force Survey)

  • View in gallery

    Activity Rates (age group: 15-64) by Level of Education Attained

    (Labor Force Survey)

  • View in gallery

    Net Replacement Rates: Initial Phase of Unemployment at Different Earnings Levels, 2004 (OECD), 2005 (Slovenia) 1/

  • View in gallery

    METRs for a Couple with Two Children where the Principal Earns 67% of Average Wage (AW) and the Secondary Earns the Minimum Wage or 2 AW

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    Slovenia has the lowest share of the private sector among NM–8, 2005

  • View in gallery

    FDI flows to Slovenia have been low over the past few years compared to the region.

    Average Foreign Direct Investment, 2001–04 (percent of GDP)

Growth has been strong over the past decade.

Slovenia has lowered inflation to euro area levels.

But progress in implementing structural reforms has been less impressive.
Figure 1.

Slovenia: Economic Indicators, 1999–2007
Figure 2.

Slovenia: Labor Market Indicators, 2000–05

(y–o–y percent change, unless otherwise indicated)

Slovenia has maintained a conservative fiscal policy with low deficits and debt.
Figure 3.

Slovenia: Monetary Conditions, 2000–06

(In percent)
Figure 4.

Slovenia: CPI Inflation and Components, 2000–06

(Year–on–year change, in percent)
Figure 5.

Slovenia: Wages and Productivity, 1998–2005
Figure 6.

Slovenia: External Sector Developments, 2001–05

(In percent of GDP, unless otherwise indicated)

Inflation declined in 2005 despite an increase in administered prices.
Figure 7.

Slovenia: Exchange Rate Indicators, 1998–2005

(1998q1═100) 1/
Figure 8.

Slovenia: Wages, Productivity, and Product ULC in Manufacturing, 1998–2005

(1998q1═100) 1/
Figure 9.

Slovenia: Competitiveness Indicators and Export Market Shares of Slovenia and New Member States

(1998q1═100), 1998–2005

Wage growth has been moderating, ensuring lower unit labor cost pressures over the past few years.

Total factor productivity trails regional peers.

Slovenia’s manufacturing wages, adjusted for productivity, are relatively high.

Slovene exports have been unable to increase market penetration in the EU–15.

Revealed Comparative Advantage of High–Tech Sector, 1994–2004

(Ratio)

Change in Market Share versus Change in UVR, 1994–2004 (Ratio)
Figure 10.

Slovenia: Bank Lending Rates on New Loans, 2003–06

(In percent)
Figure 11.

Slovenia: Credit Developments and Capital Inflows, 2000–05
Figure 12.

Slovenia: Trade Specialization and Quality Indicators, 2000–04

(In percent, unless otherwise noted) 1/

The projected rise in the elderly dependency ratio is among the fastest in Europe

Ability to contain unit labor costs upon euro adoption has been associated with faster growth in the euro area

Efficiency of primary education in Slovenia can be substantially improved.

Non–discretionary spending in Slovenia is high and rigid compared to the NM–8.

Inactivity rates, 2001

(in percent)

Age Distribution of New Retirees, 2002

(in years)

Statutory Retirement Age

(in years)

Implicit Tax

(In percent)

Activity Rate by Age Groups

(Labor Force Survey)

Activity Rates (age group: 15-64) by Level of Education Attained

(Labor Force Survey)

Net Replacement Rates: Initial Phase of Unemployment at Different Earnings Levels, 2004 (OECD), 2005 (Slovenia) 1/

METRs for a Couple with Two Children where the Principal Earns 67% of Average Wage (AW) and the Secondary Earns the Minimum Wage or 2 AW

Slovenia has the lowest share of the private sector among NM–8, 2005

FDI flows to Slovenia have been low over the past few years compared to the region.

Average Foreign Direct Investment, 2001–04 (percent of GDP)