Republic of Slovenia: Selected Issues

This Selected Issues paper analyzes the challenges that the Republic of Slovenia will face in the coming years. It examines the efficiency of the Slovene banking sector in the European Union context. The paper analyzes indicators of bank efficiency by comparing performance indicators for banks in Slovenia, the European Monetary Union, and new member states. It presents results from cross-country econometric estimates of banking sector cost efficiency. The paper also discusses results from estimates of cross-country banking sector contestability, and the determinants of efficiency and contestability.


This Selected Issues paper analyzes the challenges that the Republic of Slovenia will face in the coming years. It examines the efficiency of the Slovene banking sector in the European Union context. The paper analyzes indicators of bank efficiency by comparing performance indicators for banks in Slovenia, the European Monetary Union, and new member states. It presents results from cross-country econometric estimates of banking sector cost efficiency. The paper also discusses results from estimates of cross-country banking sector contestability, and the determinants of efficiency and contestability.

V. A Fiscal Framework for Slovenia33


  • In the coming years, Slovenia is expected to face significant fiscal challenges as it tries to meet its medium-term fiscal targets while concurrently lowering the tax burden and increasing expenditure flexibility and efficiency. Rapid population aging adds to these fiscal pressures, undermining long run debt sustainability.

  • To deal with these challenges, the fiscal institutional framework should be strengthened. Introduction of an expenditure rule, based on a cyclically adjusted deficit, could help enhance the commitment to an expenditure-based consolidation.

  • The credibility of the new fiscal framework could be further strengthened by independent assessment of fiscal trends and medium-term fiscal plans and outcomes.

A. Background

101. As Slovenia enters a new era in the European Monetary Union (EMU), fiscal policy reform has become a key priority. While Slovenia has maintained a favorable fiscal performance with low deficits and debt, sustaining this will be increasingly challenging. The government has embarked on a fiscal reform program that is expected reduce the tax burden significantly over the medium term. The program also envisages lower deficits to achieve structural balance by 2011. Expenditures also need to be restructured to increase budgetary flexibility and enhance the role of fiscal policy has a countercyclical policy tool. Over the longer horizon, age-related spending is expected to increase fiscal burden considerably.

102. Given these challenges, a strong fiscal institutional framework, including through fiscal rules, needs to be considered. Effective implementation of the fiscal reform program will require early identification of expenditure reform measures and political consensus to adhere to the government's medium term fiscal targets. A strong fiscal institutional framework could help strengthen commitment and enhance the credibility of the fiscal reform plans.

103. Against this background, the paper reviews experiences with select aspects of fiscal rules and makes some policy proposals that could strengthen the fiscal framework in Slovenia. Section B reviews fiscal trends and challenges in Slovene fiscal policy. Section C discusses the current fiscal framework. Section D focuses on key features and experiences from the adoption of fiscal rules and independent fiscal institutions in the European Union (EU) and section E discusses policy issues including key considerations for the a fiscal rule in Slovenia. Section F concludes.

B. Fiscal Policy Developments and Challenges

104. Slovenia has a history of a sound fiscal policy that has ensured low deficits and debt levels. Debt has remained at around 28 percent of GDP and fiscal deficits, at about 1½ percent of GDP in 2005, have been among the lowest in the central European new member states (Figure 1).34 While revenues and expenditures, as a percent of GDP, are high by regional standards, Slovenia has been gradually lowering them particularly over recent years, through reductions in the payroll tax and containment of public wage bill. This has led to a reduction of the fiscal deficits as well.

Figure 1.
Figure 1.

Slovenia and NMS-8: Fiscal Indicators, 2000-09

Citation: IMF Staff Country Reports 2007, 182; 10.5089/9781451835793.002.A005

Source: Eurostat, Ministry of Finance of the Republic of Slovenia.

105. Despite these favorable developments, Slovene fiscal policy does not appear to have demonstrated a strong countercyclical property. Such a countercyclical role for fiscal policy will be increasingly important for Slovenia as a member of the European Monetary Union. Although the data series for measuring economic cycles are relatively short, fiscal performance over 2000-03 suggests that even as the output gap turned negative and widened, cyclically adjusted balances narrowed from a deficit of almost 4 percent of GDP to 2 percent (Figure 2). This trend likely reflects discretionary measures for fiscal consolidation as part of EU entry preparations, mainly on the revenue side. Since 2004, however, the cyclically adjusted deficit has been stable, reflecting an acyclical stance as the output gap narrowed. This was marked by reductions in both the revenue and spending sides.

Figure 2.
Figure 2.

Slovenia: Indicators of Fiscal Stance, 2001-06

Citation: IMF Staff Country Reports 2007, 182; 10.5089/9781451835793.002.A005

Source: AMECO; Slovene authorities; and staff calculations.

106. Therefore, one key challenge for Slovene fiscal policy is consolidation of budgetary spending to enhance flexibility. This would improve the discretionary scope to run countercyclical policy as well as create fiscal space for age-related spending pressures. A cross country comparison of expenditure structure shows that Slovenia has a rigid budget structure with a relatively high share of non-discretionary spending (IMF, 2006a). This has led to measures to reduce mandatory spending including through reindexation of social benefits to inflation. Cross-country analysis of expenditure efficiency suggest scope for efficiency gains in certain areas of mandatory spending such as education, health and social transfers.


Share of Total Spending, 2000-05

(In percent)

Citation: IMF Staff Country Reports 2007, 182; 10.5089/9781451835793.002.A005

Sources: Eurostat; and staff estimates.

107. Over the next few years, Slovenia also plans to implement an ambitious revenue consolidation plan while lowering the structural deficit. The authorities envisage reducing the structural deficit to 1 percent of GDP by 2009 and to a structural balance by 2011. Concurrently, it is anticipated that revenues will decline by almost 4 percent of GDP, from 45.8 percent of GDP in 2005 to 41.7 percent of GDP in 2009, of which about 3 percent of GDP can be attributed to the decline in the tax burden. At the same time, expenditures are projected to be lowered by 4½ percent of GDP, primarily in the areas of social transfers and gross fixed capital formation. Underlying measures to achieve these targets remain to be fully identified.

108. Over the longer term, age-related spending is expected to add to fiscal pressures and undermine fiscal sustainability. With one of the fastest aging populations in the EU, Slovenia's pension and health care expenditures are expected to increase by around 7 percent of GDP by 2050 under current policies. In the absence of early and decisive measures to reform the pensions and health care systems, fiscal policy will need to be even more conservative to create fiscal space for the age-related spending pressures, and aim for a structural balance or a small surplus (IMF 2006a, Slovenia Stability Report, 2006).

109. The track record shows that medium-term policy targets have been pushed back recurrently. Although the medium term plans in 2004 targeted the deficits to be lowered to less than 1 percent of GDP by 2007, deficit targets in the budget still remain above the 1 percent threshold (Pre-accession Programs, Convergence Program and Stability Programs) for the foreseeable future. These medium-term deficit targets appear to have served as indicative targets for the two-year budgeting process but with substantial revisions in the annual budget process (Ylaoutinen, 2004).


Over/Underperformance in Revenue, Expenditures and Deficits Relative to the Budget

(In percent of GDP)

Citation: IMF Staff Country Reports 2007, 182; 10.5089/9781451835793.002.A005


Fiscal Deficit Targets

(In percent of GDP)

Citation: IMF Staff Country Reports 2007, 182; 10.5089/9781451835793.002.A005

Source: Pre-Accession Economic Programs (PEP) and Convergence Programs (CP)

110. while Slovenia has a history of sound fiscal policy implementation, there is also a risk that policies may be relaxed following Euro adoption. The experience with EU members show that fiscal policy discipline weakened and became more expansionary after the start of the EMU in 1999, as the countries used the first opportunity to relax their fiscal stance (Von Hagen, 2005, Buti and van den Noord, 2004). This was evident by the fact that once EMU membership was secured, the pattern of political budget cycles, whereby fiscal deficits worsened during election years reemerged as voter's preference for EMU entry no longer served as a restraining factor during budget formulation.

111. These challenges point to the need for a stronger fiscal framework with due emphasis on the implementation of the medium term fiscal strategy. In particular, a fiscal responsibility law which embodies a permanent target in the form of a fiscal rule or a full scale medium term budgetary framework with expenditure ceilings would help adhere to fiscal goals. With the tax reforms already in effect, a framework to ensure stronger commitment to the expenditure ceilings would be vital. A clearly defined expenditure-based fiscal framework would lend credibility to the tax reform program as being permanent, allowing efficiency gains. Such a framework would also act as a complementary mechanism to the EU's Stability and Growth Pact.

C. The Current Fiscal Framework in Slovenia

112. As an EU and EMU member, Slovenia has maintained a strong reputation for fiscal prudence and discipline. Slovenia's fiscal deficit has stayed safely within the 3 percent margin and the 60 percent debt to GDP threshold under the Stability and Growth Pact. In terms of the quality of budgetary institutions, including its transparency, the Slovene budget fares well relative to the Central European and EMU members. The finance minister's role is ranked particularly strong in the planning and decision-making phases of the budget formulation process while that of the Parliament during the legislative phase is relatively weak. These factors have been shown to contribute to greater fiscal discipline among European countries (Ylaoutinen, 2004).

article image
Source: Open Budget Initiative, 2006.

113. Slovenia currently has a two year rolling budgetary framework. The macroforecasts used for the budget are prepared by Institute for Macroeconomic Analysis and Development (IMAD), an external economic forecasting agency. Revenue forecasts based on these projections, together with the nominal overall expenditure framework, deficit and debt targets and budget priorities for the subsequent four years are presented as the draft Budget Memorandum to the Government by the Prime Minister, the Minister of Finance and the Director of IMAD. Following the guidelines issued by the government, the Ministry of Finance undertakes detailed negotiations with line ministries for the upcoming budget and the subsequent year. The government then sets the disaggregated expenditure ceilings in the second budget session. Following the submission of financial plans and development programs by line ministries, the Minister of Finance submits the budget amendment for the upcoming year, the budget for the subsequent budget year, and the Budget Memorandum to the National Assembly.

114. This unique budgetary framework provides a medium term orientation to the budget procedures, much akin to a multiannual expenditure framework, but without its automatic countercyclical feature. Since the expenditure ceilings need to be revised in light of changes in macroeconomic circumstances and fiscal policy objectives, this system prevents the functioning of automatic stabilizers embodied in multiyear expenditure ceilings (Kraan and Wehner, 2005). While this system, in principle, allows more room for a countercyclical role for expenditure policy, the high share of non-discretionary spending in the budget structure limits this possibility (IMF, 2006). Nevertheless, it has been argued that by providing a longer term horizon for budget negotiations and limiting the scope of amendments to the budget in the upcoming year, the two year budgeting system ensures that requests for additional spending are narrowed down substantially contributing to the budgetary discipline.

115. The authorities are currently discussing introduction of a fiscal rule focused on an annual deficit rule. Such a rule would require that in case of revenue underperformance, expenditures would need to be reduced to ensure compliance with the annual deficit target. An expenditure rule is not considered viable given the likely conflict with adherence to an a annual deficit target. Proposals also include a golden rule that would allow borrowing for investment or amortization of debt. While a revenue rule exists for local governments that limits borrowing to less than 20 percent of revenues of the previous year, proposals are also being considered on ways to extend the rule for the soon-to-be-formed regional governments.

D. Experience with Fiscal Rules in the EU

116. Several EU countries have fiscal rules in addition to the debt and deficit rules of the SGP (EDP) (Table 1). These national fiscal rules are stricter than the SGP rules and often take the form of an internal pact between the different levels of government reflecting differing economic circumstances, government structures, and public preferences. for instance, countries with coalition governments adopt a contract-based approach to budgetary decision-making whereas those with majoritarian governments have decision-making structures that are centralized and delegated to the finance minister. Stricter fiscal rules are more prevalent under the former system (Hallerberg, Strauch and von Hagen, 2004). Over the past two decades, the restrictiveness and coverage of national fiscal rules have increased in the EU (European Commission, 2006).

Table 1.

Deficit Target Rules in Select EU Countries.

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Source: IMF (2006), European Commission (2006).

117. Numerical fiscal rules help promote fiscal discipline provided there exists sufficient political commitment. Fiscal rules act as a permanent constraint on the government to help contain a deficit bias arising from the ‘common pool’ problem—a failure to internalize the cost of programs by individuals or interest groups when the cost is borne by a wider group. This phenomenon is known to be more acute during cyclical upswings, in fragmented political systems with a ‘commitment’ approach of budgeting, and in case of governments that face electoral uncertainty leading to a myopic policy horizon. Entry into a monetary union can also increase this problem as the cost of fiscal spending is borne among a wider group of countries. Empirical evidence is in favor of deficit reduction following introduction of a rule, although this may be subject to endogeneity bias, i.e. enactment of fiscal rule already reflects political will to consolidate (Debrun, 2007).

118. However, numerical deficit rules have some drawbacks. The main issues include:

  • Rigid annual deficit stance can lead to a procyclical stance. Hence, deficit targets are often set in structural terms or as averages over a medium term horizon. But this is difficult to calculate for a transition economy particularly when the nature of shocks are difficult to identify on a short run basis. This, in turn, also creates difficulties in interpretation for setting expenditure ceilings.

  • Strict adherence to the deficit rule could lead to a poor quality of fiscal adjustment. Frequently, measures fall on discretionary expenditures that are easiest to cut such as capital expenditures rather than spending based on efficiency consideration. Hence, a number of countries have introduced a ‘golden rule’ that excludes investment spending and targets current balance.

  • To meet the deficit rule, governments can resort to creative accounting and circumventions through off-budget activity, cash/accrual classification, etc.

  • Lack of enforceability is a major challenge at the central and general government level. Hence, such rules are more common at local level governments (European Commission, 2006). The main enforcement mechanism for fiscal rules at higher levels of government is through reputational costs, presuming voter awareness and preference for the rule.

119. Lessons from country experiences suggest that fiscal rules can be more successful under certain preconditions (IMF, 2005a). Fiscal rules require wide-ranging political consensus about the need for prudent fiscal policies. The fiscal institutional framework, including budgetary institutions and expenditure management, should be sufficiently developed. Fiscal rules should be well defined, simple, transparent, and monitorable. Independent monitoring and credible enforcement mechanisms are important. The coverage of the fiscal rule needs to be broad-based and the degree of hardness of the fiscal rule affects fiscal performance. This is more evident in case of coalition governments.

120. Fiscal rules are often complemented by medium term budgetary frameworks (MTBF) with underlying expenditure ceilings. A medium term budgetary framework defines a legal framework regulating formulation of multi-year fiscal policies in order to promote transparency and accountability. An expenditure rule, in the form of a ceiling, introduces a countercyclical feature to the budgeting system as it allows the automatic stabilizers to operate fully on the revenue side. The main characteristics of MTBFs and the underlying expenditure rule (Table 2) vary considerably. Some key features are in terms of the length of the time horizon; and whether the time horizon is fixed or rolling. Other important dimensions are the flexibility with which the ceilings are updated and whether the ceilings are defined in constant or current prices. The latter, in turn, depends on the time horizon of the expenditure ceilings: over shorter horizons, nominal rules help fiscal stabilization, but over longer horizons this will depend upon the nature of inflation forecast errors. The coverage of expenditure ceilings—on aggregate spending versus subcategories such as discretionary expenditures or current spending—is also an important consideration. The theoretical foundations of spending rules are similar to cyclically-adjusted deficit rules, but are more practical due to its transparency (Mills and Quinet, 2002).

Table 2.

Key features of Expenditure Rules in Select Countries

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Source: Danninger (2002); European Commission (2003, 2006).

121. Provided sufficient political will exists, MTBFs have played an important role in countries that have undertaken large fiscal adjustments. In the absence of political commitment, MTBF has had little impact on annual budget formulation. A MTBF that is not fully integrated into the annual budget formulation process tend to remain ineffective. Country experiences also suggest that the underlying structural reforms need to be well-identified. Ceilings imposed only on total expenditure tend to be breached. Thus, exclusions of hard to control items such as interest and cyclical items such as unemployment benefits are common. Regular reviews of budget programs and projections help promote more realistic medium-term cost projections. Furthermore, official projections tend to be biased, especially if there is no obligation to explain ex post to the public the difference between projections and outturns.

122. To enhance the credibility of the MTBF, a few countries have established independent fiscal institutions. Such institutions help to limit time-inconsistent behavior of policymakers by monitoring fiscal policy and making them more transparent to the public, thereby increasing the cost of fiscal profligacy. Given their independent expertise, these institutions serve as a guardian of fiscal policy objectives that are set ex-ante by the Parliament.

123. The model for an independent fiscal institution varies considerably by country (Table 3) and their roles generally include:

Table 3.

Key features of Independent Fiscal Institutions in Select Countries

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Source: European Commission (2006).
  • Independent monitoring and analysis of fiscal policy developments. These institutions also make normative statements on fiscal policy implementation including on adherence to the rules, which facilitates greater public debate on fiscal policy developments and objectives and evaluation of government's performance;

  • Preparation of macroeconomic forecasts and assumptions for the annual and MTBFs.

  • Enforcement of sanctions on a non-discretionary basis. An independent monitoring and assessment of the compliance of rules is crucial to maintain the credibility of the fiscal framework.

124. Survey data in the EU suggest that the presence of independent fiscal institutions has led to more transparency and public debate (EC,2006). This has contributed to fiscal discipline by improving incentives for the government to adhere to the fiscal rule. The legal restraints imposed by these institutions on fiscal policymaking and the legal guarantees on their independence have increased the perceived impact on fiscal performance. While it is unclear if fiscal institutions affect fiscal performance, there is empirical evidence that it serves as a signaling device for a commitment to fiscal discipline (Debrun, 2007).

E. Policy Issues for Slovenia

Fiscal rule

125. Rules targeting a cyclically adjusted deficit may be considered. Although estimates of potential output and the needed cyclical adjustment are subject to a high degree of uncertainty, particularly in a transition economy, an agreed method of calculating the potential output by an independent institution could form the basis for estimating cyclically adjusted revenue or deficit to be used for policy formulation and assessment. While basing formal rules on them may be challenging, fiscal policy discussions should, at the minimum, incorporate adequate attention to the development of the cyclically adjusted revenues and expenditures.

126. Long term fiscal sustainability considerations would need to guide the deficit target underlying the fiscal rule. A number of studies have highlighted the challenges of fiscal sustainability arising from aging pressures, suggesting the need to run fiscal surpluses (Stability Report, 2006). The medium term fiscal targets thus need to incorporate the longer term considerations for debt sustainability, particularly as pension reforms fail to take hold. The MTBF would serve as an effective communication device to analyze the implications of delaying reforms in age-related expenditures.

Medium term budgeting framework

127. Improvements in the MTBF could be considered to spell out the reform programs in a detailed framework while simplifying the budgetary procedures. It would include specific reform measures within a prespecified time horizon that would achieve the deficit targets under the rule along with estimates of savings from these measures. The time horizon of the MTBF could be extended to match the electoral cycle which would lend credibility to the fiscal strategy of the incoming government and raise the reputational costs of failing to adhere to it. In addition, the expenditure ceilings could be specified at a more aggregated level for the budget for the second year and beyond which would also minimize the need for negotiating and amending the second year budgets at a detailed line item level in subsequent budget cycles.

128. An expenditure rule, combined with a MTBF framework that is based on the rule for the cyclically adjusted deficit, could help promote fiscal consolidation. This could provide the necessary flexibility to conduct countercyclical fiscal policies by letting the automatic stabilizers work on the revenue side. The expenditure ceilings could be set on the basis of a spending review that analyses the objectives and performance of spending areas. To safeguard the medium-term fiscal targets, the law could include a requirement to make increases in mandatory spending program budget-neutral through offsetting measures.

129. To safeguard concerns that productive spending on infrastructure can be cut to meet the rule, a ‘golden rule’ could be considered. This prevents a poor quality of fiscal adjustment whereby expenditure cuts fall on areas which are more productive but are easiest to cut due to more discretion. However, such exclusions from a fiscal rule have also been criticized on the grounds that returns on public investment spending do not necessarily ensure a return higher than the cost of borrowing. Furthermore, the distinction between capital and current spending is not always very clear, allowing ways of circumventing the ceilings on current spending.

Independent assessment of fiscal trends and budget plans and implementation

130. Independent assessment of fiscal trends could enhance the credibility of a new fiscal framework. In Slovenia, Institute for Macroeconomic Analysis and Development (IMAD) already provides macroeconomic assumptions and projections for the underlying budgets (such as growth, inflation, and market interest rates). Analysis of macroeconomic assumptions since 1995 do not suggest evidence of a systematic bias in macroeconomic projections. Nevertheless, it may be prudent to consider a cautionary bias by applying a prudential margin to its growth forecasts for budgetary assumptions as practiced in Canada and Unites Kingdom. To strengthen the role of independent institutions, in line with international practices, additional roles could also be considered. These include:

  • Assessment of medium- and long-term fiscal trends by producing fiscal baseline projections (based on unchanged policies and legislation);

  • The yield of new fiscal measures in annual or medium-term budgets;

  • A normative assessment of fiscal policy implementation, including on adherence to fiscal strategy and rules;

  • The factors responsible for deviations from annual and medium-term budget targets.

The purposes of such assessments would be to enhance transparency and improve the methodology of projecting macroeconomic developments, budget revenue and expenditure; and eliminate political bias in the budget formulation process. To this end, the independence of the institution could be strengthened by requiring it to report its assessment directly to Parliament, readily available to the public.

F. Conclusions

131. Slovenia faces significant challenges in reforming fiscal policy in the coming years. For fiscal policy to be an effective instrument for economic stabilization, increased budgetary flexibility particularly on the expenditure side will be required. Slovenia also needs to implement significant expenditure consolidation to meet its medium-term fiscal targets while accommodating tax reforms. In light of long-run sustainability concerns, fiscal policy will need to aim for a structural balance or a surplus, if systemic pension and healthcare reforms are not addressed soon. A stronger fiscal framework that incorporates these fiscal targets will help to signal the commitment to the objectives of the fiscal reform package, specify the underlying measures, and thus enhance the credibility of the medium-term fiscal goals. Against this background, the paper examined considerations for strengthening the fiscal framework in Slovenia.

132. Strengthening the medium term budgetary framework with underlying fiscal rules and greater transparency on adherence to the fiscal objectives could help enhance fiscal discipline. Slovenia’s fiscal deficit targets that are anchored on debt-sustainability analysis need to be better integrated in the medium term budgetary framework. Introducing a fiscal rule for expenditures that is based on a structural deficit target could impose more fiscal discipline while allowing short term flexibility through revenue stabilizers. An increased role for independent monitoring of budgetary plans and an assessment of the budget implementation against the stated objectives could allow more public debate and voter awareness, helping to enforce the framework and preserve fiscal discipline.


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Prepared by Anita Tuladhar (EUR).


Fiscal data in this paper are presented on ESA-95 basis.

Republic of Slovenia: Selected Issues
Author: International Monetary Fund