Republic of Slovenia
2007 Article IV Consultation: Staff Report; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for the Republic of Slovenia

This 2007 Article IV Consultation highlights that economic performance of Slovenia strengthened in 2006, supported by a recovery in investment and continued growth spillovers from the European Union. Declining real interest rates in the run-up to euro adoption on January 1, 2007 helped sustain credit growth and domestic demand. The strong economy boosted job creation, while unemployment declined and capacity utilization reached record high levels. Growth is projected to slow down slightly in 2007–08, as the investment boom decelerates.

Abstract

This 2007 Article IV Consultation highlights that economic performance of Slovenia strengthened in 2006, supported by a recovery in investment and continued growth spillovers from the European Union. Declining real interest rates in the run-up to euro adoption on January 1, 2007 helped sustain credit growth and domestic demand. The strong economy boosted job creation, while unemployment declined and capacity utilization reached record high levels. Growth is projected to slow down slightly in 2007–08, as the investment boom decelerates.

I. Introduction

1. After 15 years of transition, Slovenia became the first new EU member to adopt the euro in January 2007. Favorable initial conditions and sound macroeconomic policies over the past decade have allowed Slovenia to sustain robust growth with small external imbalances and public debt while gradually lowering inflation and interest rates to euro area levels. PPP-based per capita income reached about 80 percent of EU-average in 2006, putting Slovenia on par with Greece and above Portugal.

2. Growth spillovers from the region intensified in 2004–06. Since EU entry in 2004, trade integration has deepened and exports have been buoyed by euro area recovery. Declining real interest rates and risk premia have sustained strong credit growth, boosting domestic demand. These factors led growth to near record levels in 2006.

3. Sustaining this performance in the euro area will require Slovenia to maintain policy discipline while addressing structural rigidities more vigorously. The strong fiscal and wage policy discipline that preceded euro adoption needs to be sustained to ensure continued balanced expansion. Fiscal flexibility is constrained by one of the most rigid public spending structures in Europe, limiting the scope of countercyclical policies, while rapid aging is exacerbating longer run fiscal pressures. Efficiency of the largely state-controlled financial sector is low, hampering financial intermediation and longer-term growth. To address these issues, the 2007 Article IV consultation focused on challenges in the financial sector and fiscal reforms, complementing last year’s in-depth assessments of the structure of public spending, long-run fiscal sustainability and structural challenges in product and labor markets.1

uA01fig01

In 2006, growth accelerated while inflation stabilized.

Citation: IMF Staff Country Reports 2007, 183; 10.5089/9781451835809.002.A001

Sources: Statistical Office of the Republic of Slovenia; and Bank of Slovenia.

II. Background

4. Growth accelerated in 2006, led by investment demand (Table 1, Figures 1 and 2). Growth rose from 4 percent in 2005 to 5¼ percent in 2006, the highest level in this decade as a recovery in investment, driven by robust credit growth and infrastructure spending, took over from exports as the main engine of activity. Private consumption remained stable, reflecting moderate wage increases. The strong economy boosted job creation mainly in services, and unemployment continued to decline. These trends, along with strong labor demand as indicated by employment rates and the continued rise in capacity utilization to record levels, suggest that the economy has reached capacity limits.

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Sources: Eurostat; Haver; and Statistical Office of the Republic of Slovenia.
Table 1.

Slovenia: Selected Economic Indicators, 2003-08

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

For 2007-08, forecasts in the Stability Program.

Revenue and expenditure exclude social security contributions paid for government employees. 2007-08 projections correspond to the budget, but exclude VAT revenues of 0.4 percent of GDP in 2008. Additional deficit from railways of 0.4 and 0.5 percent of GDP in 2007 and 2008 are excluded.

For deposits with maturity between 31 days and 1 year.

Figure 1.
Figure 1.

Slovenia: Economic Indicators, 2000–08

Citation: IMF Staff Country Reports 2007, 183; 10.5089/9781451835809.002.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, 2000-06 (y-o-y percent change, unless otherwise indicated)

Citation: IMF Staff Country Reports 2007, 183; 10.5089/9781451835809.002.A001

Sources: Employment Service of Slovenia; Monthly Bulletin, Bank of Slovenia; WEO; and IMF staff estimates.

5. The fiscal deficit continued to narrow in 2006, aided by the rapid growth (Table 2). In keeping with its tradition of fiscal prudence, Slovenia further lowered the general government deficit to about ¾ percent of GDP in 2006 from about 1 percent in 2005. The budgetary overperformance, of around ½ percent of GDP, primarily reflected stronger-than-planned tax revenues owing to both cyclical gains and one-off factors. In particular, windfall gains related to the adoption of International Accounting Standards helped boost corporate income tax collections, more than compensating for the reduction in payroll taxes. A lower-than-expected wage bill also contributed to maintaining stable expenditure levels. All in all, this implied a neutral fiscal impulse for the year.

Table 2.

Slovenia: Summary of General Government Operations, 2003-2009

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

Excludes revenues for budgeted VAT increase in 2008 and 2009 (0.4 percent of GDP) that will be foregone.

6. Monetary conditions in 2006 were broadly neutral as policy rates converged in the run up to euro adoption (Figure 3). In the face of continued strong capital inflows, the Bank of Slovenia (BoS) lowered its key policy rate (60-day bills) to 3¼ percent in the first half of the year, after keeping them constant at 4 percent since ERM2 entry in 2004. With the increases in the European Central Bank (ECB) rate, the interest rate differential was closed by year-end. As the tolar-euro rate and average inflation remained stable, real interest rates declined slightly.

uA01fig03

Core inflation has reached EU levels.

Citation: IMF Staff Country Reports 2007, 183; 10.5089/9781451835809.002.A001

Sources: Statistical Office of the Republic of Slovenia; and Eurostat.1/ For EU-15, core inflation corresponds to total CPI excluding energy and seasonal food from the European Index of Consumer Prices.
Figure 3.
Figure 3.

Slovenia: Monetary Conditions, 2000-07

(In percent)

Citation: IMF Staff Country Reports 2007, 183; 10.5089/9781451835809.002.A001

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

7. Besides balanced macroeconomic policies, incomes policies helped to contain inflation (Figures 4 and 5). Prudent wage policies, elimination of import duties, and increased competition following EU accession drove core inflation in 2005 below one percent. By mid-2006, it had reverted to the EU-15 average, picking up further towards end-year owing to capacity constraints and rapid credit growth. In this context, collective wage agreements that continued to set wage increases below productivity growth were key to price stability by containing second-round effects of energy price increases and demand pressures. Average headline inflation remained stable at 2½ percent, aided by receding oil prices.

Figure 4.
Figure 4.

Slovenia: CPI Inflation and Components, 2000-07

(Year-on-year change, in percent)

Citation: IMF Staff Country Reports 2007, 183; 10.5089/9781451835809.002.A001

Sources: Statistical Office of the Republic of Slovenia; Eurostat; and IMF staff calculations.1/ For EU-13, core inflation corresponds to total CPI excluding energy and seasonal food from the European Index of Consumer Prices.
Figure 5.
Figure 5.

Slovenia: Wages and Productivity, 2001-06

Citation: IMF Staff Country Reports 2007, 183; 10.5089/9781451835809.002.A001

Source: Statistical Office of the Republic of Slovenia; and IMF staff calculations.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.

8. The current account deficit widened slightly, mainly reflecting increased factor payments (Table 3, Figure 6). Strong demand in Europe helped sustain robust export growth at 10 percent in 2006 driven by chemicals and automotive industries. Imports accelerated to over 10 percent, owing to demand for investment goods. This, together with the higher, partly one-off, outflows of dividends to foreign investors, resulted in a widening of the current account deficit from 2 percent of GDP in 2005 to an estimated 2.6 percent in 2006.

Table 3.

Slovenia: Balance of Payments, 2004-09

(In millions of euros, unless otherwise noted)

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Source: Bank of Slovenia and IMF staff projections.

A negative number indicates net creditor position.

Figure 6.
Figure 6.

Slovenia: External Sector Developments, 2001-06

(In percent of GDP, unless otherwise indicated)

Citation: IMF Staff Country Reports 2007, 183; 10.5089/9781451835809.002.A001

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

9. Competitiveness appears adequate, although Slovenia’s ability to sustain its export markets remains a longer-run concern (Figures 7-9). Low inflation has led to stable real effective exchange rates while moderate wage increases and a recent surge in productivity have contributed to lower unit labor costs. Export growth is solid and staff estimates using the CGER methodology suggest that the real exchange rate is aligned with fundamentals. However, gains in export market shares have been sluggish reflecting, in part, rapid catch-up by lower-cost regional competitors. Technological upgrading, which is crucial for a high-wage economy such as Slovenia’s, has been lagging behind regional competitors, reflecting relatively low FDI.2

uA01fig04

Slovenia’s gains in export market share have been lacklustre.

Citation: IMF Staff Country Reports 2007, 183; 10.5089/9781451835809.002.A001

1/ Value index, major Slovene trading partners include Austria, France, Germany, Italy, UK, and USA.Source: IMF DOT; and IMF Staff calculations.
Figure 7.
Figure 7.

Slovenia: Exchange Rate Indicators, 1998-2006 (1998q1=100) 1/

Citation: IMF Staff Country Reports 2007, 183; 10.5089/9781451835809.002.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, 1998-2006 (1998q1=100) 1/

Citation: IMF Staff Country Reports 2007, 183; 10.5089/9781451835809.002.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), 1998-2006

Citation: IMF Staff Country Reports 2007, 183; 10.5089/9781451835809.002.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.

10. Cross-border investment positions continued to expand in 2006, raising vulnerability to external conditions. With declining domestic interest rates, households turned to foreign-oriented mutual funds, while banks and enterprises increased their holdings in high-return countries, especially in Southeastern Europe. To finance these investments and the rising credit demand, banks continue to resort to cheaper foreign borrowing, which made gross external debt to climb to 80 percent of GDP and reversed Slovenia’ net creditor position.

Banks have increased foreign borrowing to finance asset growth. Slovenia: Sources of Growth of Bank Balance Sheets, 2001-05

(In percentage points of GDP, y-on-y change)

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Source: Bank of Slovenia.

11. Rapid credit growth is increasing credit risks, especially in the corporate sector (Box 1). Real credit to the private sector continued to grow by nearly 25 percent, driven by investment demand. Household credit, at 15 percent of GDP, is still low compared to countries with similar incomes (Figure 10), but rising rapidly owing to the greater demand for housing. In contrast, credit to enterprises is near euro area levels. Given low FDI and absence of a developed equity market, enterprises have relied primarily on debt financing, which has led to relatively high leverage ratios compared to the region.

Sectoral Balance Sheet Analysis

The corporate sector in Slovenia has important net total and non-equity financial liabilities, which coupled with the high debt-to-assets-ratio point to rising leverage of enterprises. The liabilities are mainly to domestic banks, increasing the banks’ exposure to credit risks. Banks’ rising net foreign liabilities, in turn, are increasing their vulnerability to changes in foreign market conditions.

Indicators of underlying corporate vulnerabilities in selected markets, 2005

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Source: Corporate Vulnerability Database.

Based on limited sample

uA01fig05

Slovenia: Total Net Financial Position of Main Sectors, 2001-05

(All assets less liabilities as share of GDP)

Citation: IMF Staff Country Reports 2007, 183; 10.5089/9781451835809.002.A001

Source: Bank of Slovenia; and IMF staff estimates.
uA01fig06

Slovenia: Net International Financial Position, 2001-05

(Percent of GDP)

Citation: IMF Staff Country Reports 2007, 183; 10.5089/9781451835809.002.A001

Figure 10.
Figure 10.

Bank Credit to Households and Non-financial Corporations in European Emerging Markets, 2005

Citation: IMF Staff Country Reports 2007, 183; 10.5089/9781451835809.002.A001

Source: Eurostat; ECB; Country Authorities; and IMF staff calculations.1/ Credit figures include domestic and foreign loans. For EMU, loans to enterprises include loans to domestic and (other) euro area countries.

12. The financial sector remains sound to deal with these risks, but vulnerabilities are building up (Tables 4-5). Banks’ financial soundness indicators remain adequate. However, declining interest margins and loss of foreign exchange revenue are putting pressure on profitability, which is already regionally low. High levels of indirect ownership linkages could amplify transmission of shocks in the economy.

uA01fig07

Return on equity is among lowest in the region.

Citation: IMF Staff Country Reports 2007, 183; 10.5089/9781451835809.002.A001

Source: FSI database.
Table 4.

Slovenia: Banking Sector Soundness Indicators, 2002–06

(In percent; end of period)

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Source: Bank of Slovenia.

2006 data as of Q3.

Table 5.

Slovenia: Vulnerability Indicators, 2002-07

(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.

Remaining maturity basis.

Series present a structural break in 2004.

III. Report On The Discussions

13. Against this background, the discussions focused on the main current policy challenges for Slovenia—maintaining the strong commitment to policy discipline and advancing structural reforms—to ensure continued success in the euro zone. The main themes were policy requirements for a balanced expansion, and using the favorable times to contain vulnerabilities and increase economic flexibility and productivity. In line with past consultations, there was broad agreement on the direction of policies.

Slovenia: Effectiveness of Fund Surveillance

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A. Outlook

14. The authorities and staff expect the near-term economic outlook to remain favorable (Table 6). Growth in 2007 is projected to slow down, but remain robust at 4½ percent, assuming prudent fiscal and wage policies. With household consumption rising in line with higher disposable incomes, domestic demand is expected to continue driving growth. While the investment boom should decelerate owing to the reduced tax breaks and higher interest rates, business confidence surveys, manufacturing orders, and infrastructure investment plans suggest still strong trends. While the euro area slowdown will affect exports, a concurrent decline in imports will limit the impact on net exports and the current account is expected to be broadly unchanged at 2½ percent of GDP. Despite the pressures on capacity, there are no signs of overheating as yet, with private consumption flat and inflation expectations stable. Headline inflation is projected to remain at 2.6 percent, assuming prudent macroeconomic policies and moderate increases in administrative prices, and core inflation will gradually rise on account of services. This assessment is broadly in line with BoS and consensus forecasts.

uA01fig08

Confidence indicators point to sustained growth.

Citation: IMF Staff Country Reports 2007, 183; 10.5089/9781451835809.002.A001

Source: Statistical Office of the Republic of Slovenia.

Growth will slow down moderately in line with Euro-area trends. Summary of Macroeconomic indicators

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Source: WEO.
Table 6.

Slovenia: Macroeconomic Framework, 2003-12

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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.