Euro adoption

The introduction of the Euro on January 1, 2007 was smooth and with low costs for companies and households. It is estimated that the changeover to the Euro caused a minimal increase in inflation, only about 0.2 to 0.3 percentage points. Reduced transaction costs, absence of exchange rate risk, and low Euro area interest rates have added momentum to the economy. Also, confidence in the economy has strengthened further. The Euro adoption process was facilitated by a decade of prudent macroeconomic and financial policies. These policies have laid ground for further economic expansion and job creation.

Economic developments in the first quarter of 2007

Slovenia’s economic growth accelerated from 4 percent in 2004–2005 to 5.2 percent in 2006. This positive trend has thus far also continued in 2007. The first quarter recorded an increase of 9.3 percent in industrial production and 18 percent in exports over the same period in 2006. Wage increases continue to be moderate, at 3.1 percent year-on-year in the first two months of 2007.

Inflation is low. Since early 2005, headline inflation (HIPC) is practically unchanged at about 2.5 percent. After a small pick up in the last quarter of 2006, core inflation declined to 1.5 - 1.7 percent.

Fiscal developments in the first quarter of 2007 seem to be on track and consistent with a budget deficit target of 0.9 percent. Total government revenues are broadly in line with the projections. Expenditures continue to be on a downward trend.

The business climate indicator also remained high, at its peak level since 1996.

On May 16, 2007, Slovenia received OECD’s invitation to start negotiations for membership.

Short-term economic outlook

Considering these positive economic trends and the improved economic climate in some of Slovenia’s important trading partners, forecasts for 2007–2009 have been revised upwards. Strong investment activity and employment growth are expected to contribute to an expansion in the economy’s potential supply capacity. The government’s base scenario projects economic growth at 4.7 percent for this year, which is slightly above the staff’s 4.5 percent forecast. For the remaining period until 2009, growth is expected to remain above 4 percent, hence facilitating the process of real convergence with the EU. The expansion during the period 2007–2009 is expected to be driven mostly by domestic demand, but the contribution made by net trade will be positive.

The favorable growth in aggregate demand is expected to exceed the output potential marginally, but the risks for inflation are considered moderate given the expected continuation of moderate low growth of labor costs. The 2007–2008 inflation is expected to exceed, the 2005–2006 level of 2.5 percent only slightly, by 0.2 percentage points, mostly because of the prices for food and services. But in 2009, it is expected to return to its present level of 2.6 percent.

Financial sector

The staff rightly points out that deepening EU financial integration and liberalized capital flows bring about new challenges, especially to small and open economies like Slovenia. There is no doubt that the stability and soundness of the financial system, a robust macroeconomic environment and increased coordination among supervisors make up the first line of defense. In Europe, financial sector consolidation has been advanced primarily at a national level. However, EU-wide integration is becoming more significant. In most central European countries, a large share of the banking sector is foreign owned. Although these banks are often of systemic importance in the host country, they are supervised by the authorities of the home country according to EU banking supervision directives. The Slovene authorities place great emphasis on improving for these banks the flow of information between bank supervisors, enhancing risk management and improving the cost sharing arrangements in crisis situations between home and host countries. Discussions of these issues at the EU level would be timely and welcome.

In early May, the government decided to list on the stock exchange, by the end of this year, the second largest state-owned bank and offer 49 percent of the shares to institutional and individual investors. Floating the remaining shares will be decided at a later stage. For now, the long term strategy is to keep at least 25 percent plus one share under the control of the state. The government aims at building a strong financial conglomerate around this bank and including three predominately state-owned insurance companies. The revenues from this sale would be used for reducing public debt.

Structural agenda

With the Euro adoption successfully completed and the convergence criteria met, structural policies will be critical for Slovenia to benefit fully from its participation in the Euro zone. In this regard, some important steps have been taken.

As a result of the government’s Program of Measures for Reducing Administrative Burden, competitiveness has been increased through improved quality of administrative services and simplified procedures. In line with this program more than thirty measures have been adopted. Each new regulation must now pass a test that its implementation can be efficient. Establishing new businesses, especially small ones, has been facilitated. A portal called “e-VEM” has been recently launched, providing user friendly services such as registration in Slovenia’s business register and providing essential information for entrepreneurs, including on taxation. The portal will be further improved and constantly updated.

Slovenia’s integration in the global economy is deepening mainly through trade and outward investments. Inward foreign direct investment that would promote technological restructuring in Slovenia’s manufacturing sector is still relatively modest. Thus, the authorities plan to improve further the competitiveness and flexibility of the economy, including by providing larger support for R&D. In this context, some important measures are under preparation.

In the fiscal sector, the government plans to make the budget more flexible and to reform the pension and health care systems to contain the costs as the population ages.