Republic of Slovenia
2009 Article IV Consultation: Staff Report; Staff Statement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Slovenia

This 2009 Article IV Consultation highlights that inflation and the current account deficit in Slovenia are expected to moderate. The main downward risks to growth are lower-than-projected growth in Europe, and a credit crunch in the event that foreign financing of domestic banks dries up. In the medium term, the main challenge is that the economy needs to emerge from the global crisis on a sustainable growth path. Executive Directors have commended the authorities for their swift and decisive policy responses to slower growth and financial sector strains.

Abstract

This 2009 Article IV Consultation highlights that inflation and the current account deficit in Slovenia are expected to moderate. The main downward risks to growth are lower-than-projected growth in Europe, and a credit crunch in the event that foreign financing of domestic banks dries up. In the medium term, the main challenge is that the economy needs to emerge from the global crisis on a sustainable growth path. Executive Directors have commended the authorities for their swift and decisive policy responses to slower growth and financial sector strains.

I. Context

1. The economy overheated following the adoption of the euro in 2007. After a decade of solid economic growth, Slovenia's per capita income rose to 90.8 percent of the EU average in 2008. With the adoption of the euro, inflation rose to the highest level in the Euro area, wage growth eroded competitiveness, the real exchange rate appreciated, and the current account deficit widened significantly.

A01ufig01

Real GDP

(Annual percent change)

Citation: IMF Staff Country Reports 2009, 161; 10.5089/9781451835823.002.A001

Source: Statistical Office.

2. The global crisis hit Slovenia in the fall of 2008 (Table 1, Figures 1 and 2). Following 5.4 percent in the first half of 2008, growth slowed to 1.4 percent in the second half of the year, with a sharp decline in the last quarter. Manufacturing and trade, and later investment, decelerated sharply. Private consumption growth moderated from the high level in 2007.

Table 1.

Slovenia: Selected Economic Indicators, 2005–10

(Annual percentage change, unless noted otherwise)

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

HICP: Total excl Energy, Food, Alcohol, Tobacco (NSA, 2005=100), period average.

Floating or up to one year fixed rate for new loans to enterprises over an amount of 1 million euro.

For household time deposits with maturity up to one year.

Figure 1.
Figure 1.

Slovenia: Economic Indicators

Citation: IMF Staff Country Reports 2009, 161; 10.5089/9781451835823.002.A001

Sources: Bank of Slovenia; Ministry of Finance; Statistical Office; and IMF staff projections.
Figure 2.
Figure 2.

Slovenia: Short-term Indicators

(Year-on-year percent change, seasonally adjusted, unless otherwise indicated)

Citation: IMF Staff Country Reports 2009, 161; 10.5089/9781451835823.002.A001

Sources: Statistical Office of the Republic of Slovenia; European Commission; and IMF staff estimates.
A01ufig02

Real GDP Growth

Citation: IMF Staff Country Reports 2009, 161; 10.5089/9781451835823.002.A001

Sources: Statistical Office; Eurostat; and IMF staff projections.
A01ufig03

Investment and Export Growth

Citation: IMF Staff Country Reports 2009, 161; 10.5089/9781451835823.002.A001

3. The labor market lost momentum at the end of 2008 (Figure 3). Until fall 2008, employment creation was strong, especially in construction and services, with full-time employment increasing 3 percent. Nominal wage growth also accelerated to 8.3 percent in 2008, as wage agreements were implemented. However, the labor market cooled in the fall, with unemployment increasing to 4.3 percent in the last quarter.

Figure 3.
Figure 3.

Slovenia: Labor Market Indicators

Citation: IMF Staff Country Reports 2009, 161; 10.5089/9781451835823.002.A001

Sources: Statistical Office of the Republic of Slovenia; Eurostat; WEO; and IMF staff estimates.

4. Inflation has dropped sharply since the summer (Figure 4). Reflecting a strong pass-through of fuel and food prices, inflation stood at 5.5 percent in 2008, 2.2 percentage points above Euro-area inflation. In addition, second-round effects led to a pickup in core inflation to 3.8 percent in 2008. After reaching a peak of 6.9 percent in July, inflation came down to 2.1 percent in February 2009, owing to the decline in fuel and food prices and the slowing economic activity.1

Figure 4.
Figure 4.

Slovenia: CPI Inflation and Components

(Year-on-year percent change)

Citation: IMF Staff Country Reports 2009, 161; 10.5089/9781451835823.002.A001

Sources: Eurostat; and IMF staff estimates.1/ Core CPI is defined as total HCPI excluding energy, food, alcohol, and tobacco.
A01ufig04

Inflation

Citation: IMF Staff Country Reports 2009, 161; 10.5089/9781451835823.002.A001

Sources: Eurostat; and IMF staff projections.

5. The government's budget was broadly balanced in 2008, with a positive fiscal impulse (Table 2, Figure 5). The fiscal deficit was 0.3 percent of GDP in 2008, slightly better than budgeted owing to strong revenues from direct taxes. The fiscal impulse was 0.7 percent of GDP, reflecting a deterioration in the structural balance. Public debt stayed broadly unchanged at 23 percent of GDP.

Table 2.

Slovenia: Consolidated General Government Operations (cash basis), 2004–2010

(Percent of GDP)

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Sources: Ministry of Finance; and IMF staff calculations.
Figure 5.
Figure 5.

Slovenia: Fiscal Sector

(Percent of GDP)

Citation: IMF Staff Country Reports 2009, 161; 10.5089/9781451835823.002.A001

Sources: Ministry of Finance of the Republic of Slovenia; and IMF staff estimates.

6. Monetary conditions tightened in the fall 2008 (Figure 6). Until then, monetary conditions were loose as the decline in real interest rates more than offset the real exchange rate appreciation. However, monetary conditions tightened in the fall when the rapid decline in inflation led to an increase in real interest rates. Private credit growth also decelerated sharply.

Figure 6.
Figure 6.

Slovenia: Monetary Conditions

(Percent, unless otherwise indicated)

Citation: IMF Staff Country Reports 2009, 161; 10.5089/9781451835823.002.A001

Sources: Bank of Slovenia; and IMF staff estimates.1/ SITIBOR / EURIBOR three-month interest rate.2/ Nominal three-month interest rate deflated by HCPI year-on-year percent change.3/ Floating and up to one year initial rate fixation on loans over 1 million euro.

7. The financial sector is increasingly affected by the global crisis (Figure 7). Banks weathered relatively well the first impact of the crisis, thanks to their limited exposure to the U.S. financial system, the low level of households' indebtedness, and the financial stability measures promptly put in place by the authorities. However, equity prices have fallen sharply, following international trends, and banks' funding costs have risen with a soaring sovereign risk spread. In response to tight international liquidity, banks have partly substituted foreign financing with other sources including ECB funds and government deposits. Loans to the nonfinancial private sector have decelerated sharply and banks' profits have fallen.

Figure 7.
Figure 7.

Slovenia: High-Frequency Financial Indicators 1/

Citation: IMF Staff Country Reports 2009, 161; 10.5089/9781451835823.002.A001

Sources: Thomson Financial/DataStream; and Bloomberg.1/ The latest observation is as of March 18, 2009.

8. The current account deficit continued to rise, reaching 5.9 percent of GDP in 2008 (Table 3, Figure 8). The main driver was a weakening of the goods balance by about 2.4 percentage points of GDP. Export growth declined starting in the fourth quarter of 2007 in line with the deceleration of activity in trading partners. Import volumes continued to grow faster than exports because of the overheating of the economy. The current account has been financed by banks' foreign borrowing and deposits from nonresidents. Consequently, Slovenia's net external debt rose to 25.4 percent of GDP by the end of 2008.

Table 3.

Slovenia: Balance of Payments, 2005–11

(Millions of euros, unless otherwise noted)

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A negative number indicates net creditor position.

Figure 8.
Figure 8.

Slovenia: External Sector Developments

Citation: IMF Staff Country Reports 2009, 161; 10.5089/9781451835823.002.A001

Sources: Bank of Slovenia; European Central Bank; Direction of Trade Statistics; and IMF staff estimates.
A01ufig05

Current Account Balance

(Percent of GDP)

Citation: IMF Staff Country Reports 2009, 161; 10.5089/9781451835823.002.A001

Sources: Statistical Office; and IMF staff projections.

9. Slovenia's competitive position has deteriorated in the past two years. Fundamental determinants of saving and investment suggest that the equilibrium current account deficit for Slovenia is around 2–2.5 percent, the actual level observed in 2004–06.2 While the significant deterioration in the current account since 2006 included some temporary components (the oil price hikes), the overheating of the economy led to second-round effects and a deterioration of competitiveness. Unit labor costs grew by 2.2 percent in 2007 and 7.6 percent in 2008. Hence, both the CPI-based and ULC-based real effective exchange rates have undergone an appreciation in the order of 5 percent. Using the three CGER methodologies, staff estimates that the competitiveness gap is 6 to 9 percent. The lagging competitiveness also reflects a lack of technological upgrading and the catch-up of regional competitors with resulting stagnating market shares over the past few years.3

II. Policy Discussions

10. The policy discussion focused on the outlook, the policy responses to the crisis, the medium-term challenges of competitiveness and structural reforms, and the sustainability of the pension system. In the past, the authorities have broadly followed staff's recommendations, although less so in the areas of fiscal policy and structural reforms (Box 1).

Effectiveness of Fund Surveillance

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A. Outlook

11. The authorities and staff concurred that the economy will experience a recession in 2009. Staff projects that output will contract by 2.7 percent in 2009 following the sharp decline in the last quarter of 2008 (Table 6). The main factors driving the downturn are the deceleration of exports, as the Euro zone is in recession, and of investment, as credit conditions tighten and exports decelerate. Through production linkages, Slovenia's export industry is particularly sensitive to the cycle of the automotive industry. Private consumption should be more resilient because of the recent wage increases and the strong net asset position of the households (Box 2). Staff revised sharply downward the projections during the mission as the negative news on the last quarter of 2008 became known. In light of the new data, the authorities also revised their projections with the Bank of Slovenia (BoS) forecasting a contraction of 2 percent and the Ministry of Finance (MoF) expecting a more pessimistic contraction of 4 percent, on the account of lower employment, consumption, and investment.

Table 4.

Slovenia: Banking Sector Soundness Indicators, 2004–08

(Percent, end of period)

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Source: Bank of Slovenia.

Figures refer to Q3.

Table 5.

Slovenia: Vulnerability Indicators, 2003–08

(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.

Series present a structural break in 2004.

Table 6.

Slovenia: Macroeconomic Framework, 2006–14

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

Government capital transfers are not included in government investment.

Table 7.

Slovenia: External Debt Sustainability Framework, 2004–2014

(In percent of GDP, unless otherwise indicated)

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

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

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.