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.
The Slovene authorities thank the staff for the productive and stimulating Article IV discussions. They broadly concur with the staff's assessments of economic developments in Slovenia and the challenges that it faces.
Global crisis imposing a heavy toll
Slovenia was experiencing solid growth and a strong fiscal position, supported by buoyant investment and exports, before the global economy entered the current crisis. An annual inflation of 5.7 percent in 2008 and a widening current account deficit of 5.5 percent of GDP were a concern, although considered manageable over time in light of the monetary integration and rapid convergence processes. However, a sudden drop in external demand and foreign financing, associated with spillovers to domestic demand, were a strong shock to the economy with an export share in GDP of about 70 percent.
Designing the response
The authorities acted swiftly to deal with the adverse effects of the crisis with three sets of measures. First, provide liquidity to banks and enterprises. Second, safeguard production and jobs. Third, soften the impact of the crisis and restore medium-term fiscal sustainability. The fiscal stimulus package amounts to 2.1 percent of GDP, of which 1.8 percent would be spent in 2009. If necessary, the government will scale up the fiscal support in 2010, depending on the evolution of the national and regional situation. The first two sets of measures are already in effect, while the third is set for formal approval by mid-May.
The above measures were based on the following three principles. The measures should be (i) temporary, (ii) diversified, and (iii) tailored to Slovenia's fiscal space and anchored to a credible medium-term fiscal framework. Given the limited economic options for a small and open economy, the timing and pace of a sustained turnaround will depend mainly on actions to stabilize financial conditions and boost demand in Slovenia's main trading partners.
The global crisis has hit Slovenia's economy hard but it will leave the country better prepared for the future. The first two sets of measures are primarily aimed at counteracting the effects of the crisis. But the third set is more development-oriented. It includes proposals for medium- and long-term structural reforms, such as performance budgeting, expenditure rationalization in public institutions, modernization of the pension system, and changes in social expenditures. It also includes short-term measures in the field of employment, social protection and business environment, such as subsidies for workers made temporarily redundant and waiting for re-employment, training programs, active employment policies, a trade financing facility, “green tax reform”, public procurement rationalization, etc. The authorities also introduced measures aimed at increasing the efficiency of using the EU cohesion funds for public investments.
Credit growth has declined
The banking sector continues to be well capitalized and liquid, but credit growth has declined. Difficulties in borrowing abroad, lower demand for credit and reluctance of banks to lend in the uncertain economic environment have contributed to a slowdown in credit activity, to 13.3 percent y-o-y in March, down from an average annual growth of 20 percent recorded over the past few years, and a peak of 40 percent in 2007.
The banks' funding structure is changing. By making net repayments of foreign borrowing, banks are substituting foreign funding (which backs about one third of the banks' credit exposure) by government deposits (from the EUR 1 billion government bond issue) and Eurosystem liquidity. Nevertheless, foreign parent banks continue to provide funding to their banks in Slovenia. In the same vein, Slovenian banks are determined to keep the linkages with their subsidiaries in the region strong and provide additional capital to them if needed.
Possible rebound, but still contraction in 2009
Recent preliminary data for Slovenia, as for Europe and other parts of the world, suggest that the pace of contraction may be slowing, and that a recovery is on the horizon. Notwithstanding this, the economy is expected to record a sharp decline in economic activity in 2009. The government projects a decline of 4 percent, the European Commission of 3.4 percent, the IMF of 2.7 percent, and the Bank of Slovenia of 2 percent. For 2010, projections show a slightly positive economic growth in the range of 0.7 to 1.9 percent, driven by stronger exports and increased investments in motorways and railway infrastructure.
Public finances are also deteriorating, reflecting the weakening economy, the cost of the fiscal stimulus package and the effects of changes in tax and expenditure legislation approved in 2007. The government is now preparing a second supplementary budget for 2009 that projects a widening of the general government deficit to 5.1 percent of GDP, or 1.4 percentage points more than envisaged in the first supplementary budget adopted in March. Cuts in investments, material expenditures and services are being planned in order to prevent the deficit from reaching 6 percent of GDP, a level the government considers unsustainable. The public debt to GDP ratio will increase from the current 23 percent to 36 percent by 2011. The general government deficit is expected to decline to 3.9 percent of GDP in 2010 and to 3.4 percent in 2011.
Other economic indicators also reflect the impact of the crisis. The current account deficit is expected to narrow this year by around 2 percentage points to 3.2 percent of GDP, due to lower imports and improved terms of trade. Inflation has moderated to 1.8 percent y-o-y in March. Unemployment is rising, especially in manufacturing, and is currently at 6 percent and trending towards 7 percent. As a result, the wage growth in the private sector has slowed. In the public sector, however, real wage growth in 2009 is currently projected at 6.2 percent, reflecting agreements with social partners, reached last August, on a gradual elimination of wage disparities.
Development policy priorities and challenges
Key elements of Slovenia's development policy have been set by the 2008 Reform Program for Achieving Lisbon Strategy Goals, the government's anti-crisis measures and the Stability Program approved at the end of April. The priority is to pursue policies that will foster economic growth underpinned by sustainable public finances. Slovenia's growth prospects will depend very much on its ability to reduce the competitiveness gap, keep the external and internal accounts in check and contain public sector wage growth. It will also depend on how soon the banking sector will resume lending activities.
In the short run, further steps are planned in the following areas:
Quality of public finance. Introduction of performance budgeting in the 2010–2011 budget cycle is aimed to improve prioritization, resource allocation and performance measurement. Rationalization of social transfers and other expenditures is also in the pipeline.
Pension system. The plan is to finalize the proposals for modernizing the pension system by autumn, and to agree with the social partners on the main elements by the end of this year, including on solutions for the population to remain active longer, active aging, life-long learning, etc.
Public sector wage policy. Negotiations with social partners on adjusting collective wage agreements for the public sector are also being planned.
Business environment and labor market policy. Promoting investments in R&D, stimulating R&D cooperation between the research community and the economy, increasing labor market flexibility, and reducing administrative barriers also top the development agenda.
The task ahead is certainly not easy, in particular as it involves important trade-offs and social consensus. Slovenia's experience with transition, EU accession and Euro adoption proves that at the critical juncture the momentum does build up to move things forward.