Economic developments

Even though Slovenia largely avoided the first wave of the financial crisis, it was severely hit when the crisis affected the real sector. As an export-dependent economy, Slovenia experienced a sharp GDP decline in 2009 (-8.1 percent), which was aggravated by the concurrent phasing out of the national highway construction program. The sharp decline in external demand and curtailed credit supply weighed heavily on the highly leveraged corporate sector, particularly construction. Due to the relatively low debt-to-GDP ratio and solid household balance sheets Slovenia managed to avoid spillovers from the European sovereign debt crisis.

The crisis left a strong mark on the Slovenian economy. An export-led recovery is under way, but remains gradual. Whereas the export-oriented manufacturing sector is rebounding relatively fast, the recovery in other sectors is sluggish due to persistent high unemployment, a very low level of investment and weak domestic demand. The unemployment rate, which increased to 7.2 percent in 2010, is expected to peak this year at 7.5 percent but is likely to start decreasing gradually in 2012 and thereafter. Against this background, GDP growth, which turned to a positive 1.2 percent in 2010, is estimated at 2.0 percent this year, although most international forecasters, including the OECD, the European Commission and staff tend to be somewhat more optimistic than the authorities’ conservative approach. The relatively gradual economic recovery is heavily influenced by the continuous deleveraging in the construction sector, which was over-dimensioned before the crisis, and the relatively limited activity in the financial sector.

Fiscal consolidation

During the crisis fiscal policy turned countercyclical, with automatic stabilizers working and discretional stimulus measures amounting to 1.8 percent of GDP in 2009 and 0.2 percent in 2010, thereby increasing the deficit. After a moderate surplus in 2007 and a moderate deficit in 2008, the deficit widened to 5.5 percent of GDP in 2009 and 5.2 percent in 2010. The government has been continuing with the consolidation efforts in 2011 and targeted a reduction to 4.8 percent. However, the government’s participation in the recapitalization of the systemic bank Nova Ljubljanska Banka (NLB) in the amount of EUR 243 million is increasing the deficit. The European Commission classified this participation as state aid (Commission Decision of March 8, 2011), thereby increasing the nominal deficit in 2011 by 0.7 percentage points higher (totaling 5.5 percent) than originally scheduled. Given that the measure is one-off, this move does not impact the underlying consolidation of the structural deficit.

The authorities are committed to bringing the fiscal deficit to below 3 percent of GDP by 2013. They find the staff scenario overly pessimistic, especially in view of Slovenia’s proven track-record of better-than-budgeted outcomes. Under the government’s exit strategy, all stimulus measures except subsidies for temporarily laid-off workers were phased out by the end of 2010. In line with the EU’s Excessive Deficit Procedure (EDP), a program of gradually reducing the general government deficit to below 3 percent by 2013 was prepared. In light of the already relatively high tax burden, fiscal consolidation will be expenditure-based, primarily comprising measures in the area of wages, pensions and social benefits. Among the short-term measures, wage bill growth will be contained by the reduction in aggregate salary by 2.2 percent in nominal terms and non-indexation of wages to inflation in 2011 and 2012. The policy of reducing employment in the public sector by 1 percent annually will continue. To underpin the necessary fiscal consolidation an intervention act was passed for the 2011 budget implementation. The government is contemplating additional measures by means of a new intervention act to safeguard the deficit–reduction process.

To ensure sustainability of public finances in the long run, the government has embarked on fiscal structural reforms which include pension, health care and financial management reforms. The pension reform, which is crucial, was adopted by the Parliament in December 2010, and includes an increase in the minimum and full retirement ages (to 60 and 65, respectively), a gradual extension of the period for calculating the pension base from the 18 best consecutive years to 34 years, a change in the indexation of pension benefits and changes in the system of incentives. Unfortunately, the reform will be challenged in a referendum on June 5, 2011, and the outcome remains uncertain. Pending the outcome of the referendum, the government is designing contingency measures. One of the alternative measures is a temporary freeze of pensions and the immediate submission of a new proposal.

In the public financial management area, performance budgeting has been gradually introduced across all ministries. In addition, changes to the Public Finance Law are under way and are expected to be passed by the parliament not later than by the end of the year. They will introduce a medium-term budgetary framework (MTF), expenditure ceilings (“fiscal rule”), a debt ceiling of 45 percent of GDP, and a ceiling for all government guarantees. The new act will also further strengthen the responsibilities and accountability structure for the recently created fiscal council.

The financial system

The global crisis exacerbated the weaknesses of the financial system characterized mainly by short-term external bank borrowing and over-indebted corporate sector. As a consequence, weakened banks are coping with declining profitability incurred by loan losses of the highly indebted non-financial corporate sector, especially construction and leveraged holding companies. Despite aggregate loan losses in 2009 and 2010, which were mainly due to very conservative provisioning, banks are expected to turn profitable (in aggregate) again in 2011.

The authorities are aware that Basel III will require higher capital ratios and concur with staff that strengthening capital buffers is necessary. In this context, the central bank has accelerated efforts to comply with Basel III. As the first step, the two largest banks, NLB and Nova kreditna Banka Maribor (NKBM) were recapitalized. The latest recapitalization of the systemically most important bank, NLB, will ensure a Tier 1 capital ratio of almost 8 percent, while the raising of additional capital will be explored as needed. In line with OECD recommendations and staff encouragement to ensure a greater role of private investors and to strengthen governance of the financial sector, the government adopted the Strategy for the Financial Sector Development in April 2011, as the first one in a series of sectoral strategies under preparation. The strategy advocates the creation of 3 financial pillars centered round the two largest banks (NLB and NKBM) and the largest insurance group, Triglav. While the state maintains shareholdings in all three financial groups, the Strategy envisages systematical divesting over time, whereby the state would limit its shareholding to 25 percent at the most. Following the OECD recommendations to delink state ownership in the companies from their management, an independent Capital Asset Management Agency was established. Besides managing the state assets in such companies and restructuring them for sale, the agency will prepare a recommendation on the disposal of non-strategic assets, based on sectoral strategies. In order to stimulate the credit activity of banks to the non-financial sector the government put forward a proposal for a tax on banks’ assets, aimed at taxing all banks’ assets while a tax allowance is introduced for banks which are expanding their credit activity. The draft legislation is currently discussed by the parliament with a view of enforcement by July 1, 2011.

Structural issues

The authorities agree with staff that maintaining competitiveness is crucial for Slovenia as a small and export dependent economy, especially due to the large share of labor-intensive products. In dialogue with the social partners, the government has been trying to introduce a greater level of flexible arrangements in the labor market and ensure prudent trends in the growth of unit labor costs. While consensus on increasing security can be quickly reached, increasing labor market flexibility has met with political resistance. As a consequence, the Mini-Jobs Act, regulating student work and aiming to contribute to increasing employment, was repealed in a referendum in April 2011. Reduction of regular workers’ employment protection, in particular rapid reduction in notice periods and severance payments, recommended by staff, is being considered by the government along with other measures in the labor market. To enhance FDI attractiveness and boost productivity new initiatives are currently being considered to reduce and facilitate administrative procedures in starting new businesses, as well as to accelerate bankruptcy procedures, and potentially reduce social security contributions.