Economic Developments, Measures and Outlook

In the third quarter of 2013, Slovenia’s current account balance reached 6.8 percent of GDP, growth was -0.6 percent and the unemployment rate stood at 9.4 percent. For the first three quarters of 2013, the general government deficit is estimated at 5.5 percent of GDP and its consolidated gross debt at the end of the third quarter is estimated at 62.6 percent of GDP. Inflation in December 2013 was 0.7 percent.

The authorities are more optimistic about the growth outlook than the Fund staff. The good performance of the export-oriented corporate sector, increased competitiveness and the recent bold actions taken in the banking sector are promising indicators.

Since the last Article IV Consultation, the Slovenian authorities have intensified their efforts to reduce macroeconomic imbalances which, combined with high economic uncertainty, required urgent policy responses and vigorous measures. Many remedial steps have been taken and the positive effects are becoming gradually visible.

• In January 2013, the pension reform entered into force, followed by a labor market reform in March, when the Bank Assets Management Company (BAMC) was also established.

• In March, the new government took over and was immediately faced with refinancing risks. The authorities swiftly responded to market speculations by preparing a bond issuance and raised USD 3.5 billion in early May. The Cyprus crisis challenged the trust of bank depositors also in Slovenia. Fortunately, no significant decrease in households’ deposits occurred.

• In May, Slovenia submitted to the European Commission the comprehensive 2013 stability programme covering the period 2012-2016 and its 2013 national reform programme. At the end of May, the European Commission issued its policy recommendations to the Slovenian authorities. In parallel, the authorities had agreed with the social partners on an additional 1.25 percent reduction in basic gross wages in the public sector, on top of the 3 percent reduction that had been agreed upon in May 2012. Also, Parliament had approved a constitutional basis for establishing a general government budget balance/surplus rule in structural terms and tightened the constitutional rules to call and win a referendum. The latter should facilitate the introduction of fiscal and structural reforms.

• In autumn, Slovenia presented the Economic Partnership programme and Draft Budgetary Program to the European Commission. The measures outlined in these documents were evaluated by the Commission as adequate to address the macroeconomic challenges.

• The European Commission requested the execution of an independent Asset Quality Review (AQR) and stress tests for a representative portion of the banking system as a prerequisite for the transfer of claims to the BAMC and the approval of state aid. The Slovenian authorities embarked on the aforementioned actions in July 2013 by engaging foreign experts to ensure the complete independence and credibility of the review. The AQR and stress tests results were announced on December 12. A few days later, five banks were recapitalized and the first batch of bad assets was transferred to the BAMC. Markets clearly welcomed the transparency and the measures taken, and spreads declined considerably as a result. In addition to implementing the Fund’s FSAP recommendations, the authorities will also take further measures, including privatizing now well-capitalized state-owned banks, strengthening banking supervision, implementing the banking sector consolidation, and establishing macro-prudential supervision, for which the necessary act has already been adopted. A new Banking Act that transposes the EU Capital Requirements Directive IV is expected to enter into force in the spring.

In addition to the external environment, the economic outlook depends on the implementation of technically complex reforms in the corporate, financial, and public sectors. The authorities are aware of the implementation risks, and policy measures will have to be carefully designed to ensure sufficient public support.

Banking sector, Asset Quality Review and Stress Tests

Banks dealt with bad assets before the stress tests were finalized in December 2013 by increasing write-offs and provisions, which in 2011, 2012 and in the first ten months of 2013 cumulatively amounted to EUR 4.2 billion.

The AQR, the stress tests and the bad assets transfer to BAMC exercises were designed and conducted in close cooperation with the European Commission and the ECB.

The adverse stress test scenario was based on very conservative assumptions, i.e. a cumulative 9.5 percent decline in the GDP growth rate in the period from 2013 to 2015. This is 1 percentage point higher than the realized decline in the period from 2009 to 2012, and quite different from the available projections. In addition, a conservative approach was applied through the valuation of collateral and a very stringent approach to client classifications by banks.

The estimate of a EUR 4.8 billion potential bank capital shortfall was the most conservative out of the four stress tests results, based on the two different methods and scenarios used.

The new insolvency law should work towards slowing down NPL accumulation in banks’ balance sheets by accelerating resolution procedures.

Fiscal Policy

In spite of the ongoing recession, fiscal consolidation continues in Slovenia. The pace of fiscal consolidation should take into account its impact on employment and growth. Therefore, a gradual consolidation path towards structural balance by 2017 is underway. The authorities are mindful of the fiscal risks and have made all efforts to contain them, including a pension freeze, public sector wage reduction, improved tax collection, measures to limit the grey economy, and the introduction of a property tax. Also, the conservative stress tests results and the consequent bank recapitalization have likely ruled out the need for further state-owned bank recapitalization in the medium term. Further tax increases are not envisaged and the authorities are committed to pursue any additional consolidation on the expenditure side. In the authorities’ view, staff’s analysis of Slovenia’s debt sustainability and respective policy option in the staff report should have put more emphasis on privatization. Privatizations, coupled with the debt reductions in the BAMC, can significantly reduce the debt level and the authorities intend to pursue this without delay. The authorities stand ready to promptly respond to fiscal deterioration if it emerges.

Structural Issues

Improving corporate sector governance and its deleveraging are key to achieve the much-needed increase in investment. Staff’s proposal of a multi-pronged approach is well noted. Privatization of the first selected 15 companies has started, and will be upgraded by the adoption of a full-fledged strategy for managing SOEs in 2014, which will also designate further divestment paths. After the bad assets transfers and the recent recapitalization, BAMC can start coordinating creditors and facilitate corporate restructuring. The law to establish the Slovenian Sovereign Holding, whose mandate is to improve governance in state-owned companies, is in parliamentary procedure. Once the holding is functioning and the envisaged state-owned bank privatization implemented, the connected lending problem will be significantly reduced.

The March 2013 labor market reform will be complemented by a reform of the so-called “student employment” by April 2014. The “student employment” increases labor market flexibility, but is clearly a distortion rooted in years of economic development with negligible new job creation and labor shedding. Consequently, a part of the young population is formally enrolling in college to avoid unemployment and obtain short-term temporary jobs more easily. College graduates increasingly end up with temporary short-term employment, as permanent contracts are rarely offered. New job creation has become one of the policy priorities closely connected with all growth-enhancing policy measures.