Public Information Notice: IMF Concludes Article IV Consultation with Slovenia

January 22, 1999

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

On January 7, 1999, the Executive Board concluded the Article IV consultation with Slovenia1.


Sound macroeconomic policies and basic structural reforms allowed Slovenia within a few years of gaining independence in late 1991 to reduce inflation to the high single digits, restore per capita income to its pre-independence level, and accumulate a comfortable level of international reserves as early current account surpluses gave way to progressively stronger capital inflows. Increasingly, however, fiscal pressures and delays in implementing further structural reforms began to threaten progress toward economic convergence with the European Union, membership of which has become the country’s highest priority.

After two years of decline, economic growth rebounded to 3.8 percent in 1997 and an estimated 3.9 percent in 1998. With the strengthening expansion in Europe and a real effective depreciation in 1996, the recovery was export-led and induced strong growth of investment as profitability improved against a backdrop of falling unit labor costs and interest rates. However, the upturn failed to boost employment as job gains in services were just enough to absorb labor shed in manufacturing, and unemployment remained virtually unchanged at 7½ percent of the stagnant labor force.

After remaining stuck in the high single digits for three consecutive years, the twelve-month rate of consumer price inflation began to fall in mid-1998, reaching 6½ percent by end-1998, and thus allowing the government to attain its objective of 8 percent for average CPI inflation despite substantial early-year adjustments in controlled prices.

The progress on disinflation owes much to the fall in unit labor costs since mid-1997 when the social partners agreed to keep real wage increases below productivity gains and ease wage indexation. Notwithstanding the declines in inflation and unit labor costs, however, there have been no gains in external competitiveness as progress in these areas was even more impressive in major trading partner countries. Nonetheless, the external current account recorded a small surplus in 1997 and is expected to remain in balance in 1998.

Despite capital inflow restrictions, net inflows (including an unprecedented 1¾ percent of GDP in direct foreign investment) exceeded 6 percent of GDP in 1997, before abating to an expected ½ percent of GDP in 1998. The slowdown reflects both a large reduction in the uncovered interest rate differential and the vanishing appetite for emerging market investment in the wake of the Asian and Russian crises. Except for a temporary widening of Slovenian eurobond spreads and a moderate decline in domestic equity prices, however, the recent financial turmoil has left Slovenia virtually unscathed. Short-term external debt is very low (½ percent of GDP) and international reserves slightly exceed total external debt (23½ percent of GDP).

The interest rate differential narrowed as domestic rates declined in response to a substantial easing of monetary policy since mid-1997. The more rapid expansion of base money was accompanied by vigorous demand for longer term deposits and subsiding currency substitution. Nonetheless, distortions such as backward-looking inflation indexation, an interbank cartel agreement on real rates, and a ban on foreign bank branches continue to prop up domestic interest rates.

The general government recorded its first deficit (of 1.1 percent of GDP including privatization receipts and 1.7 percent excluding privatization receipts) in 1997 after five years in approximate balance. This deficit occurred despite the inclusion of taxes collected in early 1998 and was attributable to reduced social security contributions and import duties and higher wages, social transfers, and subsidies. Another, somewhat smaller deficit is expected for 1998. Lagging tax collections prompted the government to impose a three percent across-the-board expenditure cut in the last quarter of 1998 in an effort to reach the deficit target.

The medium-term outlook depends importantly on continued expansion in the EU, growth in Central and Eastern Europe, and domestic structural reforms. With a moderate slowdown in Europe, continued wage restraint, and a fiscal policy in line with budget intentions, real growth is projected to subside to a still robust 3¾ percent in 1999. However, the balance of risks is clearly on the downside, especially in view of Slovenia’s very high openness to foreign trade (which accounts for 110–115 percent of GDP). A projected fall in average inflation to just over 7 percent in 1999 assumes no real increases in controlled prices and the smooth switchover to the VAT in mid-year. The attainment of growth rates in excess of 5 percent over the medium term would additionally require the determined implementation of structural reforms.

Executive Board Assessment

Executive Directors congratulated the Slovenian authorities on their impressive achievements in reducing inflation and establishing a solid external position while economic growth had continued at a satisfactory pace. These achievements had allowed Slovenia to make progress toward economic convergence with the EU and, together with policies that had discouraged short-term external borrowing, had helped to avoid any significant contagion effects from the recent turbulence in international financial markets. Looking to the future, Directors fully supported the authorities’ focus on completing the process of disinflation and on deepening structural reforms to boost the economy’s potential for sustained growth. Directors underscored the importance of proceeding forcefully with the process of structural reform, which had been subject to delays. It was noted that Slovenia’s application for EU membership added urgency to this need.

On macroeconomic policies, Directors agreed that a shift in the policy mix toward further fiscal adjustment was needed to underpin the process of disinflation, reinforce a sustainable incomes policy, and permit continued monetary easing. Directors noted that such monetary easing would further reduce the positive differential vis-à-vis foreign interest rates, thereby alleviating the problem of excessive foreign capital inflows, although the authorities would, of course, need to remain vigilant about any weakening of money demand.

Directors noted that liberalization of interest rates and a smooth introduction of the new value-added tax would be key to maintaining the momentum of disinflation. They therefore welcomed the authorities’ intention to let the cartel agreement on real interest rates lapse in early 1999, and urged them to end indexation of interest rates and the ban on foreign branch banking. Directors also noted that the replacement of the sales tax by the value-added tax was designed to be revenue neutral and therefore should not by itself produce much upward pressure on prices. However, any risk of a resurgence of inflationary expectations should be contained through appropriate macroeconomic policies. Directors noted the contribution that incomes policy had made in breaking the momentum of inflation, and cautioned that public sector wage restraint would be critical in preserving these gains.

Directors agreed that market-determined interest rates, strengthened prudential regulations, and a sound, well-regulated financial system were necessary preconditions for an easing of capital inflow restrictions. In this regard, they welcomed the authorities’ cautious approach to full liberalization, and stressed that the groundwork for such a move would need to be well laid. Directors also cautioned that the conduct of monetary policy would become more challenging as capital flows were liberalized.

Regarding the means by which the required tightening in fiscal policy should be achieved, Directors stressed that priority should be given to expenditure restraint, in order to reduce the size of government and promote structural reform. However, the need not to jeopardize essential capital expenditure was noted. Directors underlined the importance of holding the line on public sector wages. Civil service reform, better targeting of social transfers, and benchmarking government services on good international practice, including via outsourcing or privatization, all offered prospects for expenditure reduction. In view of longer-term pressures from population aging, Directors attached particular importance to pension and health carereform. In this connection, they urged the authorities to restart pension reform during the present government’s term, focusing on a better balance between contributions and benefits in the existing pay-as-you-go system. Directors stressed the importance of proceeding with privatization of state assets, including of the rehabilitated banks. They took note of the views of the authorities on the statistical treatment of revenues from the privatization of socially-owned enterprises.

Regarding macroeconomic policies in a medium-term perspective, Directors noted that the real exchange rate would tend to appreciate as the productivity gap with the EU narrowed and per capita incomes caught up with EU levels. For this reason, Directors cautioned the authorities against attempting to pursue price and nominal exchange rate stability simultaneously. In these circumstances, Directors recommended that the authorities give priority to price stability in implementing their monetary policy, and be prepared to accept some nominal exchange rate appreciation. It was noted that exchange rate flexibility would also have the benefit of deterring excessive short-term capital inflows. Directors were of the view that any adverse effects from real appreciation associated with successful transformation could only be moderated by other appropriate policies on the real side, such as fiscal tightening and structural reform.

To raise economic growth on a sustained basis, Directors stressed that structural reforms needed to be accelerated. Notwithstanding gradual progress toward de-indexation and evidence of improved corporate governance, Directors noted that the reform backlog had continued, especially with regard to the enactment of policy legislation. They therefore urged the authorities to kickstart the reform process in key areas by adopting measures to liberalize and deepen financial markets, deregulate product markets, privatize state assets, and make labor markets more flexible. Directors noted the relatively low level of foreign private investment, and stressed the importance of establishing a favorable environment for such investment.

Slovenia: Selected Economic Indicators

1995 1996 1997 19981 19991

Real economy (change in percent)
Real GDP 4.1 3.1 3.8 3.9 3.8
Domestic demand 7.1 2.3 6.2 5.0 4.9
Inflation (end of period)2 8.6 8.8 9.4 6.5 8.0
Unemployment (survey-based, in percent) 7.4 7.3 7.4 7.6 7.5
Gross national saving (in percent of GDP) 23.0 23.6 24.2 25.0 25.0
Gross domestic investment (in percent of GDP) 23.2 23.4 24.0 25.0 25.1
Public finance (percent of GDP)3
General government balance (incl. privatization
receipts)4 0.0 0.3 -1.1 -1.0 -0.7
General government balance (excl. privatization
receipts)4 -0.5 -0.2 -1.7 -1.4 -1.0
Public debt 18.8 23.2 23.5 24.0 24.6
Money and credit
(end of year, percent change)
Real credit to the private sector 31.0 9.6 2.8 14.0 ...
M3 27.9 21.4 24.0 23.9 22.7
Interest rates (percent)
Nominal interbank interest rate (overnight)5 12.0 13.8 9.6 6.3 ...
Real lending rates6 13-14 11-12 10-11 6-9 ...
Real deposit rates6 7-10 5-7 3-5 1-3 ...
Balance of payments
Trade balance (percent of GDP) -5.1 -4.7 -4.2 -3.7 -3.9
Current account balance (percent of GDP) -0.2 0.2 0.2 0.0 -0.1
Official reserves (US$ million) 1,802 2,279 3,297 3,501 3,806
Reserve cover (months of imports of GNFS) 2.0 2.6 3.7 3.8 3.9
Exchange rates
Exchange rate regime Managed float
Present rate (January 12, 1999) SIT 162.81 per US$1
Nominal effective exchange rate (1995=100)6 100.0 90.2 85.4 83.3 ...
Real effective exchange rate (1995=100)6 7 100.0 97.1 97.8 101.3 ...

1IMF staff projections.
2Retail price index 1993-97; consumer price index for 1998.
3The 1999 balances are based upon the new budget classifications.
4Privatization revenues are from the sale of both state and socially owned enterprises.
5The 1998 projection is the actual September value.
6The 1998 projections are averages of monthly data through September.
7CPI based.

1Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of directors, and this summary is transmitted to the country's authorities. In this PIN, the main features of the Board's discussion are described.


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