Slovenia -- 2010 Staff Visit Mission Concluding Statement
June 11, 2010
Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
Slovenia’s economy has been hit hard by the global crisis. The policy response to the crisis based on fiscal stimulus and support to the financial sector was appropriate. The economy is expected to recover slowly but uncertainty persists. However, the global financial crisis has changed the external financial conditions and the Slovenia’s growth pattern should adapt. Compared with the recent past, policymakers should aim at a more balanced and sustainable growth in the future. Fiscal deficit should be reduced in a sustainable way in the medium term. In this respect, containing the public wage bill and implementing a comprehensive pension reform are key goals. Slovenian banks have weathered the crisis well but a gradual withdrawal of government guarantees is important. Banks’ capital should be strengthened to build buffers for mounting non-performing loans and to support future credit expansion. Structural reforms in the labor and product markets should continue.
1. Slovenia’s economy has been hit hard by the global crisis. Globalization has greatly benefited Slovenia, favoring a rapid convergence of income to the European Union average. However, extensive trade and financial linkages, the domestic demand and credit boom, and the widening current account deficit left the economy exposed to the global turmoil. Following a decade of robust growth, the Slovenian economy contracted by 7.8 percent in 2009, the largest fall in euro area and the first recession since independence. The drop in domestic demand, together with favorable commodity price developments, contributed to lower inflation and reduced imports, narrowing significantly the current account deficit.
2. The policy response to the crisis was appropriate. The authorities adopted a number of stimulus measures in 2009, including subsidies to companies for shorter working hours and R&D and reductions in corporate income taxes, as well as measures to support the financial sector through several guarantee schemes. Thanks to these measures, the increase in unemployment was relatively contained. However, recourse to government guarantees for financing or lending has been relatively limited and credit growth has fallen sharply.
3. The economy is expected to recover slowly but uncertainty persists. Continued policy support, a modest pick-up in external demand, and restocking should help economic prospects. The recovery will be tenuous as consumers are cautious in face of increasing unemployment, firms need to deleverage and have excess capacity, and credit stays tight. Downside risks include a weaker-than-expected recovery in Europe and persistent international financial market turbulence, though this is mitigated to some extent by Slovenia’s relatively low public debt, a favorable sovereign rating, and full pre-funding of the 2010 budget.
A change in the growth pattern
4. The global crisis has changed the external financial environment. Before the crisis, the availability of international financing allowed a rapid expansion of domestic credit, a sizeable current account deficit, and an investment boom. The drying-up of international liquidity has led to increasing reliance on alternatives sources of financing, slowing down credit growth, and reducing investment. Recent international market turbulence adds uncertainty to the external funding conditions.
5. Policymakers should aim at a more balanced and sustainable growth in the future. Banks will need to rely more on domestic financing and corporates on retained earnings, and the government will need to prioritize its expenditure in response to the more stringent budget constraint. Fiscal consolidation should be supported by structural reforms in the labor and product markets and measures that would increase public sector efficiency.
Fiscal policy: ensuring sustainable consolidation
6. The general government fiscal deficit widened substantially from 1.7 percent of GDP in 2008 to 5.5 in 2009. This deterioration was largely due to a cyclical fall in revenues, discretionary stimulus measures of about 2 percent of GDP, and an increase in public sector wages as a consequence of the 2008 public wage reform.
7. The magnitude of the fiscal stimulus was appropriate. The severe contraction in economic activity and the low public debt ratio justified a bold fiscal response to support the economy. The fiscal stimulus package included measures aimed at: i) slowing down the impact of the global economic crisis on firms; ii) enhancing financial liquidity and safeguarding existing jobs; and iii) increasing expenditure in R&D and education to improve potential growth.
8. The mission endorses the authorities’ goal of reducing the fiscal deficit to below 3 percent of GDP by 2013. However, the authorities should consider extending further temporary support if activity does not recover as envisaged. The consolidation strategy relies on the gradual removal of fiscal stimulus and financial support measures and expenditure reduction starting in 2011. The mission welcomes measures taken to offset lower income tax revenues, including raising excise duties and broadening the tax base for social security contributions.
9. The authorities should focus on the quality and sustainability of fiscal consolidation. Setting expenditure priorities and containing entitlements are a prerequisite for a long-lasting fiscal consolidation. The full implementation of a fiscal rule limiting public expenditure growth should be accompanied by specific measures to reduce the public wage bill and a comprehensive pension reform.
10. A comprehensive pension reform is critical to ensure long-term fiscal sustainability. With age-related expenditures starting to increase in the near-term reaching 13 percentage points of GDP in the long-run, a pension reform is required to ensure long-term fiscal sustainability in face of adverse demographic dynamics. In particular, a pension reform should include a delinking of pension indexation from wages, the increase in the minimum retirement age, and eventually a transition from the current defined benefit scheme into a notional defined contribution scheme. Additionally, a pension reform should increase labor force participation.
Financial sector: challenges ahead
11. Slovenian banks have weathered the crisis well. The prompt exceptional measures taken by the authorities, the banks’ low exposure to toxic assets, and their retail-oriented nature mitigated the effect of the crisis. Banks responded to tight international liquidity by increasing reliance on government deposits, ECB funds, and issuance of securities, and by reducing lending to the corporate sector.
12. The mission supports the authorities’ plan for a gradual withdrawal of government guarantees. The exceptional measures that were needed during the crisis must be gradually phased out to minimize moral hazard and provide correct incentives. In the future, banks should rely less on public deposits and support measures to finance their portfolio.
13. Vulnerabilities in the financial system persist. Non-performing loans are increasing because of the banks’ exposure to the highly leveraged corporate sector—particularly in construction — contributing to lower banks’ profitability. While banks are currently adequately capitalized, the capital adequacy ratios for some banks are below the EU average and may be insufficient to support future credit expansion. The authorities should strengthen risk monitoring and coordination between supervisory agencies.
14. Enhancing the economy’s competitiveness requires greater labor and product market flexibility. Labor markets need to be flexible to facilitate the hiring and reallocation of workers. Hiring and firing costs should be eased for regular work contracts to ensure that workers do not get trapped in temporary forms of employment and hence avoid increasing labor market dualism. The recent large increase in the minimum wage is unfortunate because it will erode competitiveness, was not accompanied by a comprehensive reform of the labor market, and could result in job losses. To strengthen competition in the product and financial markets, reforms should focus on increasing the independence of the Competition Protection Office. Privatization process should continue as the recovery takes hold. The EU Services Directive should be implemented without further delay.
We thank the Slovenian authorities for their open discussions, excellent cooperation, and warm hospitality.