Slovenia 2012 Article IV Consultation-Concluding Statement of the Mission
October 2, 2012
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.
The Slovenian economy is suffering from negative feedback loops of recession, bank deleveraging, and corporate distress against a background of pre-existing structural weaknesses. Urgent policy actions, including bank and corporate restructuring and privatization, pension and labor market reforms, and structural fiscal consolidation, are needed to break these negative loops and to address the structural weaknesses. The government has kick-started fiscal consolidation and has announced an ambitious and comprehensive set of policy actions. Success depends ultimately on the proper and timely implementation of these measures.
Economic outlook: a double-dip recession
1. Slovenia is in the midst of a double-dip recession. The economy is now suffering from the negative feedback loops of recession, bank deleveraging, and corporate distress against the background of pre-existing structural weaknesses. The mission expects the economy to contract by 2.2 percent in 2012 and by some 1 percent in 2013 on the back of continued deleveraging, sluggish external demand, and fiscal tightening. As a result of weak economic activity, core inflation is low and the current account continues to improve with a moderate surplus expected for this year.
2. Financial conditions have worsened. Amid stress in a number of countries in the Euro Area, markets have been reevaluating Slovenia’s riskiness. Repeated rating downgrades towards the lower end of investment grade range highlighted long-standing issues and concerns on the status of publicly-controlled banks. The failure to implement pension and labor market reforms in mid-2011 and political uncertainties have contributed to markets’ concerns.
3. Strong and prompt policy actions are necessary to address the structural weaknesses and to restore confidence. The government has announced an ambitious and comprehensive set of reforms, which includes a plan to deal with bank nonperforming loans (NPLs), management of public assets, further fiscal consolidation, and pension and labor market reforms. Swift implementation of these reforms is essential to resolve the current crisis and to realize the economy’s potential.
Financial sector: dealing with the legacy of NPLs
4. The performance of Slovenian banks deteriorated markedly in recent years as a result of the weak economy and poor governance in some banks. Bank asset quality has worsened substantially, with NPLs (defined as claims in arrears of more than 90 days) climbing to 13 percent of classified claims by end-July 2012. Of particular concern are claims to the corporate sector, which is over-indebted and facing declining demand. Weak governance in publicly-controlled banks and corporations, the end of a housing/construction boom, and the international crisis have contributed to the problems. The legacy of NPLs represents a major element of uncertainty and a drag for the entire economy.
5. The mission welcomes the creation of the Bank Asset Management Company (BAMC) and stresses that proper operating rules will be key to success. The BAMC is an important first step to address the buildup of NPLs and the Law to Strengthen the Stability of Banks will help to address the financial distress faced by many large non-financial corporations. The BAMC will buy NPLs from banks by issuing publicly-guaranteed bonds. The BAMC should be independent and free of political pressures, appropriately funded, able to hire the best talent, fully accountable for its actions, transparent, and subject to external professional auditing. The BAMC should have undisputed legal rights to restructure or liquidate NPLs swiftly, with a view to minimizing fiscal cost. In this connection, the mission would welcome strengthening the bankruptcy procedure.
6. The mission urges the government to proceed with the privatization of publicly-controlled banks and corporates. Political interference should be removed from their management. To this end, the government should move decisively to privatize banks and corporations (to below a blocking minority share, which would deter strategic investors) in order to change their governance and commercial culture.
7. The mission welcomes the authorities’ efforts to address FSAP recommendations. In particular, the mission endorses the authorities’ action plan to strengthen the regulatory and supervisory frameworks and crisis contingency arrangement. The mission also stresses the importance of maintaining the current supervisory architecture in a period of financial turbulence, and coordinating with future developments in the euro area.
Fiscal sector: continued consolidation and pension reform
8. The mission welcomes the front-loaded, expenditure-based consolidation towards structural balance by 2015. The structural adjustment in 2012 is already significant and the headline deficit is projected to decrease from 4.3 percent of GDP to around 3½ percent of GDP (on a cash basis, excluding bank restructuring costs.) This deficit is slightly higher than planned, mainly due to weaker revenues. In light of financial sector restructuring costs, an aging population, and contingent liabilities, further consolidation is necessary. The government should focus on the structural balance rather than on headline targets. Also, the mission welcomes the government’s effort to increase EU fund absorption to contain the negative effects of fiscal adjustment on growth. Without bank restructuring cost and other contingencies, achieving structural balance from 2015 onwards would keep debt below 60 percent of GDP and put it on a downward trajectory for the second half of the decade.
9. The mission stresses that fiscal governance and the quality of adjustment should be strengthened. The proposed cut in the wage bill is very ambitious and the mission welcomes efforts to avoid excessive wage compression. Staff recommends a careful reassessment of the effects of the legislated reductions in the corporate income tax rate and the generous allowances for investment. A constitutional structural balance rule with a debt brake, complemented by enhanced medium-term fiscal planning, would anchor fiscal consolidation in the medium run.
10. Pension reform is essential for long-term fiscal sustainability in light of adverse demographic dynamics. Current reform proposals focus on the retirement age and are an important step in the right direction. However, they will leave Slovenia still among the euro area countries with the highest pension expenditure, and a more decisive reform will be necessary to ensure debt sustainability in the longer term.
Structural reforms: Addressing long-term weaknesses
11. Labor market reform is necessary to reduce labor market dualism and to improve competitiveness. Against a background of weak domestic demand, Slovenia needs to shift resources to the tradable sector and regain competitiveness. Employment protection for workers with permanent contracts is still very high. Unprotected workers are disproportionally young and female, leading to an inefficient and unfair segmentation in the labor market. The 2010 increase in minimum wages has also put pressure on costs and weighs on competitiveness. The mission welcomes the plan for a labor market reform to address these issues.
12. With the banks under pressure and the corporate sector highly leveraged, it has become critical to attract fresh external capital. FDI in Slovenia is low by regional standards as a result of a relatively unattractive business climate, rigid labor markets, and a high administrative burden. A preference for national ownership in key industries has led to interconnected holdings between public banks, holding companies, and large corporates. This interconnectedness is at the core of weak governance, and low levels of capital relative to debt. New FDI inflows can help mitigate these problems by injecting equity to existing firms and improving their governance.
We thank the Slovenian authorities for open discussions, excellent cooperation, and warm hospitality.