Slovenia: 2013 Staff Visit—Concluding Statement of the Mission
March 18, 2013
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.
A negative loop between financial distress, fiscal consolidation, and weak corporate balance sheets is prolonging the recession. Prompt policy actions are necessary to break this loop and restart the economy. Repairing the financial sector and improving corporate balance sheets is of the essence. The Bank Asset Management Company is an effective way to clean bank balance sheets. Banks should be quickly recapitalized. A clear and coherent plan is key to access international capital markets quickly. Fiscal consolidation should continue to reduce the structural deficit, while letting the automatic stabilizers work. Recent labor market and pension reforms are steps in the right direction.
1. A negative loop between financial distress, fiscal consolidation, and weak corporate balance sheets is prolonging the recession. Real GDP declined by 2.3 percent in 2012 as domestic demand shrank severely. The mission expects the economy to contract further by about 2 percent in 2013 and projects growth to turn positive in 2014, but this is predicated upon implementation of reforms and continued market access as well as a recovery in the euro area. Against this background, the risks are mainly on the downside.
2. Prompt policy actions are necessary to break the negative loop, to restore confidence, and to address structural weaknesses. In recent months, Slovenia has already implemented important labor market and pension system reforms. The Bank Asset Management Company (BAMC) and the sovereign state holding company have been created. Building on this framework, the new government should promptly address bank restructuring, corporate sector debt overhang and governance, and involvement of the state in the economy. A coherent and credible plan to address these issues is essential to restore confidence and access markets.
Financial and Corporate Sector: Breaking the negative loops
3. Banks are under severe distress. The share of nonperforming claims in total classified claims increased from 11.2 percent at the end of 2011 to 14.4 percent in 2012. The three largest banks saw their ratio increase from 15.6 percent to 20.5 percent in the same period with about ⅓ of their corporate loans non-performing. Meanwhile these banks have repaid the bulk of their debt with foreign private creditors, while increasing reliance on the ECB.
4. Slovenia has made progress in setting up the BAMC, which is an effective way to clean up the balance sheet of troubled banks, while at the same time helping restructure the highly indebted corporate sector. This process should be carried out with the utmost transparency, avoiding any moral hazard arising from the close relationship between banks, corporates, and the public sector. For this reason, the mission sees favorably the appointment of international technical experts as non-executive members of the board of the BAMC.
5. Banks need to be substantially recapitalized. Despite some past recapitalization, the deteriorating loan portfolio continues to erode bank capital. The transfer of assets to the BAMC is not a substitute for the need to increase capital (in cash) and actually could trigger upfront recapitalization. The recapitalization needs for the three largest banks is estimated at around €1 billion in 2013, also identified by the supervisor. Deteriorating economic conditions could increase the need for capital in outer years.
6. Corporate sector balance sheets are under significant stress. The debt to equity ratio is among the highest in Europe. Cross ownership between large industrial groups, financial holding companies and banks, and lengthy bankruptcy procedures exacerbate the underlying problem of debt overhang.
7. Addressing corporate debt overhang is key to alleviate the financial sector distress, and ultimately spur growth. The restructuring process will benefit from an enhanced bankruptcy regime and out-of-court settlement arrangements, areas where the IMF could provide technical assistance. For companies under severe financial distress, the BAMC has tools to convert corporate debt into equity. For other companies, the mission welcomes the initiatives undertaken by the Bank of Slovenia to facilitate debt restructuring. Viable publicly-owned undercapitalized companies should be recapitalized by the state or attract private capital. However, the mission cautions the authorities against taking actions on debt restructuring or recapitalization that can lead to ineffective use of public funds. Finally, Slovenia has to address corporate governance weaknesses. A Report of Standards and Codes on Corporate Governance by the World Bank and the OECD could help in this respect.
8. Slovenia needs to open up to foreign direct investment. Misconceived defense of ‘national interests,’ including the reluctance to sell assets to foreigners, burdens the budget and unduly prolongs the corporate and financial sector distress. A prominent privatization could convey a powerful signal to international investors.
Fiscal: Continuing a gradual structural adjustment
9. The frontloaded, expenditure-based, fiscal consolidation strategy remains broadly on track in 2013. The reduction in public sector wages and in transfers to households is projected to translate into sizeable expenditure savings this year, while the bulk of the impact of the pension reform will be felt over the medium term. However, the deepening of the recession, and in particular the decline in domestic demand, is projected to significantly reduce revenues, raising the deficit (excluding bank recapitalization costs) to about € 1½ billion in 2013.
10. Given the severity of the economic downturn, allowing full operation of automatic stabilizers is appropriate, and hence corrective measures are not warranted. Fiscal consolidation should continue over the medium term at its current pace of about 1 percent per year in structural terms, in order to gradually bring the budget close to balance and keep the public debt dynamics under control. The structure of public expenditure should be improved, especially in the area of social spending, as reliance on one-off measures like wage cuts is not desirable and is probably not sustainable.
11. Financing needs are large for 2013. Financing requirements are particularly pronounced in summer, with bank recapitalization needed soon and a large 18-month T-bill coming due in June. In all, financing needs for the remainder of the year (excluding the bonds to be issued by the BAMC) could reach some € 3 billion, and possibly more depending on bank recapitalization needs. A large part of this financing need should be met via external borrowing, given banks’ inability to absorb large amounts of government paper, but also to improve the maturity structure of government debt and reduce rollover risk. This highlights the importance of safeguarding market access in the near term.
Structural reforms: Important step forwards
12. Recent labor market and pension reforms are steps in the right direction. Labor market reform somewhat reduces the rigidity of permanent labor contracts and simplifies administrative procedures. With this reform, Slovenia’s employment protection index as measured by OECD will reach the OECD average. In parallel, the rules on fixed-term contracts were tightened to limit the segmentation of the labor market and encourage the use of permanent contracts. An important area not touched by the current reform is the student work program. For entry level positions companies prefer hiring student workers, which leads to increased unemployment among young graduates and extended study periods. Pension reform raises the effective retirement age, which along with other parametric and regulatory changes, will lead to a stabilization of pension expenditures as a share of GDP by 2020, but a new reform will be necessary in a few years. Both reforms are positive steps that are gradual rather than radical. Moreover, the changes have been thoroughly negotiated with social partners and were passed with near-unanimous support in the parliament, creating a stable and strong basis for further efforts.
We thank the authorities for open discussions, excellent cooperation, and warm hospitality.