Slovenia: 2013 Article IV Consultation—Concluding Statement of the Mission
October 28, 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.
Slovenia is facing a deep recession resulting from a vicious circle of strained corporate and bank balance sheets, weak domestic demand, and needed fiscal consolidation. Cleaning up and recapitalizing banks is an immediate priority to break this cycle. However, any recovery can only be sustained by restructuring the over-indebted corporate sector and reducing the role of the state in the economy. Without these reforms, recapitalizing banks will be only an expensive stop-gap solution. Shoring up banks will increase public debt, meaning that further, gradual fiscal consolidation will also be necessary, to ensure that the public finances remain sustainable. The authorities have begun to address these challenges; strong and committed follow through is essential for Slovenia to successfully exit the recession. Otherwise these challenges will become more difficult and costly to resolve in the future.
1. The economy remains in deep recession. A vicious cycle of corporate distress, increasing nonperforming loans (NPLs), bank deleveraging, and needed fiscal consolidation is prolonging the recession and weighing on the near-term outlook. A slow, export-driven recovery will likely take hold only in the second half of 2014. A more robust and sustained recovery can happen only after the financial and corporate sectors are repaired.
2. The economy has some strengths. Public and household debts are still low. Unemployment remains below the euro area average. Parliament has approved important fiscal reforms. The current account has swung from a large pre-crisis deficit to a projected surplus of almost 6 percent of GDP this year, thanks in part to improving competitiveness.
3. But decisive actions are necessary if Slovenia is to break out of this vicious circle. A prompt bank recapitalization based on a credible balance sheet assessment, which is ongoing and is expected to be finished by the end of the year, is the immediate priority. However, only by restructuring the corporate and financial sectors, and reducing the role of the state in the economy, can sustained growth be achieved. Without these reforms, recapitalizing banks will be only an expensive stop-gap solution, as loss-making corporations will generate new NPLs that will lead to renewed deterioration of bank balance sheets. Gradual, further fiscal consolidation should address the fiscal cost of the recapitalization and the rising cost of an aging population. Privatization proceeds should be used for reducing public debt.
Strengthening the financial sector is urgent to ensure stability
4. Bank balance sheets continue to deteriorate. NPLs are very high, particularly in public banks, and are growing rapidly, increasing from 12 percent of loans at end-2011 to 17½ percent by June 2013. They are highly concentrated, with the 40 largest non-financial corporate loans accounting for over one-third of NPLs. All banks, including foreign-owned banks, are deleveraging to reduce loan-to-deposit ratios.
5. Banks should be promptly recapitalized to ensure financial stability. The ongoing asset quality review (AQR) and stress test will soon provide an independent evaluation of bank balance sheets and determine of the size of banks’ recapitalization needs.
6. The Bank Asset Management Company (BAMC) will facilitate bank and corporate restructuring. A swift transfer of impaired bank assets to the BAMC after the AQR, at prices that accurately reflect expected recovery values, will support corporate restructuring. The independent and accountable BAMC has the tools to achieve a quick resolution of impaired assets. A timely disposal of restructured assets and a strong cash protocol should ensure that bonds issued by BAMC are quickly repaid.
7. Bank governance and risk management, especially in state-owned banks, should be further strengthened. This is needed to address endemic connected lending and lax risk controls. The role of the state in the financial system should be drastically reduced through privatization and independent management. Bank consolidation should be driven by market considerations favoring strong and qualified candidates.
8. Bankers should focus on banking. State-owned banks have become major owners of corporate equity, including supermarket chains, breweries, and newspapers. This creates the potential for directed and connected lending and undermines corporate governance. Thus, banks should divest their equity holdings as soon as feasible and refocus on their core activities.
Restructuring the corporate sector is crucial for strong and sustained growth
9. Corporates are under severe stress. An acute lack of equity, declining economic activity, and bank deleveraging are crippling most of the corporate sector and weighing on growth. Corporate leverage is high, with an average debt-to-equity ratio of 135 percent at end-2012, while debt service accounts for 90 percent of earnings.
10. Corporate restructuring requires a multi-pronged approach. In addition to the BAMC, the insolvency law, scheduled to take effect at the beginning of next year, is essential to facilitate effective and speedy rehabilitation of viable corporates and deleveraging through debt-to-equity swaps while allowing nonviable firms to be wound down efficiently. Enhanced out-of-court restructuring tools should also contribute. In the future, the law should be refined to bring it fully in line with international best practices. State support of troubled non-financial enterprises should be avoided because it is an inefficient use of limited fiscal resources. Moreover, it undermines management incentives and governance, while distorting competition. FDI is an important potential source of fresh capital for corporates.
Continued fiscal consolidation is needed to put public debt on a sustainable path
11. Despite consolidation, public debt remains on an upward trajectory. After three years of adjustment, the structural balance is set to improve further this year. Yet the headline fiscal deficit, even excluding the expenditure for bank restructuring and recapitalization, remains high at 4¼ percent of GDP in 2013, reflecting the sharp recession. This, combined with the costs of supporting state-owned banks, will sharply increase the public debt-to-GDP ratio.
12. The planned fiscal stance for 2014 is appropriate, but additional measures may be needed to achieve this target. The introduction of a broad-based property tax is welcome. However, most of the projected improvement in the 2014 budget hinges on large across–the–board expenditure cuts, not supported by specific reforms, and uncertain revenue yields from stronger tax enforcement. Additional measures may be needed to meet the 2014 deficit target. Therefore, the authorities should prepare contingency measures of about 1 percent of GDP. These could include a more ambitious public employment reduction, better targeting of social transfers, and reductions of specific subsidies. The publicly financed “credit fund,” which increases public debt and contingent liabilities, should be reconsidered.
13. A further gradual fiscal consolidation is in order. The still-unknown bank recapitalization costs, sizeable public guarantees, and the costs of an aging population will substantially increase public debt, necessitating gradual fiscal consolidation. A second round of reforms should address the pension indexation mechanism, benefits eligibility, and the retirement age after the recently introduced pension freeze expires.
Growth and Equity for (young) Slovenians
14. Labor market flexibility is important to facilitate corporate restructuring. The restructuring will require a reallocation of labor among firms and industries. The brunt of this adjustment is likely to fall disproportionately on the young because older workers enjoy higher job protection. The recent reform, which reduces labor market duality and increases flexibility, is a step in the right direction but its effectiveness need to be closely monitored and assessed.
15. The state should reduce its role in the economy. Slovenia’s attractiveness for foreign direct investment (FDI)—a crucial conduit of job opportunities for young educated workers—remains hindered by the excessive state control of the economy and pervasive red tape. The government’s plan to privatize 15 companies is welcome (especially if promptly executed) but further privatization will be necessary to reduce meaningfully state involvement in the economy and will help reduce the debt level. The mission welcomes the decision to set up a centralized management agency for state assets, overseen by an independent and professionally qualified supervisory board.
We thank the authorities for open discussions, excellent cooperation, and warm hospitality.