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Slovenia: Concluding Statement of the 2014 Article IV Mission
December 12, 2014
A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. 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, or as part of other staff monitoring of economic developments.
The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.
Slovenia is now recovering from a deep crisis, but risks remain high, requiring decisive policy action.
1. Slovenia was hit hard by the global crisis. Output fell by some 10 percent since 2008, one of the largest crisis-related losses in the euro area. Many lost their jobs, and the unemployment rate more than doubled. Banks suffered losses, as companies could not repay the large debts accumulated prior to the crisis, and their foreign sources of financing dried up. This led to a financial crisis last year, met with massive state support to the banks. The public finances also deteriorated, as tax revenues fell relative to rising spending. As a result, public debt quadrupled since 2008, imposing a heavy burden on current and future taxpayers.
2. The authorities took a number of steps to address the crisis. Most notably, they recapitalized the three largest banks and put two smaller ones under resolution (at a fiscal cost of about 10 percent of GDP). Almost half of the recapitalized banks’ non-performing loans (NPLs) were transferred to the state-owned Bank Asset Management Company (BAMC), and new legal tools were introduced to facilitate corporate debt restructuring. To improve the public finances, the authorities took consolidation measures and initial steps to reform the pension system.
3. The economy is now recovering gradually. Economic activity expanded at a rate of 2.6 percent (year-on-year) in the first three quarters of 2014, owing to a resilient export sector and increased utilization of EU-funds for public investment. Private consumption is also showing signs of revival, as confidence, employment, and real wages are gradually rebounding. Private investment, however, remains weak, given that many firms are burdened with high debt.
4. But the outlook for growth and jobs remains subdued. The recovery faces headwinds from necessary fiscal consolidation, the corporate sector’s need to restructure and reduce its debt, and the weak external environment. Growth is expected to reach around 2½ percent this year, and to moderate to close to 1¾ percent next year, driven by continued strong exports, public investment, and gradually improving private consumption. With growth projected at 1¾ - 2 percent over the medium-term, living standards would return to pre-crisis levels only toward the end of the decade.
5. Maintaining the reform momentum is essential to mitigate still high risks and support sustainable long-term growth. While the banking sector has been stabilized, the balance sheets of banks, corporations, and the state remain vulnerable and deeply interlinked. Without continued reforms to restructure the banks and the corporate sector, strengthen their governance, and significantly reduce the role of the state in the economy, more losses could materialize, risking renewed financial stress and further costs to future generations. These costs will rise further if public finances are not repaired, not only to address the impact of the last few years but also in anticipation of rising population-aging pressures. Slovenia can ill afford such a scenario. Pressing ahead with needed reforms is the only way to avoid it and unlock the economy’s potential to create investment, jobs, and growth.
Reducing NPLs and addressing governance issues are crucial for strengthening banks’ resilience and ability to lend to the economy.
6. Banks must address their high NPLs decisively. Total NPLs reached close to 16 percent of loans, and were substantially higher in the large state-owned banks, even after transfers to the BAMC. Reducing NPLs is key to allowing banks to focus on new lending to support investment and growth. Additional transfers of large domestic corporate NPLs to the BAMC would help. Banks should also employ all available legal tools to achieve efficient and sustainable loan restructuring agreements with viable companies, including debt-to-equity swaps. At the same time, supervisory tools should be further enhanced, including through developing a framework for standardized debt-restructuring options for SMEs, setting ambitious overall NPL reduction targets, and closely monitoring banks’ progress against them.
7. Bank governance should be strengthened, and the state’s role in credit intermediation curtailed. Lax governance and pervasive lending to connected parties contributed to the recent banking crisis and large related fiscal costs. To avoid further costs in the future, the governance of state-owned banks needs to be insulated from political pressure. This is key to ensuring that lending is geared toward productive uses rather than continuing to support loss-making companies with direct and indirect links to the state. All state-owned banks should thus be fully privatized as soon as possible. In the meantime, a governance relationship framework should be put in place ensuring their independent management on commercial principles.
8. Bank recapitalization and restructuring needs to be completed, and financial risk-management enhanced. To safeguard financial stability, the authorities should ensure that remaining capital shortfalls are addressed and the resolution of the two banks completed. These processes should be transparent and aim to minimize taxpayer costs. Banks should be encouraged to focus on core lending activities, including by divesting non-core operations and corporate equity stakes in due course. Finally, as the Single Supervisory Mechanism has entered into effect, bank regulation should continue to be brought into line with international best practice, and the authorities should speed up implementation of a centralized credit registry and a database to monitor connected lending.
Corporate restructuring and better governance are essential to reviving investment and boosting economic efficiency.
9. The BAMC can play a leading role in corporate restructuring. Many companies are heavily indebted, and often they are interlinked to others through complex structures, creating inefficiencies and making it difficult to invest and create new jobs. Corporate restructurings are needed to bring viable firms’ debts in line with their capacities to generate income and ensure that resources are not drained from sound businesses into loss-making ones. The BAMC is well positioned to lead and achieve centralized coordination of this process. Results are starting to materialize, but efforts need to accelerate. To maximize returns to the taxpayer, it is essential that BAMC maintain independent governance and a professional staff.
10. A more effective corporate insolvency framework is key to supporting restructuring efforts. While the 2013 reform brought the framework closer to best international practices, the system is still complex and requires more and better trained insolvency administrators and judges. Building capacity is all the more urgent, given the rapid increase in the number and complexity of insolvency cases. In addition, the general regime for enforcing claims, particularly mortgages, is weak and allows for delaying tactics. More efficient enforcement would facilitate credit and help underpin debt-restructuring efforts.
11. Corporate governance must be strengthened. Weak governance and wide-spread direct and indirect state control in the economy have magnified the corporate sector problems exposed by the crisis. To facilitate corporate restructuring and attract much needed equity capital, the authorities need to enhance the accountability of directors, the protection of investor rights, and auditing and reporting standards and practices. The authorities should also ensure the independent and professional management of state-owned assets now under the umbrella of the State Holding Company by providing it with clear objectives and accountability norms.
12. The authorities should step up the privatization of state assets. Slovenia has been slow to privatize compared to its peers. This has contributed to governance problems and led to inefficiencies and higher costs for the taxpayer. Privatization can bring in fresh capital and technological and managerial know-how, leading to better quality and greater choice for the consumer at lower prices. The authorities should thus intensify efforts to privatize the remaining twelve companies slated for sale, while avoiding fire sales. They should also finalize without delay their strategy for remaining state assets, with the aim to divest all non-strategic ones.
Well-paced fiscal consolidation underpinned by structural fiscal reforms is needed to safeguard debt sustainability.
13. Fiscal policy should be anchored by a credible medium-term target aiming at putting public debt on a sustained downward path. With public debt high and rising, additional fiscal consolidation is needed to reduce the burden on future generations. While a too abrupt pace of consolidation could thwart the nascent recovery, too slow a pace, or deficit reduction based on one-off measures, risks undermining fiscal sustainability. Gradually bringing public revenues and spending in line over the next five years can help balance these concerns and put debt firmly on a downward path. To enhance the credibility of fiscal policy, this medium-term objective needs to be supported by legislation, which should include a corrective mechanism in case of deviations while providing flexibility when responding to large unanticipated shocks.
14. The 2015 budget includes an adequate consolidation effort, but the quality of measures could be improved. Recently announced measures—including select tax increases, an agreement on public sector wages, and centralization of procurement, among others—are estimated to yield some 1 percent of GDP, consistent with a broadly evenly-paced adjustment to reach fiscal balance by 2019. This appropriately balances short-term cyclical and long-term sustainability concerns. However, one-quarter of the adjustment measures are temporary (such as the one-year agreement on the public wage bill), and the authorities are advised to replace these with high-quality permanent ones to ensure a sustained improvement in the public finances.
15. Over the medium-term, structural reforms should underpin consolidation efforts. Further fiscal consolidation measures will be needed during 2016-19 to align spending with the capacity to generate revenues. The authorities should implement a property tax based on up-to-date housing values and in line with the Constitution. This would not only help bring in needed revenues, but would also promote social and inter-generational equity by ensuring an adequate sharing of the tax burden based on wealth. To address pressures from population aging, the pension system should be further reformed, including by linking benefit indexation to prices and increasing incentives for staying in employment longer.
16. The authorities should also identify and pursue measures to boost the efficiency of public finances and reduce risks. The planned health expenditure review is an opportunity to modernize the sector and improve its efficiency. More broadly, a public administration review could help reduce inefficiencies and improve the quality of public services. A tax reform to simplify the system, reduce compliance costs, eliminate biases in favor of debt, and provide incentives for debt restructuring, can support economic activity and enhance the resilience of the corporate sector. Finally, to minimize risks to the taxpayer stemming from high government guarantees, the authorities should monitor guarantees carefully and ensure adequate cash buffers in case they come due.
Structural reforms can help support corporate restructuring, investment, jobs, and growth.
17. Labor and product and service market reforms can help unlock the economy’s growth potential. Building on the labor-market reform introduced in 2013, further cutting the cost of open-ended contracts can help reduce differences between permanent and temporary work, enhancing human capital and job security, and boosting long-run productivity. This can also facilitate the reallocation of labor across firms and sectors, thus supporting corporate restructuring. Opening up of closed professions can also help create new job opportunities. Reducing red tape, especially by streamlining procedures and regulations, is key to spurring investment both domestic and foreign. Finally, educational curricula could be better aligned to the needs of the economy, and cooperation between universities and industry can be further strengthened to boost innovation.
We thank the authorities for open discussions, excellent cooperation, and warm hospitality.
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