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Republic of Slovenia and the IMF
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On March 20, 2002, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Slovenia.1
Benefiting from strict macroeconomic discipline, Slovenia is currently among the most successful transition economies. Tight fiscal discipline and a monetary policy based on monetary targeting and a managed float for the tolar brought inflation to the single digits since 1996; kept government debt to about 25 percent of GDP; maintained strong competitiveness and a balanced current account for most of the 1990s; and earned it the highest investment rating and per capita income among transition countries.
Economic growth slowed in 2001 from around 4.5 percent to about 3 percent as domestic demand fell sharply and external demand weakened. Competitiveness remained strong and the current account deficit narrowed to about ½ percentage point of GDP. Real export growth decelerated from 12.7 percent in 2000 to 7.9 percent in the first three quarters of 2001.
The inflation rate had been stuck at the 9-10 percent range since mid-1999, reflecting a combination of successive exogenous shocks (VAT, energy costs, administered prices) and an accommodating monetary stance. However, the unwinding of these shocks and progressive tightening of monetary conditions during 2001 brought average inflation in 2001 down to 8.4 percent and end-year inflation to 7 percent.
The planned reduction in the budget deficit in 2001 did not materialize because of expenditure overruns. The 2001 budget aimed at a general government deficit of 1 percent of GDP, down from 1.4 percent of GDP in 2000. In the event, higher-than-budgeted wage, consumption, and pension outlays resulted in a general government deficit of 1.3 percent of GDP in 2001.
Monetary policy was gradually tightened during 2001, although capital inflows kept broad liquidity high. Interest rates were raised in March and remained unchanged until November, when they were eased as inflation pressures abated; the pace of the depreciation of the tolar slowed from an annual rate of about 8-9 percent in the first half to about 4.5 percent in the second half; and domestic credit and base money growth were contained. This tightening of monetary conditions helped curb inflation in late 2001. However, capital account liberalization and foreign direct investment inflows boosted broad liquidity.
The pace of structural reforms accelerated in 2001. A new basic budget law was passed, stipulating two-year budgets starting in 2002. Backward-looking full wage indexation was abandoned in favor of partial indexation to projected inflation in both the public and the private sectors in 2001. The government decided to close the Slovene Development Corporation, a government holding company with shares in loss-making enterprises, and lowered its stake in Telekom Slovenije. The privatization of two large state-owned banks is proceeding slowly, and there is considerable opposition to foreign participation in the privatization process. Also, insurance company privatization is stalled by a court challenge.
Growth is not expected to pick up in 2002 as foreign demand is likely to slow further and domestic investment to recover only gradually. The 2002 budget aims at a small reduction in the general government deficit to 1.1 percent of GDP and a further increase in the expenditure-to-GDP ratio. However, the cash deficit will reach 2.6 percent of GDP as the budget accounting will be shifted onto pure cash basis in 2002, discontinuing the practice of booking in the current year revenues accrued in December but collected the following January. The Bank of Slovenia has announced an inflation goal of 5.8 percent for end 2002, notwithstanding the increase in the VAT rate in January 2002.
Executive Board Assessment
Directors noted that Slovenia is among the most successful transition economies and well advanced in terms of convergence and smooth economic integration with the European Union. They commended the Slovene authorities for their strategy of strict macroeconomic discipline, strong efforts at institutional development, and recent progress in structural reforms, which have led to broad-based sustainable growth and strong competitiveness. Directors welcomed the recent decline in inflation after more than two years of persistently higher rates, and the improvement in the current account in 2001.
Directors, noting the uncertain near-term outlook, emphasized the need for a stable policy environment to support private sector economic activity and promote medium-term growth. In this context, they endorsed the authorities' intention to keep policies focused on medium-term goals. They noted that allowing automatic fiscal stabilizers to work would have only limited benefits in a small and very open economy like Slovenia, which would be outweighed by the costs of a rapidly rising deficit. Therefore, they supported the government's intention to limit the operation of automatic stabilizers in 2002, noting that this would likely require restraining expenditure relative to budgeted levels.
Directors underscored the advantages of an appropriate medium-term fiscal policy framework. They endorsed the authorities' medium-term goal of a balanced budget, and emphasized in particular the need to place the expenditure-to-GDP ratio on a downward path, reversing its recent upward creep. Directors considered the introduction of a rolling two-year budget framework a positive step, but called for supplementing it with a fully fledged medium-term expenditure plan that would aim to reduce the overall spending ratio while accommodating new expenditures associated with European Union and NATO accession. This would require reducing the share of public wages and social transfers, which constitute the bulk of public spending, through changes in the public wage determination system and reforms to improve the efficiency and targeting of social transfers.
Directors agreed that the authorities should capitalize on the opportunity provided by the easing of exogenous price pressures to consolidate the downward trend in inflation in 2002. They therefore welcomed the new monetary policy framework's focus on disinflation and urged the authorities to maintain a tight monetary policy. They noted however that the framework remains discretionary and, therefore, that its effectiveness would depend on how it is implemented, in particular in conditions of increased liquidity caused by capital account liberalization. In this respect, many Directors considered that exchange rate policy should be subordinated to the goal of disinflation, especially in the event of large capital inflows, although it was also noted that with continued skilful and pragmatic coordination of exchange rate and short-term interest rate policies, speculative capital flows could be mitigated, the inflation objective achieved, and policy credibility enhanced. Directors underlined the importance of effective communication by the Bank of Slovenia to explain its policy actions to the public, and the need to enhance coordination with fiscal and administered price policies. Directors felt that, in the medium term, moving to a formal inflation targeting framework would enhance policy credibility and provide an effective framework for policy within the Exchange Rate Mechanism 2 bands.
Directors commended the authorities for the Financial Sector Action Plan they prepared in response to the recommendations of last year's Financial Sector Assessment Program and the considerable progress achieved in strengthening financial sector supervision and improving liquidity management. Directors especially welcomed the adoption of rules limiting connected lending and the progress in consolidated supervision. They noted that these achievements would help the Bank of Slovenia deal with the supervisory challenges arising in the newly liberalized and highly integrated financial sector. Directors also welcomed recent steps to develop the money market and deindex financial contracts, and thought that rapid progress in these areas would improve the transmission of monetary policy by promoting the development of market-determined interest rates. Directors commended the authorities for their efforts to combat money laundering and terrorism financing.
Directors encouraged the authorities to move decisively and quickly to privatize two large state-owned banks, which they considered necessary for a more efficient and competitive banking system. They stressed the need for an accelerated privatization approach that is transparent and would create strong, internationally competitive banks with good corporate governance. Directors urged the authorities to be open toward foreign investors in bank privatization, as the Slovene banking system could otherwise be at a disadvantage in the broader European context and discourage foreign investment in other sectors as well.
Directors welcomed the recent acceleration in structural reforms as laying the groundwork for continued rapid convergence of living standards to European Union levels, but saw the need for broadening and deepening the reform measures. Directors urged the authorities to keep up the momentum in liberalization and deregulation in order to enhance the efficiency of the economy and reduce the role of the state. They welcomed the adoption of forward-looking wage indexation, which should promote disinflation, and called for a rapid adoption of the draft Labor Relations Law in order to increase flexibility in the labor market. Directors called for rationalizing extrabudgetary funds by retaining only those that perform public policy functions and applying the same rule to the entity that would succeed the Slovene Development Corporation. Finally, Directors welcomed the assessment in the Report on the Observance of Standards and Codes that Slovenia meets the requirements of the Fiscal Transparency Code in many important respects, and urged the authorities to move forward with its recommended improvements.
1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. This PIN summarizes the views of the Executive Board as expressed during the March 20, 2002 Executive Board discussion based on the staff report.
IMF EXTERNAL RELATIONS DEPARTMENT