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Public Information Notice (PIN) No. 04/60
May 24, 2004
International Monetary Fund
700 19th Street, NW
Washington, D.C. 20431 USA

IMF Concludes 2004 Article IV Consultation with the Republic of Slovenia

Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2004 Article IV consultation with the Republic of Slovenia is also available.

On May 7, 2004, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Slovenia.1

Background

Domestic demand rebounded strongly in 2003 after three anemic years. All components of domestic demand strengthened appreciably, fueled by declines in interest rates and the associated pickup in bank credit to the private sector. However, there was a large negative swing in the contribution of net foreign demand to growth. Real GDP growth slowed to 2.3 percent, and the output gap widened. The external current account position receded from a sizeable surplus in 2002 to approximate balance in 2003. Competitiveness and other external vulnerability indicators remained satisfactory.

Progress with disinflation was better than expected. Year-on-year inflation declined from 7.2 percent at end-2002 to 3.5 percent in March 2004. Staff analysis suggests that the widening of the output gap associated with the economic slowdown was the dominant driving force behind disinflation in 2003. Other contributory factors, albeit to a lesser degree, were a moderation of the pace of tolar depreciation, smaller increases in regulated prices and indirect taxes, and excise tax adjustments to offset increases in international oil prices. While wage drift in the public sector slowed and economy-wide real wage growth in 2003 was broadly similar-about 2 percent-to that in 2002, the gap between wage and productivity growth narrowed.

The fiscal outturn in 2003 implied some withdrawal of stimulus. The general government deficit-1.4 percent of GDP-was slightly smaller than that envisaged in the mid-year supplementary budget and broadly similar to the outturn in the past three years.

Monetary conditions at the policy level remained broadly unchanged in 2003. Prompted by the deceleration in inflation, European Central Bank interest rate cuts, and a perception of falling country-risk premium, the Bank of Slovenia lowered its key policy rate steadily by a total of 3½ percentage points since December 2002 to 4.75 percent in April 2004. Meanwhile, the tolar continued to depreciate vis-à-vis the euro, though the pace of depreciation slowed from an annualized rate of 3.3 percent in December 2002 to 2 percent in March 2004. The indexation of financial contracts was eliminated in 2003. Bank lending rates fell in real terms, and private credit demand and interest-sensitive capital inflows picked up. A large part of the expansion of credit to enterprises was foreign currency-denominated, and was financed by rising bank borrowing from abroad.

GDP growth is expected to rebound in 2004 and rise above the potential rate subsequently. Growth is likely to be driven by strong domestic demand boosted by favorable business and consumer expectations triggered by European Union (EU) accession and prospective euro adoption, and a convergence-related decline in interest rates. In this environment, there is some risk of domestic demand boom. The contribution of net foreign demand to growth would likely remain negative in the foreseeable future, and the current account is expected to swing into a modest deficit. The prospective narrowing of the output gap is likely to slow down the disinflation process, complicating achievement of the Maastricht inflation criterion. Slovenia already meets the Maastricht criteria for long-term interest rates and the fiscal deficit and public debt ratios.

Following Slovenia's accession to the European Union on May 1, 2004, the authorities plan to enter ERM2 in the course of the second half of 2004 with the aim of adopting the euro in January 2007.

Executive Board Assessment

Executive Directors congratulated the authorities for their successful entry to the European Union (EU) on May 1, 2004 and their impressive macroeconomic policy achievements, and noted that the main challenge now is to ensure a smooth ERM2 entry and euro adoption, as well as to continue preparing the economy for successful performance within the union. Directors observed that Slovenia is in many respects well poised to join the euro area, particularly in light of the substantial real and nominal convergence in meeting most of the Maastricht criteria. They also considered that Slovenia's competitiveness appears adequate. Inflation, however, while falling, remains above the EU average.

Directors stressed that the intended early ERM2 entry and eventual euro adoption would depend critically on bringing inflation sustainably down to a level that, in addition to meeting the Maastricht criterion, would not hamper competitiveness once the exchange rate is fixed. Other key tasks are to ensure that fiscal and wage policies are capable of absorbing shocks. Directors cautioned that a credit-financed demand boom could complicate achieving the Maastricht inflation criterion and create stresses on the banking sector.

Directors welcomed the recent sharp drop in inflation. They noted that while the increased slack in the economy in 2003 was probably the main driving force behind disinflation, policy measures-such as a slower pace of tolar depreciation-also contributed. Directors also welcomed the efforts to limit excessive increases in administrative and regulated prices by pressing for greater cost efficiency and savings in public companies. In this context, some Directors stressed the need to further liberalize those prices. Directors commended the decision to eliminate indexation of financial contracts.

Directors underscored that monetary policy needs to play a pro-active role in the run-up to ERM2 entry by restraining monetary conditions in order to contribute to disinflation and help contain possible intense demand pressures under ERM2. While acknowledging the Bank of Slovenia's (BoS) concern that monetary restraint could trigger capital inflows and potentially impact competitiveness, Directors stressed that monetary conditions should not be loosened prematurely.

Directors emphasized that fiscal policy should be oriented to alleviating budgetary pressures related to EU accession and coping with the risk of a possible private sector demand boom. They welcomed the significant expenditure saving measures incorporated in the budget for 2004-05, and noted that these measures should be carefully safeguarded in an election year. Nevertheless, they stressed that further expenditure rationalization-particularly in the areas of health care, education, and social transfers-is essential to ensure sustained flexibility in fiscal policy and to achieve the authorities' medium-term goal of structural balance. Directors urged that, in the event of a demand boom, any revenue overperformance should be saved and any further lowering of payroll taxes avoided.

Directors stressed that wage policy needs to play a central role in fostering disinflation and safeguarding competitiveness. They commended the authorities for weakening wage indexation and reducing wage drift in the public sector, and urged them to consolidate these gains by restricting the cost of the new wage structure. Directors noted that wage policy can usefully contribute to disinflation by reducing wage increases relative to productivity growth, particularly in the nontradable sector. They also considered that achieving the Maastricht inflation criterion might warrant a temporary wage pact at the national and enterprise levels under the guidance of the government. Directors encouraged the government and social partners to fully eliminate wage indexation and move to a wage-setting system that ensures wage differentiation based on productivity.

Directors noted that the banking system is generally sound. However, they emphasized that strengthening supervisory and prudential oversight-in line with the Financial System Stability Assessment update-is essential to guard against the risks of rapid credit growth and stresses on the financial system. They noted signs that banks were starting to shift to more risky borrowers as a result of increased competition, and cautioned that this tendency was likely to intensify as profit margins were squeezed further. Given the potential for a credit boom and related risks in the run-up to euro adoption, Directors cautioned against any easing of the existing prudential regulations. They deemed appropriate the BoS's intention to complement the supervisory framework by introducing dynamic provisioning appropriate, while noting that other prudential tools may have to be considered to control surges in credit growth. Directors welcomed Slovenia's active AML/CFT efforts.

Directors urged the authorities to maintain the momentum behind structural reforms in other areas and to improve the environment for private sector development. They welcomed achievements in liberalizing utilities and transport services, and called for further progress in the natural gas, telephony, and transport sectors, as well as a broader privatization program. Directors also noted that stronger competition was likely to lead to lower prices, and hence usefully complement the authorities' disinflation efforts. The move toward the adoption of the euro would be helped by greater labor market flexibility and higher participation rates-especially among older workers.


Slovenia: Selected Economic Indicators, 1999-2005


                     

Prelim.

 

Proj.

     

1999

 

2000

 

2001

 

2002

 

2003

 

2004

 

2005

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

                                 
   

(Annual percentage change)

                                 

Real GDP

 

5.9

 

4.1

 

2.9

 

2.9

 

2.3

 

3.5

 

4.1

 
 

Domestic demand

 

9.5

 

1.5

 

1.0

 

2.1

 

4.0

 

5.0

 

5.4

 
 

Private consumption

 

5.9

 

0.3

 

2.4

 

1.1

 

3.1

 

4.5

 

5.5

 
 

Public consumption

 

2.9

 

2.3

 

4.0

 

2.5

 

2.8

 

2.3

 

1.3

 
 

Gross capital formation

 

22.4

 

3.3

 

-4.2

 

4.1

 

7.0

 

8.0

 

8.0

 
                                 

Industrial production

 

-0.5

 

6.2

 

2.9

 

2.4

 

1.4

 

...

 

...

 
                                 

Consumer prices

                             
 

Period average

 

6.1

 

8.9

 

8.4

 

7.5

 

5.6

 

3.7

 

3.4

 
 

End of period

 

8.0

 

8.9

 

7.0

 

7.2

 

4.6

 

3.7

 

3.3

 
                                 

Wages

                             
 

Nominal

                             
 

All sectors

 

9.6

 

10.6

 

11.9

 

9.7

 

7.5

 

7.0

1/

5.3

1/

 

Manufacturing

 

9.1

 

11.9

 

10.7

 

10.4

 

7.6

 

...

 

...

 
 

Public services

 

10.1

 

11.2

 

13.9

 

8.7

 

6.3

 

...

 

...

 
 

Real

                             
 

All sectors

 

3.3

 

1.6

 

3.3

 

2.1

 

1.9

 

2.0

1/

2.2

1/

 

Manufacturing

 

2.8

 

2.8

 

2.1

 

2.7

 

1.9

 

...

 

...

 
 

Public services

 

3.7

 

2.1

 

5.1

 

1.1

 

0.7

 

...

 

...

 
                                 

Employment

                             
 

Person basis

 

1.8

 

1.3

 

1.4

 

0.6

 

-0.8

 

...

 

...

 
 

Full-time-equivalent basis

 

1.2

 

1.1

 

0.5

 

-0.5

 

-0.2

 

0.5

1/

0.6

1/

                                 

Unemployment rate (in percent, ILO definition)

 

7.6

 

7.0

 

6.4

 

6.3

 

6.7

 

6.7

2/

6.4

2/

                                 

General government finances

(In percent of GDP)

                                 
 

Revenue

 

41.4

 

40.9

 

41.5

 

40.9

3/

41.9

 

42.7

4/

42.8

4/

 

Expenditure

 

42.0

 

42.2

 

42.8

 

42.5

 

43.3

 

44.4

4/

44.3

4/

 

General government balance

 

-0.6

 

-1.3

 

-1.3

 

-1.5

3/

-1.4

 

-1.7

4/

-1.6

4/

 

State budget balance

 

-0.5

 

-0.9

 

-1.0

 

-1.2

3/

-1.2

 

-1.5

4/

-1.7

4/

 

General government debt

 

23.6

 

24.7

 

26.6

 

27.8

 

27.0

 

27.3

4/

27.4

4/

                                 

Money and credit

(Percentage change, end-period)

                                 
 

Broad money (including foreign exchange deposits)

 

12.2

 

15.3

 

28.3

 

18.4

 

4.9

 

...

 

...

 
 

Base money

 

21.2

 

1.9

 

37.7

 

-4.3

 

4.1

 

...

 

...

 
 

Credit to the private sector

 

29.3

 

18.6

 

18.4

 

11.3

 

15.7

 

...

 

...

 
 

Interest rates (in percent)

                             
 

BoS Lombard rate

 

9.0

 

11.0

 

12.0

 

10.5

 

7.3

 

...

 

...

 
 

Rate on 60-day BoS bills

 

7.0

 

10.0

 

8.0

 

8.3

 

6.0

 

...

 

...

 
 

Lending rates

 

13.1-17.2

 

14.6-18.4

 

12.3-15.8

 

11.6-14.7

 

9.6-10.3

 

...

 

...

 
 

Deposit rates 5/

 

9.6-11.4

 

10.9-13.2

 

8.5-11.0

 

7.6-8.6

 

4.8-4.9

 

...

 

...

 
                                 

Balance of payments

(In millions of euros, unless noted otherwise)

                                 
 

Merchandise exports

 

8,103

 

9,574

 

10,454

 

11,081

 

11,427

 

12,147

 

13,141

 
 

Exports volume (percent change)

 

2.7

 

12.9

 

6.9

 

6.5

 

4.5

 

5.9

 

6.9

 
 

Merchandise imports

 

-9,267

 

-10,801

 

-11,139

 

-11,347

 

-11,971

 

-12,836

 

-13,938

 
 

Imports volume (percent change)

 

8.6

 

7.7

 

3.2

 

4.4

 

6.8

 

8.0

 

8.4

 
 

Current account balance

 

-664

 

-583

 

38

 

330

 

17

 

-149

 

-288

 
 

(in percent of GDP)

 

-3.3

 

-2.8

 

0.2

 

1.4

 

0.1

 

-0.6

 

-1.0

 
 

Gross official reserves

 

3,159

 

3,436

 

4,984

 

6,781

 

6,879

 

7,426

 

8,220

 
 

(in months of imports of goods and nonfactor services)

 

3.5

 

3.3

 

4.7

 

6.2

 

5.9

 

6.0

 

6.1

 
                                 
 

External debt (percent of GDP, end-period) 6/

 

40.4

 

46.1

 

47.7

 

49.2

 

53.6

 

57.3

 

60.1

 
 

External debt service

 

843

 

1,103

 

1,877

 

1,778

 

2,144

 

2,424

 

2,724

 
 

(in percent of exports of goods and nonfactor services)

 

8.5

 

9.5

 

14.9

 

13.1

 

15.4

 

16.5

 

17.2

 
                                 

Exchange rate

                             
                                 
 

Tolars per U.S. dollar (end-period)

 

196.8

 

227.4

 

251.0

 

221.1

 

189.4

 

...

 

...

 
 

Tolars per euro (end-period)

 

197.3

 

211.5

 

221.4

 

230.3

 

236.7

 

...

 

...

 
 

Nominal effective exchange rate (1998Q1=100, period average)

 

96.8

 

90.6

 

85.0

 

81.8

 

80.5

 

...

 

...

 
 

Real effective exchange rate

                             
 

(CPI based, 1998Q1=100, period average)

 

103.1

 

102.1

 

101.1

 

102.8

 

105.0

 

...

 

...

 
 

(ULC based, 1998Q1=100, period average)

 

100.5

 

97.9

 

97.6

 

97.7

 

99.1

 

...

 

...

 

 

Sources: Data provided by the Slovene authorities; and IMF staff calculations and projections.

 

1/ Budget projections by the Ministry of Finance for 2004-05.

 

2/ Projections by the Institute for Macroeconomic Analysis and Development (IMAD).

 

3/ Revenues and deficit figures have been adjusted for the shift of budget accounting to a pure cash basis. Without the adjustment, the general government

 

deficit would have reached SIT 156 bn, or 3.0 percent of GDP, as the unadjusted figures contained only 11 months of VAT and excise tax.

 

4/ Budget figures for 2004-05. Revenue projections include transfers from the EU budget, and expenditure projections include payments by Slovenia to the EU budget.

 

5/ For deposits with maturity between 31 days and 1 year.

 

6/ Data have been revised according to the External Debt Guide 2003.


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.




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