IMF Executive Board Concludes 2012 Article IV Consultation with the Republic of Slovenia

On November 21, 2012, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Slovenia.¹

Background

With a loss of more than 8 percent of GDP, Slovenia experienced one of the largest economic contractions since 2008 among euro area countries. The timid externally-driven recovery observed in 2010 faded as export growth slowed, deleveraging picked up pace, and fiscal consolidation started. The recession intensified in 2012, as euro area growth decelerated, external financial conditions worsened, and private consumption growth turned negative. Unemployment reached 8.4 percent in August 2012. Inflation has been kept in check by weak demand and averaged below the euro area aggregate, more so in core indicators. The current account reached broad balance in 2011 and a moderate surplus is expected for this year, largely as a result of import compression. With stringent financial and economic conditions continuing in the euro area, deleveraging, and fiscal consolidation, staff expects the economy to contract by 2¼ percent in 2012 with growth resuming in the second half of 2013 led by the projected euro area recovery.

The performance of Slovenian banks deteriorated markedly in recent years as a result of the unfavorable operating environment. Bank asset quality worsened substantially since 2007, especially in publicly-owned banks. Of particular concern are loans to the over-indebted corporate sector. The increase in non-performing loans (NPLs) resulted in substantial impairment charges, leading to system-wide bank losses in the last two years and repeated downgrades of bank ratings. Although capital adequacy improved in 2011, many banks will need further capital increases. The loan-to-deposit ratio remains high, and banks have replaced lost external commercial funding with government deposits and ECB financing. Alongside an external assessment of the size of bank losses, the government is creating an asset management company to deal with NPLs and is elaborating a strategy to reform governance of publicly-owned banks.

The headline deficit is set to drop to around 3½ percent of GDP in 2012 from 4.3 percent of GDP in 2011 (excluding capital injections to publicly-owned banks and corporations), and the 2013 headline deficit target is 2.8 percent of GDP in spite of weaker-than-expected economic activity. The authorities target a structurally-balanced budget by 2015, with adjustment frontloaded in 2012 and 2013. Under the staff’s baseline scenario, which conservatively assumes a debt increase of about 11 percent of GDP in connection with bank restructuring, the debt-to-GDP ratio would peak around 70 percent of GDP around 2016 and gradually fall thereafter. However, Slovenia has one of the most adverse pension expenditure dynamics in the euro area, and further action will be required after the realization of current pension reform plans. After more than a year of absence from the long-term markets, the government cash position was alleviated thanks to a successful 10-year bond issuance in US dollars on October 19. This is Slovenia's first dollar-denominated bond since 1996.

Executive Board Assessment

Executive Directors noted that Slovenia’s economy is suffering from the negative feedback loops of recession, bank deleveraging, and corporate distress against a background of structural weaknesses, financial sector vulnerabilities, and weak domestic and external demand. They underlined the need for strong and prompt action to address these problems. In this regard, Directors considered appropriate the authorities’ emphasis on fiscal consolidation and their plans for ambitious and comprehensive structural reforms to restore macroeconomic and financial stability and economic growth. They looked forward to swift implementation of the reform agenda.

Directors welcomed the proposed establishment of a Bank Asset Management Company to address the build-up of nonperforming loans, stressing that timely implementation will be of the essence. Directors noted that publicly-owned banks may need more capital, while the corporate sector is highly leveraged. They encouraged the authorities to move decisively to restructure, recapitalize and ultimately privatize banks and corporations, which will also help strengthen governance. Directors welcomed the authorities’ efforts to implement the FSAP recommendations. In particular, they emphasized the importance of strengthening the regulatory and supervisory framework and improving macroprudential oversight and crisis contingency arrangements.

Directors commended the progress with fiscal consolidation and the efforts to strengthen the fiscal framework. They supported the front-loaded, expenditure-based consolidation as necessary to bolster market confidence. They encouraged focusing on structural rather than on nominal targets, and endorsed the goal of a structural balanced budget by 2015 net of bank restructuring costs. Directors called for a strengthening of the quality of adjustment and fiscal governance, including through a constitutional structural balance rule with a debt brake and enhanced medium-term fiscal planning.

Directors emphasized the importance of structural reforms to ensure fiscal sustainability, enhance competitiveness, and spur growth. They considered the current pension reform proposals to be a step in the right direction, but observed that more decisive measures will be needed to ensure medium-term fiscal and debt sustainability. Directors welcomed the engagement with social partners on labor market reform, which is essential to reduce market segmentation and improve competitiveness. They also called for improvements to the business climate to attract foreign investment.

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. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.