Construction site at Bled, Slovenia: euro area slowdown has magnified preexisting economic weaknesses (photo: Srdjan Zivulovic/Reuters)
ECONOMIC HEALTH CHECK
“Prompt action to address problems in the financial sector, consolidate public spending, and reform the labor market is essential to resolve the current crisis and lay the groundwork for future growth in Slovenia,” said Antonio Spilimbergo, IMF mission chief for Slovenia.
After achieving independence in 1991, Slovenia grew steadily, achieving the highest level of income among transition countries. In 2004, the country joined the European Union, and in 2007, it adopted the euro. But the reform agenda was left unfinished.
During the global economic crisis, the economy suffered the sharpest GDP decline in the euro area, excluding Greece. Real GDP contracted by more than 8 percent following a sharp decline in external demand. The significant tightening in external credit forced banks to limit access to domestic loans, and a construction and housing price boom came to an abrupt end.
Speaking to IMF Survey, Spilimbergo discussed the economic outlook, the most pressing issues facing Slovenia, and the policy actions needed to get the country out of its deep recession.
IMF Survey: What is the outlook for Slovenia’s economy? Are the problems in the eurozone having a big impact?
Spilimbergo: Slovenia is affected by the euro area slowdown, possibly more than other countries, because of preexisting weaknesses. While Slovenia was one of the European countries with the highest rates of growth before the crisis, it failed to implement pension and labor market reforms and restructure its financial sector. The crisis magnified these weaknesses, and currently there is a negative feedback loop of recession, bank deleveraging, and corporate distress, which is bringing down economic growth. The government recognizes the challenges it faces to break this loop and the need for steadfast implementation of reforms.
We are projecting that GDP will contract by around 2.2 percent in 2012 and by around 1 percent in 2013. This is because banks will continue deleveraging, and fiscal consolidation will cause a temporary negative drag on economic growth—all this in an environment of sluggish external demand. But we expect that growth will resume in the second half of 2013.
IMF Survey: What are the most pressing issues facing the economy right now?
Spilimbergo: The authorities need to break this negative loop that has kept the economy in a deep recession—and to do so they have announced that they will act on several fronts.
One is to solve the financial problems. The performance of Slovenian banks deteriorated markedly in recent years as a result of the weak economy and poor governance in some banks. This led to a large increase in bad loans. The authorities have announced the creation of a public company to take and manage bad assets, an important first step to address the buildup of nonperforming loans.
The authorities have also announced ambitious fiscal consolidation measures that will lower the budget deficit and reassure markets about long-term fiscal sustainability. Finally, they are planning important structural reforms, including in the labor market, which will help ensure an increase in future potential output.
Prompt implementation of these reforms will address the most pressing issues and steer the economy out of its current crisis.
IMF Survey: You mention ambitious fiscal consolidation. What does it entail, and why is it necessary?
Spilimbergo: As a result of the 2008 crisis, Slovenia’s fiscal accounts worsened considerably, so the authorities have embarked on a consolidation path that is rightly based on cutting expenditures. In particular, the authorities realize that pension reform is badly needed to ensure long-term fiscal sustainability.
The authorities’ goal is to have a balanced budget by 2015, with most of the adjustments frontloaded—taking place in 2012 and 2013.
There is, of course, a delicate balance between pursuing sustainable fiscal consolidation and avoiding dampening demand and growth. In this respect, the key is credibility—implementing credible reforms that will restore confidence.
We support the frontloaded fiscal consolidation but have stressed also that fiscal governance and the quality of adjustment should be strengthened. The proposed reduction in public wages, for example, needs to be calibrated—it should maintain sufficient wage differentiation for rewarding performance, and any employment cuts should be selective. Finally, our advice is for the government to focus on the structural fiscal balance rather than on headline targets.
IMF Survey: What factors have contributed to the difficulties in the banking sector? What measures are needed to address them?
Spilimbergo: The banks in Slovenia are suffering for two reasons. First, we are in a deep recession—any banking system in such a prolonged recession is bound to encounter problems.
Second, the three major publicly owned banks had played an important part in financing unsustainable booms in the construction and housing sectors, and in several leveraged buy-outs in the corporate sector. Unresolved weaknesses in the financial sector, in particular poor governance in publicly controlled banks and corporations, compounded the difficulties.
This resulted in a rapid increase in nonperforming loans, with 12 percent of all loans currently in arrears for more than 90 days. As mentioned earlier, the authorities’ plan to deal with these loans includes the creation of a bad asset management company. This company would take some of the bad assets from banks and dispose of them, so that banks have a clean balance sheet and can go back to normal lending activities. And, if needed, the authorities also plan to recapitalize banks once these bad assets are transferred.
To address unresolved vulnerabilities that were put in the spotlight by the crisis—such as the governance and risk management practices of publicly controlled banks—we also recommend privatization as an option. We believe this could help strengthen these banks by bringing about a change in governance and commercial culture.
IMF Survey: Slovenia recently issued $2.25 billion in ten-year bonds. Has it now met all of its financing needs?
Spilimbergo: This is the first time in about 18 months that Slovenia has issued bonds in the international market—a sign that markets have confidence in the reforms announced by the authorities.
The recent issuance should give Slovenia sufficient time to implement the announced reforms if implementation is prompt and quick.
IMF Survey: Looking ahead, what reforms are needed to put the economy back on a sustainable and competitive path?
Spilimbergo: Slovenia needs reforms in the fiscal sector, labor market, and financial sector.
In terms of fiscal policy, the government is negotiating a pension reform with social partners. Slovenia is one of the countries that spend the most on pensions in the euro area—with pension payments projected to increase by 6.5 percentage points of GDP between 2015 and 2055. The reform would focus on increasing the retirement age, which would bring down the projected spending increase by about 1.5 percentage points of GDP. We think this is an important step but not sufficient—a more comprehensive reform may be necessary in the future to ensure debt sustainability in the longer term.
In the labor market, Slovenia needs to reduce unemployment. The current system protects workers who have permanent contracts. Unprotected workers are mostly young people and women, leading to an inefficient and unfair segmentation in the labor market.
And, as mentioned earlier, the financial sector needs to be reformed. We see this as the most urgent reform at the moment. The new bad asset management company is a good start—but strong implementation will be essential.
We have recommended the prompt adoption of the draft Banking and Recovery Acts, which will give the authorities the tools to deal effectively with future financial sector crises.
We are also recommending the privatization of publicly owned banks. Political interference should be removed from bank management to avoid repeating the problems Slovenia is facing right now.
