## _cr05254

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### A. Introduction
- Slovenia experienced rapid private sector credit growth in 2004 fueled by interest rate convergence and heightened competition in the banking sector.
- Despite strong credit growth, there was not a commensurate pick-up in domestic demand.
- Peer countries for comparison: Czech Republic, Estonia, Lithuania, Poland, and the Slovak Republic.
- Paper organization:
  - Section B: reviews credit growth developments in Slovenia and selected NMSs and compares with noncore euro area countries (Ireland, Greece, Portugal, Spain) before euro adoption.
  - Section C: presents correlation and regression analyses of credit and domestic demand.
  - Section D: discusses Slovenia-specific factors (higher household savings in non-bank financial institutions and outflows of investable resources).
  - Section E: concludes.
- Prepared by Hiroko Oura (ICM).

### B. Developments in Private Sector Bank Credit
- Findings:
  - In 2004, real credit to both enterprises and households increased by over 17 percent; total loan-to-GDP ratio rose to 44 percent from 39 percent in 2003.
  - Private sector credit expansion accelerated following EU accession, particularly household credit growth.
  - Supply-side drivers:
    - Convergence of interest rates since 2000 as the Bank of Slovenia gradually lowered its policy rate in response to declining inflation.
    - Intensified competition and aggressive pricing by foreign-owned banks, sometimes yielding lower interest rates than comparable euro area rates for some products.
    - Easing of regulations on foreign currency lending and reserve requirements on foreign currency deposits, triggering higher foreign-currency denominated lending.
    - Strong retail banking expansion targeting Slovene households with relatively small prior debt.
  - As of end-2004, household debt was about 20 percent of gross disposable income in Slovenia, one fourth of the euro area average.
  - Housing ownership in Slovenia is over 90 percent; housing loans were 26 percent of outstanding bank credit to households at end-2004 (compare: 70–75 percent in Estonia and the Czech Republic; about 40 percent in Poland).
  - Among selected NMSs, Estonia and Lithuania maintained private sector credit growth over 15 percent per year; Estonia reached 37 percent in 2004.
  - The NMSs’ average private sector credit-to-GDP ratio rose from about 28 percent in 1999 to 35 percent in 2004; noncore euro area countries’ ratios jumped from nearly 60 percent in 1995 to 100 percent in 2000.
- Data points and benchmarks:
  - Honohan (1997) criterion: real credit growth of over 10 percent per year is classified as a credit boom.
  - Alternative thresholds: Kaminsky and Reinhart (1999) — growth in credit-to-GDP ratio of over 9.3 percent GDP as a boom; Gourinchas and others (1999) — absolute deviation from trend of over 4.8 percent of GDP and relative deviation from trend of over 24.9 percent.

### C. Relationship Between Domestic Demand and Credit Growth
- Correlation analysis:
  - Strong correlation between private consumption and household credit growth in Slovenia: 0.74 during 2000–2004.
  - Cross-country patterns:
    - Negative correlation between private consumption growth and household credit growth in Estonia, Poland, and the Slovak Republic.
    - Lithuania and Slovenia show the strongest positive correlations.
    - Linkages strengthen when household credit is related to investment or total domestic demand in many cases; in Estonia the negative linkage intensifies despite strong credit growth and a large share of housing loans.
  - For noncore euro area countries (five years before euro adoption), correlation between credit and domestic demand is generally weaker than for NMSs, except Spain which shows strong positive correlation; Ireland shows a negative correlation over five years (and also over a four-year period excluding 1995).
- Regression analysis (pooled panel for five NMSs, 2000–04):
  - Dependent variables: real growth of domestic demand components.
  - Explanatory variables: household and private sector credit growth, disposable income growth, and country dummies.
  - Key econometric results:
    - Model 1: household credit growth alone has a significant, positive coefficient for private consumption.
    - Model 2: when disposable income growth is added, the coefficient for household credit growth becomes statistically insignificant; disposable income growth is significant and raises explanatory power.
    - Similar pattern when using private sector credit (Models 3 and 4).
    - For total domestic demand (Models 6–9), credit growth variables remain statistically significant even after controlling for income growth, suggesting investment components of demand are more influenced by credit growth.
    - The coefficient on credit growth is small relative to disposable income, and models for total demand have weaker explanatory power than those for private consumption.
  - Selected regression statistics:
    - Significance notation: *** significant at 1 percent level; ** significant at 5 percent level; * significant at 10 percent level.
    - Adjusted R square values: 0.55; 0.72; 0.54; 0.71; 0.73; 0.48; 0.52; 0.45; 0.49; 0.51.
    - Sample sizes (N) reported: 25 23 25 23 25 23 25 23 23.
- Interpretation:
  - Current income flows are a primal determinant for consumption growth rather than credit growth.
  - Credit growth plays a more robust role in explaining total domestic demand—primarily through investment—but its quantitative impact is smaller than that of disposable income.

### D. Explaining the Credit Boom Without a Demand Boom in Slovenia
- Principal Slovenia-specific mechanisms:
  - Structural changes in household saving behavior:
    - Households’ net position vis-à-vis domestic banks—net deposits—weakened in absolute amounts and as a ratio of disposable income and GDP as households borrowed more than they added to deposits.
    - Savings in alternative non-bank financial instruments and deposits abroad increased markedly and more than compensated for the fall in domestic net deposits, suggesting dualism in the household sector: one group saved more; another borrowed more as credit costs declined.
    - Key figures:
      - Households held SIT 1,103 billion of domestic securities as of September 2004, up from SIT 920 billion at end-2003.
      - Households held SIT 29 billion of foreign securities at end-2004, up from SIT 12 billion at end-2003.
      - Stock of domestic bank deposits held by households at end-2004 was SIT 2,341 billion.
    - Factors supporting growth in household financial savings:
      - Voluntary private pension insurance participation rose to 27 percent at end–2003 from 10.5 percent at end–2001; assets under management of the voluntary pension insurance scheme increased to 0.9 percent of GDP in 2003 from 0.1 percent in 2001.
      - Investments in mutual funds surged beginning in 2002; unit values of mutual fund shares increased by over 17 percent in 2004.
      - Slovene mutual funds invested 40–70 percent of their assets in domestic equities.
      - Net inflows to mutual funds from households were about 36 percent of deposit inflows in 2004 compared to about 15 percent in 2002 and 2003.
      - Decline in bank deposit rates during convergence increased incentives to favor mutual funds.
      - Improvements in mutual funds’ legislative framework through harmonization with European legislation; modernization of sales and distribution.
      - Higher deposit rates abroad (notably Croatian banks offering deposit rates over 200 bps higher than those in Slovenia) incentivized deposits abroad.
      - Income distribution shifted in favor of higher-paid workers, who tend to have higher saving propensity.
  - Investment pattern of mutual funds:
    - Mutual funds absorbed increasing household savings but channeled resources to equities and increasingly to foreign securities rather than financing domestic demand.
    - Asset allocation (share of total, in percent) in 2004: Bank deposit 9.7, Bonds 19.6, Equity 42.9, Foreign Securities 16.3, Other 11.4 (total 100).
    - Absolute total mutual fund assets rose to 210.1 (In billions of tolars) in 2004.
    - Consequences:
      - Significant capital outflows as mutual funds invested abroad reduced resources available in domestic financial markets to fuel domestic demand.
      - Domestic resources that remained did not meaningfully finance domestic demand: initial public offerings were rare; bond market is extremely small and mainly comprises government securities.
      - Banks do not accept equity-type financial instruments as quality collateral, preventing an indirect channel from mutual fund-driven asset price increases to bank credit expansion.
    - Drivers:
      - Fund managers avoided small, illiquid domestic capital markets to limit risk of excessive price movements.
      - Deregulations in 2004 eliminated the 10 percent cap on investment in foreign securities for qualified funds, intensifying investment abroad.
  - Shift in corporate borrowing and outward investment:
    - From 2000–2004, enterprises shifted between domestic and international loan financing; domestic loans grew faster than international loans in 2003–2004.
    - Outward FDI rose markedly in 2003 to 1.7 percent GDP and remained close to this level in 2004 (outward FDI / GDP: 1.7 in 2003; 1.5 in 2004).
    - Total loans / GDP in 2004 was 63.8.
    - Some bank credit to enterprises financed foreign direct investment abroad rather than domestic investment, dampening domestic investment despite rising domestic credit.
  - Comparative observations in other NMSs:
    - Net position vis-à-vis domestic banks deteriorated in all observed countries as households borrowed increasingly.
    - In Poland and the Slovak Republic, household deposits declined nominally; in Estonia, the Czech Republic, and Slovenia domestic bank deposits increased but not enough to offset borrowing.
    - Non-bank financial institutions grew rapidly in other NMSs; investment funds’ relative size to GDP in the Czech Republic, Poland, and Estonia exceeds that of Slovenia.
    - Estonia: share of foreign assets in total assets of investment funds increased to 62 percent in September 2004—much higher than Slovenia’s 16 percent share as of end–2004; investment in domestic stock and bond markets and domestically issued shares of investment funds amounted to only 20 percent of investment funds’ assets in Estonia.

### E. Main findings, risks, and policy implications
- Main finding:
  - "The rapid credit growth in Slovenia and some NMSs has not led to a commensurate pick-up in domestic demand so far."
  - Country-specific mitigating factors reduced the expansionary effects of credit growth.
  - Because there was no demand boom, "the risks to inflation from the credit boom were subdued."
- Empirical summary:
  - The link between credit growth and consumption growth was weak on average for these NMSs, and the ties weakened further once we control for income growth.
- Risks and policy implications:
  - Higher credit growth increases the need for vigilance.
  - Policy recommendation: "Greater supervisory oversight of credit risk" is required in the presence of rapid credit expansion.

### Key macroeconomic indicators (selected)
- CPI (average): 2000: 8.9; 2001: 8.4; 2002: 7.5; 2003: 5.6; 2004: 3.6.
- Real GDP (change in percent): 2000: 3.9; 2001: 2.7; 2002: 3.3; 2003: 2.5; 2004: 4.6.
- Total domestic demand (change in percent): 2000: 1.5; 2001: 0.9; 2002: 2.3; 2003: 4.7; 2004: 4.7.
- Credit to the private sector (end-of-year percent change): 2000: 18.1; 2001: 18.5; 2002: 10.5; 2003: 15.5; 2004: 20.2.

*Source: _cr05254 - References*

### References..............................................................................................................

### _cr05254 - References

### A. Introduction
- Slovenia experienced rapid private sector credit growth in 2004 fueled by interest rate convergence and heightened competition in the banking sector.
- Despite strong credit growth, there was not a commensurate pick-up in domestic demand.
- Peer countries for comparison: Czech Republic, Estonia, Lithuania, Poland, and the Slovak Republic.
- Paper organization:
  - Section B: reviews credit growth developments in Slovenia and selected NMSs and compares with noncore euro area countries (Ireland, Greece, Portugal, Spain) before euro adoption.
  - Section C: presents correlation and regression analyses of credit and domestic demand.
  - Section D: discusses Slovenia-specific factors (higher household savings in non-bank financial institutions and outflows of investable resources).
  - Section E: concludes.
- Prepared by Hiroko Oura (ICM).

### B. Developments in Private Sector Bank Credit
Findings
- In 2004, real credit to both enterprises and households increased by over 17 percent; total loan-to-GDP ratio rose to 44 percent from 39 percent in 2003.
- Private sector credit expansion accelerated following EU accession, particularly household credit growth.
- Supply-side factors contributing to the credit boom:
  - Convergence of interest rates since 2000 as the Bank of Slovenia gradually lowered its policy rate in response to declining inflation.
  - Intensified competition in the Slovene banking sector and aggressive pricing by foreign-owned banks, leading to lower interest rates than comparable euro area rates for some products.
  - Easing of regulations on foreign currency lending and reserve requirements on foreign currency deposits, triggering higher foreign-currency denominated lending.
  - Strong retail banking expansion targeting Slovene households with relatively small prior debt.
- As of end-2004, household debt was about 20 percent of gross disposable income in Slovenia, one fourth of the euro area average.
- Housing ownership in Slovenia is over 90 percent, limiting housing loan demand; housing loans were 26 percent of outstanding bank credit to households at end-2004 (compare: 70–75 percent in Estonia and the Czech Republic; about 40 percent in Poland).
- Among selected NMSs, Estonia and Lithuania maintained private sector credit growth over 15 percent per year; Estonia reached 37 percent in 2004.
- The NMSs’ average private sector credit-to-GDP ratio rose from about 28 percent in 1999 to 35 percent in 2004; noncore euro area countries’ ratios jumped from nearly 60 percent in 1995 to 100 percent in 2000.

Data points and benchmarks
- Honohan (1997) criterion: real credit growth of over 10 percent per year is classified as a credit boom.
- Alternative thresholds cited: Kaminsky and Reinhart (1999) — growth in credit-to-GDP ratio of over 9.3 percent GDP as a boom; Gourinchas and others (1999) — absolute deviation from trend of over 4.8 percent of GDP and relative deviation from trend of over 24.9 percent.

### C. Relationship Between Domestic Demand and Credit Growth
Correlation analysis: key observations
- Strong correlation between private consumption and household credit growth in Slovenia: 0.74 during 2000–2004 (Table 1).
- Correlations across NMSs are diverse:
  - Negative correlation between private consumption growth and household credit growth in Estonia, Poland, and the Slovak Republic.
  - Lithuania and Slovenia show the strongest positive correlations.
- Linkages strengthen when household credit is related to investment or total domestic demand in many cases, highlighting the role of investment as a use of credit; however, in Estonia the negative linkage intensifies despite strong credit growth and a large share of housing loans.
- For noncore euro area countries (five years before euro adoption), the correlation between credit and domestic demand is generally weaker than for NMSs, except Spain which shows strong positive correlation; Ireland shows a negative correlation over five years (and also over a four-year period excluding 1995 when extraordinary credit expansion occurred).

Regression analysis: main results (pooled panel for five NMSs, 2000–04)
- Dependent variables: real growth of domestic demand components.
- Explanatory variables: household and private sector credit growth, disposable income growth, and country dummies.
- Key findings:
  - Model 1: household credit growth alone has a significant, positive coefficient for private consumption.
  - Model 2: when disposable income growth is added, the coefficient for household credit growth becomes statistically insignificant; disposable income growth is significant and raises explanatory power.
  - Similar pattern when using private sector credit (Models 3 and 4).
  - For total domestic demand (Models 6–9), credit growth variables remain statistically significant even after controlling for income growth, suggesting investment components of demand are more influenced by credit growth.
  - Nevertheless, the coefficient on credit growth is small relative to disposable income, and models for total demand have weaker explanatory power than those for private consumption.

Selected regression statistics (as presented)
- Reported constant coefficients and t-statistics in the text table; significance levels indicated as: *** significant at 1 percent level; ** significant at 5 percent level; * significant at 10 percent level.
- Adjusted R square values (for the reported models): 0.55; 0.72; 0.54; 0.71; 0.73; 0.48; 0.52; 0.45; 0.49; 0.51.
- Sample sizes (N) reported in the table: 25 23 25 23 25 23 25 23 23 (as shown under "N").

Interpretation
- Current income flows are a primal determinant for consumption growth rather than credit growth.
- Credit growth plays a more robust role in explaining total domestic demand—primarily through investment—but its quantitative impact is smaller than that of disposable income.

### D. Explaining the Credit Boom Without a Demand Boom in Slovenia
- Several Slovenia-specific factors may explain the weak transmission from credit growth to domestic demand:
  - Higher household savings in non-bank financial institutions (financial deepening and shift in household saving patterns away from banks to non-banks).
  - Outflows of investable resources (external outflows) that may have mitigated domestic spending effects of rising credit.
- These factors, together with supply-side credit expansion, help explain a credit boom in the absence of a proportional domestic demand boom.

*Source: _cr05254 - References*

### 14.      A number of factors explain why the credit boom in Slovenia did not lead to a

### _cr05254 - 14.      A number of factors explain why the credit boom in Slovenia did not lead to a

### Structural changes in household saving behavior
- Households’ net position vis-à-vis domestic banks—net deposits—weakened in absolute amounts and as a ratio of disposable income and GDP as households borrowed more than they added to deposits.
- Savings in alternative non-bank financial instruments and deposits abroad increased markedly and more than compensated for the fall in domestic net deposits, suggesting dualism in the household sector: one group (most likely higher income) saved more; another (lower income) borrowed more as credit costs declined.
- Key factual figures:
  - Households held SIT 1,103 billion of domestic securities as of September 2004, up from SIT 920 billion at end-2003.
  - Households held SIT 29 billion of foreign securities at end-2004, up from SIT 12 billion at end-2003.
  - Stock of domestic bank deposits held by households at end-2004 was SIT 2,341 billion.
- Factors supporting growth in household financial savings during the credit boom:
  - Voluntary private pension insurance participation rose to 27 percent at end–2003 from 10.5 percent at end–2001; assets under management of the voluntary pension insurance scheme increased to 0.9 percent of GDP in 2003 from 0.1 percent in 2001.
  - Investments in mutual funds surged beginning in 2002; unit values of mutual fund shares increased by over 17 percent in 2004.
  - Slovene mutual funds invested 40–70 percent of their assets in domestic equities (Text Table 3).
  - Net inflows to mutual funds from households were about 36 percent of deposit inflows in 2004 compared to about 15 percent in 2002 and 2003.
  - Decline in bank deposit rates during convergence increased incentives to favor mutual funds.
  - Improvements in mutual funds’ legislative framework through harmonization with European legislation; modernization of sales and distribution (banks establishing mutual fund subsidiaries; foreign mutual funds entering Slovenia).
  - Higher deposit rates abroad (notably Croatian banks offering deposit rates over 200 bps higher than those in Slovenia) incentivized deposits abroad, partly substituting away from domestic banks.
  - Income distribution shifted in favor of higher-paid workers, who tend to have higher saving propensity.

### Investment pattern of mutual funds
- Mutual funds absorbed increasing household savings but did not finance domestic demand directly; they tended to channel resources to equities and increasingly to foreign securities.
- Asset-allocation dynamics (selected highlights from Text Table 4):
  - Asset allocation (share of total, in percent) in 2004: Bank deposit 9.7, Bonds 19.6, Equity 42.9, Foreign Securities 16.3, Other 11.4 (total 100).
  - Absolute levels (In billions of tolars) show total mutual fund assets rose to 210.1 in 2004.
- Consequences:
  - Significant capital outflows as mutual funds invested abroad reduced resources available in domestic financial markets that could have fueled domestic demand.
  - Domestic resources that remained did not meaningfully finance domestic demand: initial public offerings were rare; bond market is extremely small and mainly comprises government securities.
  - Banks do not accept equity-type financial instruments as quality collateral, preventing an indirect channel from mutual fund-driven asset price increases to bank credit expansion.
- Regulatory/demand drivers:
  - Fund managers avoided small, illiquid domestic capital markets (risk of excessive price movements from additional funds).
  - Deregulations in 2004 eliminated the 10 percent cap on investment in foreign securities for qualified funds, intensifying investment abroad.

### Shift in borrowing structure and outward investment by Slovene companies
- Corporate sector loan composition and amounts (Text Table 5 highlights):
  - From 2000–2004, enterprises shifted between domestic and international loan financing. Domestic loans grew faster than international loans in 2003–2004.
  - Outward FDI rose markedly in 2003 to 1.7 percent GDP and remained close to this level in 2004 (outward FDI / GDP: 1.7 in 2003; 1.5 in 2004).
  - Total loans / GDP in 2004 was 63.8 (Text Table 5).
- Interpretation:
  - Part of domestic credit growth to enterprises reflected substitution of direct foreign borrowing by domestic bank borrowing.
  - Some bank credit to enterprises financed foreign direct investment abroad rather than domestic investment—investment abroad intended for trade promotion and labor-cost efficiency, including investment in former Yugoslav countries and more developed EU members following EU accession.
  - The tendency to invest abroad likely dampened domestic investment despite rising domestic credit.

### Household saving behavior in other NMSs (comparative observations)
- Data limitations: household financial saving behavior data are partial for other NMSs.
- Commonalities and contrasts with Slovenia:
  - Net position vis-à-vis domestic banks deteriorated in all observed countries as households borrowed increasingly.
  - In Poland and the Slovak Republic, household deposits declined nominally; in Estonia, the Czech Republic, and Slovenia domestic bank deposits increased but not enough to offset borrowing.
  - Non-bank financial institutions grew rapidly in other NMSs; investment funds’ or mutual funds’ relative size to GDP in the Czech Republic, Poland, and Estonia exceeds that of Slovenia.
  - Drivers similar to Slovenia: legislative harmonization during EU accession, declines in bank deposit rates due to interest rate convergence, and strong financial market (equity) performances.
- Estonia-specific data:
  - Share of foreign assets in total assets of investment funds in Estonia increased to 62 percent in September 2004—much higher than Slovenia’s 16 percent share as of end–2004.
  - Investment in domestic stock and bond markets and domestically issued shares of investment funds amounted to only 20 percent of investment funds’ assets in Estonia.
  - Estonian pension funds show similar foreign-biased allocation.

### Key mechanisms explaining why the credit boom did not generate a domestic demand boom
- Four principal factors identified:
  - Financial deepening and strengthened propensity to save in non-bank financial assets.
  - Outward-oriented asset allocation of mutual funds (shift to foreign securities).
  - Continued outward investment by Slovene firms (higher outward FDI, corporate investment abroad).
  - Conservative practices in the Slovene banking sector (limits on using equity instruments as collateral; small, illiquid domestic capital markets).

*Source: IMF staff report text (Text Tables 2–5, 2000–04 data excerpts).*

### 23.      Overall, the rapid credit growth in Slovenia and some NMSs has not led to a

### _cr05254 - 23.      Overall, the rapid credit growth in Slovenia and some NMSs has not led to a

### Main findings on credit growth and domestic demand
- Overall finding: "The rapid credit growth in Slovenia and some NMSs has not led to a commensurate pick-up in domestic demand so far."
- Country-specific mitigating factors reduced the expansionary effects of credit growth.
- Because there was no demand boom, "the risks to inflation from the credit boom were subdued."
- Empirical relationship: "The link between credit growth and consumption growth was weak on average for these NMSs, and the ties weakened further once we control for income growth."

### Risks and policy implications
- Higher credit growth increases the need for vigilance.
- Policy recommendation: "Greater supervisory oversight of credit risk" is required in the presence of rapid credit expansion.

### Related empirical context (selected macro indicators from the source)
- CPI (average): 2000: 8.9; 2001: 8.4; 2002: 7.5; 2003: 5.6; 2004: 3.6.
- Real GDP (change in percent): 2000: 3.9; 2001: 2.7; 2002: 3.3; 2003: 2.5; 2004: 4.6.
- Total domestic demand (change in percent): 2000: 1.5; 2001: 0.9; 2002: 2.3; 2003: 4.7; 2004: 4.7.
- Credit to the private sector (end-of-year percent change, as listed for Slovenia under "Money and credit"): 2000: 18.1; 2001: 18.5; 2002: 10.5; 2003: 15.5; 2004: 20.2.

*Source: IMF staff report (content unit _cr05254).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05254.pdf_