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Slovenia: 2009 Article IV Consultation - Concluding Statement of the Mission
March 17, 2009
Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
Slovenia's economy is increasingly affected by the global financial and economic crisis. While banks have so far weathered the turbulence relatively well, the crisis is affecting Slovenia through decelerating investment and foreign demand. To date, the fiscal and financial policy responses have been broadly appropriate. Going forward, it is essential that these measures be complemented by broad-ranging reforms aimed at raising the economy's growth potential and ensuring fiscal sustainability.
Economic outlook
1. Slovenia's economy is being increasingly affected by the global financial and economic crisis. Slovenia weathered relatively well the first impact of the crisis, thanks to the banks’ limited exposure to the U.S. financial system, the low level of households’ indebtedness, and the financial stability measures promptly put in place by the authorities. During the past few months, the slide of equity prices has accelerated, spreads on bank and government debt have spiked, wholesale funding markets have dried up, especially at long maturities, and credit growth has decelerated sharply. At the same time, external demand has declined substantially following the sharp slowdown of economic activity in Slovenia’s trading partners.
2. The mission expects a recession in 2009. Severe recessions in main trading partners will exacerbate the sharp fall in export and investment demand observed in recent months. The increasing unemployment rate, the falling equity markets, and the drop in confidence point to a weakening of domestic consumption, only partially offset by increased government spending. The mission expects output to decline by at least 1 percent. Thanks to lower international commodity prices and the growth slowdown, inflation is projected to fall but will remain higher than the average inflation in the Euro area, partly reflecting the wage setting mechanism. The current account deficit is expected to narrow, largely due to an improvement in the terms of trade.
3. The risks are on the downside. The immediate risks are a further decline in global economic activity and a worsening of the global financial distress, which would lead to a further deterioration in exports and investment. The recovery can start only when economic activity picks up in major trading partners, given the economy’s reliance on exports.
Policy priorities in the short, medium, and long term
4. Short-term actions are needed to counter the effects of the global crisis. Policies should focus on attenuating the consequences of the crisis, taking into consideration that the slowdown may be protracted and the following recovery sluggish. Tight credit markets also limit the ability to finance fiscal deficits.
5. In the medium term, the economy needs to emerge from the global crisis on a sustainable growth path. As the crisis subsides, Slovenia will face new challenges from tighter international credit conditions, lower potential growth, and neighboring countries with competitive exchange rates. To address these challenges, reforms in the labor, product, and financial markets are required. Wages need to be flexible to avoid a structural increase in unemployment and a large divergence of inflation from other Euro area countries.
6. The main long-term challenge comes from the fiscal implications of a rapidly aging population. The current pension system needs to be reformed to address the imbalance between the means available and commitments deriving from the current pension provisions and an aging population.
Financial markets
7. The Slovenian banks have weathered the initial stages of the global crisis relatively well. In response to tight international liquidity, banks have partly substituted foreign financing with other sources including ECB funds and government deposits. Banks have also maintained adequate liquid assets to cover their liabilities. The banks’ regulatory capital ratio is in line with their European peers. The level of nonperforming loans is still low, while banks are well provisioned owing to prudent regulation. However, loans to the nonfinancial private sector have decelerated sharply on a month-to-month basis and banks’ profits have fallen.
8. Nonetheless, vulnerabilities in the banking system have increased and preventive actions are in order. Given the banks’ high reliance on foreign funding, efforts should continue ensuring that the banks have enough liquidity in case of further international credit squeeze, especially at longer maturities. Equally important is to ensure that banks are adequately capitalized to deal with the likely increase in nonperforming loans as the conditions in the real sector deteriorate.
9. The authorities have acted promptly and appropriately to the turmoil. In line with actions taken by other European countries, the authorities adopted the following measures:
• an unlimited guarantee for all deposits by individuals and small enterprises until the end of 2010;
• the provision of up to €12 billion in guarantees on new debt issuance by financial institutions until the end of 2010, which is estimated to cover all banks’ foreign refinancing needs for the next two years; and
• amendments to the Public Finance Act to empower the government to lend and provide guarantees to financial institutions, recapitalize banks, and purchase bank assets.
In addition, the treasury issued bonds in the amount of €1 billion in January and temporarily deposited the receipts with the domestic banking system. So far, the government has approved only one bank guarantee. These measures have eased immediate funding concerns, especially at short maturities. The authorities plan to make available additional public funds to the banks in case of further squeeze.
10. The authorities are considering measures to increase lending to nonfinancial companies. A second anti-crisis package, which includes partial state guarantees on new loans to nonfinancial enterprises of up to €1.5 billion, is currently under study. In addition, the publicly owned and recently recapitalized Slovene Export and Development Bank (SID) has expanded considerably its portfolio since September. While the mission appreciates the benefits of providing support to viable companies during difficult times, the allocation of state guarantees needs to be transparent and to limit banks’ moral hazard. Finally, the authorities’ priority should be maintaining banks’ stability rather than expanding further their portfolios given the protracted nature of the crisis.
11. The authorities should strengthen the monitoring of credit risk. Rapid credit growth in the last few years and the severe economic downturn have increased banks’ vulnerabilities. As more nonfinancial companies are coming under pressure, updated stress tests on credit risk are necessary to gauge the impact of nonperforming loans on banks’ capital needs. Banks should be encouraged to maintain precautionary capital buffers against worsening of the portfolio quality. The authorities should strengthen coordination with foreign supervisors and be mindful of potential spillovers from the neighboring countries, especially in the Balkans.
Fiscal policy
12. The fiscal deficit is set to widen substantially in 2009. The deficit of the general government is projected to increase from 0.3 percent of GDP in 2008 to 3.4 percent of GDP in 2009. This deterioration reflects mostly the working of automatic stabilizers and a fiscal stimulus of about 2 percentage points of GDP, which includes cuts in payroll and corporate taxes, subsidies to firms to shorten working time, R&D subsidies, and increased public investment.
13. The magnitude of the planned fiscal deficit is appropriate. The expected severe economic downturn calls for a bold fiscal response to support the economy. This policy is possible given the relatively low initial debt and deficit, and is in line with the coordination of fiscal policy responses at the EU level. Should the economic crisis deepen further, the mission advises against any further fiscal loosening. A spiking spread on Slovenian sovereign bonds reminds of the necessity to keep a low level of borrowing. In order to maintain the overall deficit at the projected level while leaving the automatic stabilizers work, the government should identify possible savings (not focused on investment) in such a case.
14. The composition of the fiscal package could be improved by allocating relatively more resources to public investment. Public investment increases directly aggregate demand and can be leveraged with EU funds; looking forward, public investment is also key to upgrading infrastructure and increasing potential growth. The authorities should act swiftly to remove the legal and institutional bottlenecks, which hindered the use of EU funds in previous years. To this end, a task force to coordinate this effort among ministries should be considered.
15. The mission’s assessment of the fiscal subsidies to shorten working hours and to stimulate R&D is mixed. These measures provide some relief to workers and to medium and large-sized enterprises but are not sufficiently targeted to the most vulnerable groups. They may entail a risk of abuse, which is hard to monitor; therefore, access criteria to the subsidy should be elaborated. Finally, they may be hard to reverse if the crisis continues, causing large fiscal costs. The mission recommends not to renew these measures and to use the funds for more targeted interventions in case the crisis continues.
16. Looking forward, the fiscal position should be reverted back to a more conservative stance as soon as the crisis subdues. The short-term fiscal measures should be embedded into a long term fiscal strategy, which highlights the future fiscal liabilities of the pension system and contingent liabilities owing to the extensive guarantees that the government may issue. In this context, the government should present as soon as possible next year’s budget, indicating which measures will be taken to reduce the deficit. The mission recommends bringing the deficit below 3 percent of GDP in 2010 and moving to a solid surplus once a robust recovery takes hold. Having a clear deficit reduction strategy coupled with an effective communication framework will also help financing the budget.
Structural reforms
17. Substantive changes to the pension system are necessary to ensure longer-term fiscal sustainability. The rapidly aging population, current pension provisions, and low retirement age will put growing pressure on the fiscal accounts, which will require increasing public transfers. As a solution, the government is considering greater incentives for a longer working life and private pension savings. In addition, the authorities are implementing active aging policies aimed at increasing labor participation especially among older workers. These measures go in the right direction but are insufficient to ensure long-term sustainability and to generate resources to increase minimum pensions. Fiscal sustainability requires a systemic reform that raises retirement age and/or moderates the indexation mechanism of the pension benefits.
18. The public payroll bill needs to be contained. The implementation of the reform of public sector wages will raise the wage bill substantially over 2009 and 2010. The mission recommends that future public wage increases should be based on a sustainable policy. The mission recommends not to include the effects of the implementation of the public sector wage agreement in the indexation of pensions, given that they are part of a one-off reform of the wage system. The mission welcomes the authorities’ goal of reducing by attrition public employment by 2 percent a year over the next two years. More generally, the government should link the employment reduction measure to a more comprehensive strategy to improve the efficiency and effectiveness of public expenditure, which would include the introduction of performance budgeting.
19. Successful competition in the Euro zone requires greater labor market flexibility. As a consequence of large devaluations in other countries in the region, Slovenia will face tougher competition, especially in labor-intensive sectors. Labor markets need to be flexible to facilitate the reallocation of workers from sectors no longer competitive to new sectors and to contain the wage pressures that were observed after the Euro adoption. To this end, further liberalization of employment protection legislation is necessary in the medium term and could be implemented in the context of a broader reform of the labor markets.
20. Improvements in the product and financial markets are needed to enhance competitiveness. Slovenia ranks low among European economies in the World Bank’s Ease of Doing Business indicators and has attracted few FDIs in the past few years. To ease business and property registration, authorities have adopted several measures, including the introduction of the “one stop shop” for companies’ registration. Further reforms should focus on enhancing competition in the product and financial markets, including by increasing the independence of the Competition Protection Office and continuing the privatization process once the crisis is over.
We thank the Slovenian authorities for their open discussions, excellent cooperation and warm hospitality.
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