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Country Report Slovenia

Country Report

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Slovenia has taken further steps to tackle its banking crisis, but progress has been delayed by an extensive asset quality review that is yet to reveal the true scale of the problem. Depending on the outcome, an EU-led bailout may be needed soon. 

Strenghts (+) and weaknesses (-)

(+) Favorable geographic position and well-educated workforce

Thanks its proximity to the German and Austrian markets, the integration of its local economy into regional supply chains, and its well-educated workforce, Slovenia’s economy holds considerable potential to rebound once the current severe banking crisis has been resolved.

(-) Lingering political instability

Due to a lacking consensus on the direction of economic policies, the stability of Slovenia’s current coalition government remains at constant risk. The collapse of the government would likely trigger a political crisis that could halt recent fiscal consolidation efforts and increase the need for external assistance.

(-) Severe banking sector crisis and strongly rising public debt

Slovenia’s mainly state-owned banking sector is burdened with very large and rising amounts of bad loans that erode capital adequacy levels, forcing the government to repeatedly recapitalize banks. Consequently, public debt levels have risen strongly in recent years.

(-) Wide-spread state-ownership in various sectors

Owing to past reluctance to privatize large parts of the local economy, direct and indirect state-ownership is prevalent in various industries, particularly in the financial sector. The resulting close ties between various sectors and Slovenia’s political elite undermine economic efficiency through conflicts of interest, corruption and connected lending practices.

Key developments

1. Slovenia’s economic outlook remains very bleak

Slovenia’s economy continues to face considerable headwinds in both 2013 and 2014, as the still pending resolution of its deep banking crisis delays the emergence from a protracted eight-quarter recession. At home, domestic demand remains depressed by the combination of a severe credit crunch, very high corporate indebtedness, fiscal consolidation measures, and rising unemployment levels, leaving net exports as the sole source of growth. Meanwhile, export demand from both the euro area and the Balkans remains quite weak. Consequently, the positive contribution of net exports to economic growth mainly reflects strong import contraction. Even though Slovenia’s recession weakened this year, the outlook will remain bleak as long as the urgently needed banking sector clean-up and corporate sector deleveraging drag on and contribute to lingering concerns among investors about an EU-led bailout. Reflecting Slovenia’s current very weak economic performance, various national and international institutions have slashed their growth projections for this year and the next. Following last year’s contraction of 2.4%, the IMF currently expects Slovenia’s economy to shrink by another 2.6% in 2013 and 1.4% in 2014.

Figure 1: Growth performance
Figure 1: Growth performenceSource: Reuters EcoWin
Figure 2: CDS spreads
Figure 2: CDS spreadsSource: Bloomberg

2. Slovenia's new government struggles to avoid an international bailout

Since taking office last March, Slovenia’s new center-left coalition government has continued its predecessor’s efforts to avert an international bailout. As borrowing costs rose sharply and doubts about Slovenia’s access to international capital markets emerged, prime minister Alenka Bratušek’s cabinet focused its efforts on reining in a widening budget deficit, the transfer of non-performing loans to a bad bank, and the privatization of 15 state-owned enterprises. While fiscal consolidation measures focused on various tax increases, public sector wage cuts and the introduction of a balanced budget rule, reforms of the justice system and the streamlining of insolvency legislation were intended to facilitate the clean-up of the banking sector. As progress on structural reforms had been blocked by referenda in recent years, the current cabinet also implemented constitutional changes that impose stricter rules on calling future plebiscites. Yet, this year’s budget deficit (assuming bank recapitalization in 2013) is expected to reach 7.9% of GDP. While Ms Bratušek has managed to ensure cabinet cohesion so far, despite several policy initiatives running counter to the convictions of the coalition partners, keeping the cabinet together amid considerable public disenchantment with the austerity measures remains challenging. An upcoming self-initiated confidence vote in November to ensure the approval of the 2014 budget will likely constitute a litmus test. If successful, the confidence vote could boost government stability, but recent tensions within the coalition and an intra-party power struggle between Ms Bratušek and Ljubljana mayor Zoran Jankovič illustrate that unanimous support is not guaranteed. Still, general agreement among coalition partners that a bail-out needs to be avoided at all cost should help the prime minister win the vote, as a collapse of the cabinet could derail recent fiscal consolidation efforts.

Progress on Slovenia’s banking-sector clean-up came to an abrupt halt this summer, when the European Commission (EC) refused to approve the start of non-performing loan transfers to a bad bank pending the conclusion in early December of an asset quality review (AQR) and stress tests of 10 local banks by external auditors. The EC had asked for an external review amid lingering doubts about the true scale of Slovenian banks’ recapitalization needs. According to estimates by the Slovenian central bank, non-performing loans increased from about EUR7bn (14.4% of total loans) at the end of 2012 to EUR 7.9bn (17.5% of total loans) by June 2013, while Slovenia’s government earmarked EUR 1.2bn for bank recapitalizations this year. Yet, depending on the results of the AQR and the Slovenian authorities fears of a bank run, banking sector rescue costs could be much higher. The recent choice for an expensive guarantee of all deposits  following the liquidation of two small banks bears witness to this concern. Given the lingering uncertainty regarding the true scale of banking sector recapitalization needs, it is too early to tell whether the government will manage to avoid an international bail-out. Still, given the ongoing deterioration in asset quality due to the current deep economic contraction, bank recapitalization needs could exceed currently earmarked funds, while worse-than-expected tax revenues could put continuous pressure on government finances. Consequently, Slovenia could be forced to issue considerably more debt next year than the finance ministry’s current projection of EUR 4bn suggests. Since any additional financing need could push currently-elevated government yields even higher, the government may opt for external assistance, as a EUR 1.5bn bond matures on April 2nd, 2014.

Factsheet of Slovenia
Factsheet of SloveniaSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

Slovenia is a small country in Central Europe with an open economy and a population of 2 million inhabitants, a nominal GDP of USD 45bn in 2012. The former Yugoslav republic was the first former Communist economy to join the euro area on January 1st, 2007. Given a nominal GDP per capita at PPP of USD 28,242, it ranks among the wealthiest economies in central- and eastern Europe, but its income level is still 35% lower than neighboring Austria’s. In spite of its small size, Slovenia’s economy is relatively well-diversified. Besides a sizeable tourism sector, the country has a large manufacturing sector that focuses on the production of transportation equipment (e.g. Renault) and car parts, machinery, metals, chemicals, and electric appliances. In contrast to many of its regional peers, Slovenia has so far avoided large-scale privatizations and consequently, state-ownership is widespread, particularly in the country’s financial sector. The consequent close links between various state-owned enterprises and banks, resulting conflicts of interest and sizeable amounts of connected lending have been at the roots of Slovenia’s current severe banking crisis, in which state-owned banks are in constant need for government-funded recapitalizations after having accumulated very large amounts of non-performing loans. In order to finance these expenses, Slovenia has embarked on a strict fiscal consolidation course, which worsened the country’s protracted credit-crunch driven recession. Still, public debt has increased strongly in recent years. Even though unemployment levels remain far below levels seen in other euro area crisis countries, public disenchantment with the political elite has increased considerably, which came at the cost of increased political instability. Following the resignation of the previous government amid a corruption scandal in March 2013, Slovenia is currently governed by a center-left four-party coalition government under the leadership of prime minister Alenka Bratušek.

Economic indicators of Slovenia
Economic indicators of SloveniaSource: EIU, IMF, Slovenian government

*Government projection of this year’s deficit based on a EUR 1.2bn capital injection into the three largest banks in 2013. Excluding bank recapitalization costs, the budget deficit is expected to come in at 4.0% of GDP.

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Author(s)
Fabian Briegel
RaboResearch Global Economics & Markets Rabobank KEO
+31 6 5357 3114

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