IMF Executive Board Concludes 2013 Article IV Consultation with the Republic of Slovenia
On January 13, 2014, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation1 with the Republic of Slovenia.
After a brief stabilization in 2010, the recession resumed in 2011 and the economy now has contracted for eight consecutive quarters. While a sharp contraction in investment was the main driver of the downturn in the early stages, consumption—until then buffered by healthy household balance sheets—also started to decline from 2012, weighed down by deep fiscal cuts, stagnant wages, and growing uncertainty. The current account has moved into a substantial surplus. While competitiveness is on the mend, the bulk of the external adjustment has come from import compression. In all, through mid-2013, real GDP has fallen by 11 percent from its pre-crisis peak, the largest output loss among the euro area members after Greece.
The combination of an overly indebted corporate sector and weak banks has led to a vicious circle of deepening recession, mounting bankruptcies, rising nonperforming loans (NPLs), and further deleveraging. NPLs (inclusive of guarantees) increased from 11.2 percent at end-2011 to 20.9 percent by end-October 2013. NPLs are highly concentrated in large corporate debtors and in state banks. The deterioration in asset quality has led to an erosion of profitability and capitalization, forcing banks into deleveraging. At the same time, Slovenian corporates have one of the highest leverage ratios in the euro area, mainly because of a lack of equity. The average interest bill to earnings ratio has reached 90 percent, pushing into the red companies that might be viable with lower debt.
On December 12, 2013, the Slovenian authorities announced the results of the comprehensive bank asset quality review and stress test exercise carried out by independent consultants. The exercise found that the banking system would need €4.8 billion in additional capital to withstand a severe adverse macroeconomic scenario. The authorities have since proceeded to address these capital needs by recapitalizing the three state-owned banks from budgetary resources, with the remaining five banks expected to raise private capital in the first half of 2014.
Public debt has been increasing rapidly. Before the global financial crisis public debt was low (22 percent of GDP) and the fiscal position close to balance. The prolonged recession and the burden of supporting the state-owned banks have put public finances under considerable strain. Public debt has more than doubled since 2008, reaching 55 percent of GDP by end-2012, and is set to increase sharply after bank restructuring. The deficit is slated to exceed 4 percent of GDP in 2013 (excluding bank support costs), despite a significant fiscal consolidation over the last three years. Reflecting in part concerns about the fiscal impact of bank restructuring, government bond yields averaged about 2 percentage points higher than in similarly-rated Spain and Italy in the second half of 2013, posing a challenge for debt sustainability, before moderating to about 1 percent following the announcement of the bank asset quality review results.
Executive Board Assessment2
Executive Directors noted that, with the economy still in recession, comprehensive bank and corporate restructuring is essential to achieve financial stability, fiscal and debt sustainability, and durable growth, and called on the Slovenian authorities to step up the current reform effort. Directors welcomed as key milestones the completion of the bank asset quality review and stress tests, recent bank recapitalization, ongoing transference of banks’ problem loans to the Bank Asset Management Company (BAMC), and the adoption of new insolvency legislation.
Directors supported the authorities’ 2014 fiscal deficit target, but raised concerns about the quality of the fiscal measures underpinning the budget. They advised more ambitious public employment reduction, better targeting of social transfers, and specific cuts in transfers and subsidies. Directors noted that further gradual consolidation would be necessary beyond 2014 to support debt sustainability in the face of sizeable government guarantees and bank restructuring costs, and highlighted the need for pension reform, given unfavorable demographic trends.
Directors underscored that durable financial stability hinges on reducing banks’ vulnerabilities through improved bank governance, risk management, and profitability. In this regard, reducing the role of the state, including through privatization, is particularly important. Directors also recommended strengthening financial sector supervision and addressing shortcomings in the bank resolution framework. At the same time, Directors noted that public banks should focus on core activities, including through divestment of their corporate holdings, and that limiting connected lending is essential to contain moral hazard and excessive risk taking.
Directors emphasized that comprehensive non financial corporate restructuring that addresses the debt overhang is essential to break the negative feedback loop of recession, bank deleveraging, and corporate distress, which has been at the root of Slovenia’s recent problems. They cautioned that budgetary support of distressed corporates would amplify fiscal risks, and should be avoided given limited fiscal space. Directors encouraged the authorities to utilize the tools provided by the BAMC and the new insolvency law for restructuring the sector, and welcomed the recent launching of the privatization program. They supported the authorities’ plans to adopt a coherent state owned enterprise management strategy and a centralized management agency for state assets.
Directors welcomed the reduction in unit labor costs and labor market rigidities that have enhanced Slovenia’s external competitiveness. They called for further regulatory and product market reforms to strengthen the business climate and better attract foreign direct investment.
Source: International Monetary Fund
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