An export-led economic recovery in 2014-15 raised employment and private consumption and strengthened Slovenia’s external position. Financial stability has improved. However, decisive policy action is required to address significant constraints to growth and mitigate important vulnerabilities. In particular, further measures to repair balance sheets of small and medium enterprises (SME) would help stimulate private investment. A comprehensive fiscal adjustment package is needed to reduce public debt, create room to absorb potential adverse shocks, and prepare for coming demographic challenges. Additionally, faster privatization, further strengthening of the governance of state-owned enterprises (SOEs), and an improved business environment would raise potential growth.
1. Crisis legacies continue to weigh on Slovenia’s economy. In the boom years prior to the 2008 global crisis, state banks had imprudently made a number of risky loans. When the crisis hit, Slovenia’s highly leveraged corporations found it difficult to service their debts¸ and banks access to external funding was abruptly cut. Nonperforming loans (NPLs) accumulated on bank books, credit contracted, investment fell sharply, and bank losses mounted. These effects led to a second recession and a sovereign debt crisis in 2012-13. The authorities subsequently recapitalized major state-owned banks and moved some of their NPLs to a bank asset management company (BAMC). The bank recapitalization, alongside restored sovereign market access, stabilized the financial system and enabled an economic recovery. However, still debt-laden company balance sheets, particularly in the SME sector, coupled with extensive state ownership, limit growth opportunities. As a result, Slovenia’s GDP and employment remain below pre-global crisis levels, in contrast with its Central European neighbors, whose recoveries have generally been much stronger.
2. Strong demand in trading partners and large European Union (EU) structural fund transfers buoyed growth in 2014-15, but the outlook is less reassuring. Rising exports, a spike in public investment financed by EU funds, and a pick-up in private consumption propelled GDP growth to 3.0 percent in 2014 and 2.9 percent in 2015. While exports and private consumption should continue to be supportive of growth, public investment is likely to fall significantly this year and remain low going forward as EU structural funds are reduced. As a result, we project GDP growth to decelerate to 1.9–2 percent in 2016–17. Over the medium term, private investment, employment, and productivity would likely grow only modestly under current policies, limiting potential growth to about 1½ percent, a rate insufficient to narrow the gap in per capita incomes between Slovenia and the richer parts of the EU.
3. The financial and external positions have improved in the last year. Bank capital ratios have strengthened and liquidity is abundant, while profitability turned positive in 2015. The NPL ratio has declined, and banks have reduced their external liabilities. The external current account surplus exceeded 7¼ percent of GDP in 2015 thanks to strong partner country demand, favorable terms of trade, and sustained cost competitiveness, although it also reflects still weak domestic demand. The net international investment position, while remaining negative, has been improving rapidly.
4. However, significant constraints to growth and important vulnerabilities need to be decisively addressed:
- With more ambitious reforms, Slovenia can grow faster and more sustainably.Besides exports, solid sustainable growth needs a second engine, namely private investment. However, investment is held back, among other reasons, by over-leveraged company (especially SME) balance sheets. A burdensome business environment and low productivity in SOEs constrain potential growth as well.
- Despite the reduced headline budget deficit in the past two years, fiscal adjustment is far from complete. The deep recession, persistent budget deficits and the cost of bank recapitalization have quadrupled public debt from 21½ to over 83 percent of GDP between 2008 and 2015. Under current policies, we project that the budget deficit will start widening again from 2017 on, and the debt ratio to GDP will rise further in the medium term. The costs associated with population ageing exacerbate these trends.
- Bank profitability is at risk in the current environment of low interest margins and low lending volume. Moreover, the NPL reduction process is incomplete.. These factors pose risks to bank capital and thus financial stability should adverse economic shocks materialize.
5. In this environment, we see three policy priorities:
- Repair further bank and corporate (especially SME) balance sheets to sustain financial stability and restart credit flows to private companies;
- Implement a comprehensive strategy to rebuild fiscal buffers; and
- Accelerate privatization, strengthen the governance and efficiency of state-owned enterprises and banks, and improve the business environment.
Further company deleveraging and NPL resolution would strengthen prospects for private investment
6. Despite recent deleveraging, SMEs remain over-indebted and unable to adequately service their liabilities. While recent debt restructuring agreements have reduced excess debt and NPLs of large corporations, our analysis indicates that in 2014 the bulk of medium, small, and micro firms—a sector that accounts for 60 percent of investment in the economy—remained indebted above the point where debt adversely affects their investment. Further policy action is needed to unlock these companies’ ability to borrow and invest:
- The Bank Association and the Bank of Slovenia’s (BoS) guidelines for SME NPL resolution provide a welcome framework for restructuring the debt of viable companies. By extending helpful methodological advice to both banks and borrowers, the guidelines can significantly speed up the process and raise the frequency of successful restructurings. To incentivize the banks to resolve NPLs promptly, firm supervisory oversight on the implementation of the banks’ NPL reduction plans should be maintained. Moreover, existing measures such as time-bound write-off requirements (with the attendant provisioning) for uncollectible loans and nonaccrual of interest for loans past a set delinquency threshold should be strictly enforced.
- Government and BoS support for a centralized privately-funded entity (SPV) to bundle and sell non-performing SME loans could help resolve NPLs quickly, returning resources such as pledged collateral to economic circulation. By selling adequately provisioned loans, the banks would also strengthen further their financial position, rebuilding capital for new lending.
- To raise equity and provide debt financing to SMEs on favorable terms, the export and development bank (SID) should develop appropriate instruments, including by channeling EU funds.
7. Proper allocation of credit and adaptation of banks’ business models to the new environment are critical to preserve the recently established financial stability. Credit extension should reflect commercially-driven arms-length transactions between banks, including state-owned ones, and their clients. A return to pre-crisis lending practices could easily lead to a resurgence of NPLs in a few years. Moreover, to sustain adequate profitability in the current environment and prevent erosion of their capital in case of adverse shocks, banks need to proactively and substantially reconsider their cost structures and revenue sources.
8. Timely and well-designed bank privatization is important to ensure strong corporate governance and reduce public debt. The sale of NKBM appears imminent and we are encouraged to see the start of the privatization process for NLB, the largest bank. However, the chosen privatization model for NLB—a sale of shares on a stock market, with the state retaining the largest stake—is unlikely to attract strategic investors that would want to manage and develop the institution based on sound commercial principles. We urge the authorities to consider the benefits of a tender for the controlling stake, actively market the bank to strategic investors, and reconsider plans to prevent any investor from acquiring more than the state’s designated share stake (25 percent plus 1 share). In addition, the process should ensure that potential shareholders above the relevant threshold are fit and proper. As for the third largest bank, Abanka, we see a case for accelerating its privatization relative to the current deadline (July 2019) to move to a fully competitive banking market as soon as possible and recoup more quickly the government’s investment in Abanka.
9. The operational independence of the BAMC is key for its ability to successfully dispose of its assets. Recent legal arrangements that call for non-interference of the state in the BAMC’s case work should be respected and the vacant seat in its supervisory board should be filled by a competent and independent professional. Progress with asset sales and corporate restructurings should not be slowed by the extension of its mandate to 2022. To facilitate restructuring operations, we recommend that the BAMC acquire all large bank exposures to debtors on whom it already holds a claim. The BAMC mandate to maximize value from asset sales should ensure that any related increase in public debt is offset over the medium term.
A comprehensive fiscal adjustment package is needed to meet looming fiscal challenges
10. The structural adjustment embedded in the 2016 general government budget is broadly appropriate. We estimate that the budgeted cash deficit now amounts to 2.2 percent of GDP, which entails a structural primary adjustment of 0.8 percent of GDP, slightly above our recommended 0.6 percent of GDP. Achieving the budget deficit target, however, is subject to risks that could lead to significant overruns: (i) pressures to increase the wage bill as the temporary wage restraints introduced in the crisis are being unwound; and (ii) uncertainty about the yield from administrative measures to improve indirect tax collections.
11. A broad-based fiscal consolidation strategy is needed to ensure sustainability over the medium term. The authorities acknowledged this in 2015 by setting a medium-term structural budget balance target of zero. With a closed output gap from 2017 on, the next several years are indeed the right time to rebuild fiscal buffers. Specifically, we recommend a continuing structural primary balance adjustment of 0.6 percentage points of GDP a year until the overall structural balance reaches zero, and then maintaining the zero structural balance until public debt falls below 60 percent of GDP. Substantial additional policy measures, amounting to about 3 percent of GDP, will be needed to achieve this adjustment. In this regard, ensuring that the public sector wage bill resumes its downward path relative to GDP is critical for the success of the overall consolidation. More generally, the focus of the consolidation should be on structural fiscal reforms in areas where Slovenia is spending more than its peers without achieving better outcomes:
Pensions, by indexing pensions to inflation only, abolishing the pension bonus and pensioners’ preferential tax treatment, and, once the retirement age reaches 65 as planned, continuing its increase to 67 and then linking it to life expectancy. Part of the savings should be directed to support low-income pensioners through the social assistance system;
- Education spending, by raising pupil-teacher ratios, shifting resources from areas with declining school population to those with expanding ones, and better means-testing financial support for tertiary students;
- Health care spending, by increasing reliance on primary care, introducing service-based copayments, and linking payments for treatments to their demonstrated clinical and cost effectiveness.
On the revenue side, we strongly encourage the introduction of a modern broad-based property tax, in line with IMF technical assistance recommendations, from 2017. While the tax could start as revenue-neutral until its implementation is tested and technical issues resolved, in the medium term it should yield higher revenue than the levies it replaces to adequately support the overall fiscal effort. In addition, the authorities’ intention to shift the burden of taxes away from labor would appropriately reduce companies’ labor costs and support employment growth. The resulting revenue loss should be offset by raising excise taxes on fuel given the current low energy prices and tightening transfer pricing rules to raise corporate income tax receipts.
Faster privatization and further strengthening of SOE governance would raise potential growth
12. Extensive state ownership may impede growth. The state is the largest employer, asset manager, and corporate debtor. State-owned enterprises are both more indebted and less profitable than are their peers. The strategy for managing SOEs adopted in 2015 is a step forward in introducing economic and commercial principles based on OECD guidelines in SOE management. However, the strategy goes too far in its call for the state to retain direct control over a number of large companies, including in sectors where other OECD and EU countries have not, as a rule, sought to retain state control (e.g., consumer goods and tourism). This approach carries the risk of continuing low productivity growth, low profitability, and insider capture in these enterprises and prevents a faster and much-needed reduction of public debt. For the planned revision of the state asset management strategy this summer, we recommend:
- Faster and more comprehensive privatization: The number of companies where the state wants to retain control by designating them as “strategic” or “important” should be significantly reduced. In addition, the restriction that no private investor should hold a stake larger than the state’s in the “important” companies should be lifted, as it prevents the entry of strategic investors, which has negative implications for these firms’ performance and governance. Moreover, we strongly urge a restart of the privatization of Telecom Slovenje, for the reasons mentioned above, and the removal of any remaining legal and financial uncertainties prior to its sale.
- Improved SOE governance : We support the strategy’s provision for setting profitability and other performance targets for SOEs. These targets should aim at performance comparable to that of private companies in the corresponding sectors of the economy, and should encourage disposal of the non-core assets owned by the SOEs, including cross-ownership in other SOEs. Setting targets should also be accompanied by a robust and credible process of verification of their achievement and accountability for misses.
13. Other structural reforms will also raise potential growth. We call for attention to reforms in areas where (i) the estimated gain from improvement is large, and (ii) the distance from EU and world best practices is significant. Specifically:
- Judicial system: raise the recovery rate in-court restructuring proceedings and speed up the process; protect property rights in both in-court and out of court settlements;
- Company financing: reduce obstacles to foreign ownership and investment, and facilitate equity financing;
- Education and R&D: eliminate skills mismatches by tailoring educational fields financially supported by the state to the needs of the market place.
- Governance and corruption: reduce the perception of favoritism to specific companies in decisions of government officials.
We thank the authorities for their warm hospitality, open and constructive discussions, and excellent assistance to the mission’s work.
A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. 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, or as part of other staff monitoring of economic developments.
The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.
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