Not yet doomed, but running out of time

By Katja Mann. Originally published on 2013/04/23

Despite severe financial and economic problems, Slovenia can still avoid a bail-out – if investors stay confident

Slovenia’s course: From model student to problem case of Central Eastern Europe

When Slovenia joined the EU in 2004, it was the most developed among the countries of Central Eastern Europe (CEE) and generally considered a success story of economic transition towards market economy. Slovenia’s income level had already reached 80% of the EU’s and its macroeconomic performance was so promising that in 2007, Slovenia was the first CEE country to be admitted into the Euro zone[1].

Only six years later, Slovenia has turned into a problem case for the Euro zone and is named a strong candidate for the next bail-out. The economy has re-entered into recession in 2012, its banking sector is ailing and the government persistently runs a primary deficit. What has gone wrong? Slovenia was hit by the financial and economic crises in a way much similar to what other advanced economies experienced[2]: an unsustainable boom of the construction and housing sector came to an abrupt end, the consecutive credit defaults forced domestic banks to deleverage, which in turn led to a tightening of credit that transmitted the crisis into the real economy. Slovenia’s banking sector was hit harder than other CEE’s because its biggest banks are still state-owned and had been badly managed prior to the crisis. But it is not only the banking sector that is in bad shape: pension system and labour market have long been needing structural reforms, but these were delayed until 2011 – only to be vetoed in a referendum[3]. Additionally, the export-oriented Slovenian economy suffered from the recession in the rest of Europe and particularly in its biggest trading partner Italy.

Next to economic problems, Slovenia has just gone through a political crisis: A government formed after elections in 2011 was brought down by a vote of no confidence against former Prime Minister Janez Janša who was accused of corruption[4]. Opposition leader Alenka Bartušek managed to form a centre-left coalition, but her government has already had to deal with a first scandal – a minister that had to resign due to a real estate affair[5].

Implementing structural reforms – gradually, but thoroughly

So all in all, Slovenia’s current situation looks rather gloomy – and this picture is not going to change overnight. Recession will prevail for at least another year, the government deficit is still much above the 3% Maastricht threshold and the banking sector is likely to need some more 1€ billion of fresh capital[6].

But things are changing in Slovenia:  Since 2012, a number of reforms have been initiated to tackle the most pressing financial and economic problems. The newly founded Bank Asset Management Company, a “bad bank” in finance jargon, will take on bad assets and allow troubled banks to clean up their balance sheets. A pension reform adopted in December 2012 increases the retirement age and will thus help to face the consequences of a rapidly ageing population. In the labour market, reforms have rendered work contracts more flexible and administrative processes easier. These measures might in particular benefit young graduates who are facing severe troubles entering the labour market. Furthermore, the Janša government started a process of fiscal consolidation, the goal being a balanced budget by 2015. It is not yet clear whether the Bratušek government will stick to this strict course, but in general, there has been a high tendency of continuity in politics despite the change of government. Not only were reforms passed with near-unanimous support in the parliament, but they are also backed by social partners. This might help to contain public protests which had been rising recently.

Slovenia’s reforms have been greeted by the EU and by other international organisations as steps in the right direction[7]. Though many of the measures might turn out not to be sufficient, they could mark the beginning of a gradual process of restructuring that will bring the country’s economy and financial system back on track. Slovenia could still avoid a bail-out – if it just had enough time.

A race against time

Slovenia now has to pay the price for having delayed necessary reforms for too long: The country is under an extreme time pressure to prove that the measures initiated over the last year are not only the right ones, but will also be implemented with rigour. The new government has only been in office for a month and nobody is yet able to say whether it will be up to the job. If Ms. Bratušek and her ministers do not quickly succeed in gaining credibility at home and abroad, Slovenia could well tumble into the abyss.

But even if Slovenia managed to implement its reform agenda as projected, it could still lose the race against time and end up asking for a bail-out. This is where Cyprus enters the stage. The uncoordinated and delayed rescue plan for Cyprus has yet again squandered investors’ trust in the Euro area and made them look for the next victim in the Euro domino play. The risk of contagion becomes visible when looking at the long-term interest rates for Slovenian government bonds.  In March 2013, yields for 10-year bonds were still at 5.09%, but within little more than a month they rose to 6.33%[8] and are now nearing the psychologically important mark of 7% above which a bailout is said to be inevitable. Of course, Italy’s political crisis and drawbacks in the Portuguese reform agenda are not helping either. The moment of truth for Slovenia is likely to come at the beginning of June when the government will have to issue about 1€ million of new debt. While Ms. Bratušek keeps repeating that her country does not need a bailout, the Slovenian public is less optimistic. An opinion poll by the market research agency Delo Stik in March showed that 48% of Slovenians believe that the country will not survive without international help, while only 44% believe that it will[9].

[1] European Commission,http://ec.europa.eu/economy_finance/publications/publication11325_en.pdf

[2] See IMF Country Report Slovenia 2012,http://www.imf.org/external/pubs/ft/scr/2012/cr12319.pdf

[3] OECD: Economic Survey Slovenia April 2013, http://www.oecd-ilibrary.org/docserver/download/1013071e.pdf?expires=1366453664&id=id&accname=ocid177643&checksum=C73E93C9CBD71066AA2E5F1B056E0150

[4]The Economist, http://www.economist.com/blogs/easternapproaches/2013/02/slovenia

[5]http://blogs.ft.com/beyond-brics/2013/03/26/guest-post-slovenia-not-as-bad-as-cyprus/#axzz2P0XbBBsd

[6] IMF Slovenia 2013 staff visit – concluding statement of the mission,http://www.imf.org/external/np/ms/2013/031813d.htm

[7] See Statement by President Barroso following a meeting with Ms Bratušek on 09/04/2013,http://europa.eu/rapid/press-release_SPEECH-13-296_en.htm , IMF: Concluding Statement of the Slovenia 2013 Staff Visit,http://www.imf.org/external/np/ms/2013/031813d.htm, OECD: Economic Survey Slovenia April 2013, http://www.oecd-ilibrary.org/docserver/download/1013071e.pdf?expires=1366453664&id=id&accname=ocid177643&checksum=C73E93C9CBD71066AA2E5F1B056E0150

[8]Reuters, http://www.bloomberg.com/news/2013-04-18/germany-s-bonds-little-changed-before-spanish-french-debt-sales.html

[9]Reuters, http://uk.reuters.com/article/2013/04/05/uk-slovenia-bailout-insight-idUKBRE9340IJ20130405