Monetary and financial issues

Economic Survey of Slovenia 2009: Restoring a sustainable growth path within the monetary union

 

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The following OECD assessment and recommendations summarise chapter 1 of the Economic Survey of Slovenia published on 1 July 2009.

 

Contents

 

A successful economic catch-up over the last decade

Since 1997, Slovenia has enjoyed dynamic growth, steadily moving toward the OECD average gross domestic product (GDP) per capita. Strong growth reflected a favourable business environment and significant structural reforms that paved the way to European Union (EU) accession in 2004. Prudent macroeconomic policies also helped to maintain growth without creating any major imbalances, until recently. In particular, the social agreement of 2002 to keep wage growth below that of productivity helped to reduce inflation toward the level in the euro area within a couple of years. The agreement also contributed to improved competitiveness while preventing a significant deterioration in the current account balance, in contrast to the experience of many other transition economies. A strict agreement on public wage restraint since 2004 and cautious implementation of the two-year budgeting rule helped bring the fiscal balance back to surplus in 2007. These positive developments suggest a sustainable catch-up during this period. However, some signs of overheating emerged after euro area entry in 2007, which coincided with strong food and energy price shocks, with inflation peaking mid 2008 at the highest level within the euro area and unemployment falling significantly below its estimated natural rate.

 

Real per capita incomes have converged rapidly to that of EU15
Real GDP per capita in USD at constant prices and constant purchasing power parities, EU15 = 100

Source: OECD (2008), Productivity database, September, www.oecd.org/statistics/productivity; and OECD 2009), National Accounts of OECD Countries – online database, February.


Economic convergence is now challenged by the global crisis

The main channel through which the global crisis has affected Slovenia is trade, as foreign demand, especially from Germany, has fallen sharply. The worst-affected sectors have been those producing cyclically-sensitive goods, such as the automobile sector (1.1% of Slovenian value-added). Slovenia’s banking sector has not been spared by the financial crisis either, despite not being directly exposed to the toxic assets. The banking sector has been facing refinancing difficulties since the last quarter of 2008. Both foreign and domestic banks had been borrowing abroad in recent years to finance a credit boom that outstripped the growth of domestic deposits. As a consequence, the total amount of short-term debt to be refinanced within a year has reached EUR 5.5 billion, about a sixth of Slovenian GDP, forcing banks to hold cash and limit credit to households and firms. The economy of Slovenia is expected to enter into recession in 2009 and slowly pick up in 2010. This outlook remains fragile as it relies on a recovery in exports and on the effectiveness of recent policies to support growth.

 

Measures to support the financial sector and avoid credit rationing have not yet resulted in a pickup in bank lending

The government, with the help of the Bank of Slovenia, is actively supporting the banking system, but with mixed results so far. A state guarantee scheme (allowing up to EUR 12 billion of bank refinancing to be guaranteed by the state until end-2010) was put in place last year but only one bank has applied. The government took new measures at the beginning of 2009 to support bank refinancing and to help banks resume lending. To support bank liquidity, the government used its higher credit rating to borrow EUR 1 billion and deposited most of the proceeds in bank accounts. The government has also used three instruments to give incentives for banks to resume or keep lending to the domestic firms: a state guarantee (up to EUR 1 billion in total) for which banks can apply when they lend; credit lines from the state-owned development and export bank (SID), whose recapitalisation decision has been approved; and direct state guarantees when firms borrow in financial markets. Having started in 2009, the positive impact of these measures on bank lending has not yet been clearly felt. Should they fail, the government has also been contemplating direct lending to firms, or even more radical options to support the banking system, such as purchasing assets directly from banks, recapitalising them or creating a bad bank. Despite the difficulties in the financial sector, household confidence in bank deposits has not been affected thanks to the removal of the ceiling on the state guarantee for deposits.


In this context, there is room for discretionary fiscal policy

The favourable fiscal position built up before the crisis hit has provided room for fiscal stimulus. The revised 2009 budget goes beyond automatic stabilisation and incorporates a discretionary stimulus amounting to 1.2% of GDP. Including measures to increase public wages decided in July 2008 raises the discretionary fiscal impulse to about 2% of GDP in 2009. With an expected strong impact of automatic fiscal stabilisers, the general government deficit is expected to reach nearly 6% of GDP in 2009.

 

But policy measures that put long-term fiscal sustainability at risk should be avoided

Slovenia should prioritise discretionary fiscal measures that help foster its potential growth, including public investment, spending on human capital or research and development. Measures whose only purpose is to support short-term activity should clearly be made temporary and removed as soon as activity picks up. In this respect, composition of the stimulus package is mixed. On the positive side, it contains a recapitalisation (EUR 160 million) of the state-owned development and export bank (SID) to support lending to firms as well as diverse tax measures to support investment (about EUR 100 million). On the other hand, the main government fiscal measure (EUR 230 million), which subsidises firms for reduced working hours to maintain employment, may prove difficult to reverse and lead to a reduction in potential output if kept in place too long. The government should also reconsider its planned increase in public wages, since this will permanently raise public spending by roughly 1% of GDP at the expense of long-term fiscal sustainability.

 

And fiscal policy needs to pay attention to the appropriate policy mix

Taking into account the usual time lag for fiscal measures to kick in, the Slovenian government will need to progressively withdraw the fiscal impulse as soon as the economic prospects start improving, probably from 2010 or 2011 onwards. For this purpose, a strong political commitment is needed to restore a balanced fiscal position over the medium term in the context of the Stability and Growth Pact. Ways to foster this commitment would be to introduce performance budgeting and consideration can be given to put in place an independent Fiscal Council that regularly assesses the appropriateness of the fiscal stance and long-term sustainability. As a catching-up economy with monetary conditions which may be easier than in other euro area countries, it is important that the fiscal stance takes into account the actual monetary conditions in Slovenia so as not to repeat what happened after euro area entry, when fiscal policy was de facto not sufficiently restrictive to provide an appropriate policy mix vis-à-vis the euro area monetary stance, which was relatively loose for a booming economy. This would help to keep inflation at a level closer to the objectives for the euro area as a whole.

 

Fiscal-monetary policy mix


1. In per cent of GDP.
Source: European Commission (2009), Economic and financial Affairs, AMECO database, April.


Beyond the crisis, efforts toward real convergence should be renewed

Beyond 2009 and as the economy recovers, efforts to achieve real convergence towards the euro area average need to be renewed. Entry to the euro area was supported by the 2002 social agreement of keeping wage growth below the growth of productivity. The implementation of the law reducing wage disparities in the public sector should be reviewed in light of its macroeconomic impact, since this law will result in a higher fiscal deficit and add to wage pressures once the economy recovers, potentially damaging employment and competitiveness if wage growth remains durably above productivity growth. A new social agreement ensuring that real wage growth does not exceed that of trend productivity is necessary.

The speed of real convergence will depend critically on the scope of structural reforms. Slovenia has achieved a broad modernisation of its economy since independence through the gradual implementation of structural reforms. This gradualism in reforms brought positive results, such as maintaining low inequality and consensus for market-oriented reforms. However, gradualism also entails costs. As some reforms were only partial, especially in the labour and product markets, Slovenia could not reap all the benefits from previous reforms in other sectors (trade, finance and tax policy). Moreover, in the long run, structural reforms are key to ensure resiliency to shocks within a common currency area. Looking ahead, the rapid ageing of the population will reduce potential output growth. To foster further convergence, structural reforms need to be accelerated, and bad times should not be used as an excuse for postponing the political discussion on the necessary reforms. Toward this end, policy makers need to shift attention to reforms to increase labour supply and foster productivity growth through enhancing the business environment, while restoring fiscal prudence to maintain a macroeconomic framework conducive to growth.

 

How to obtain this publication

 

The complete edition of the Economic Survey of Slovenia is available from:

The Policy Brief (pdf format) can be downloaded in English. It contains the OECD assessment and recommendations. (It can also be downloaded in Slovene, see link below, but does not contain all the charts available in the English version.)

Policy Brief v slovenščini je dostopen tudi v PDF formatu. Povzema oceno in priporočila OECD, ne zajema pa vseh grafov z zgornjih spletnih strani.

 

Additional information

For further information please contact the Slovenia Desk at the OECD Economics Department at eco.survey@oecd.org

The OECD Secretariat's report was prepared by Margit Molnar and Colin Forthun under the supervision of Pierre Beynet. Research assistance was provided by Desney Erb.

 

 

 

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