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Ernst & Young Eurozone Forecast June 2013Eurozone

Outlook for Slovenia

Ernst & Young Eurozone Forecast — June 2013

Published in collaboration with

17 Eurozone countries

Spain

Portugal

France

Ireland

Finland

Estonia

Netherlands

BelgiumLuxembourg

Slovakia

Austria

Italy

Greece

Malta

Cyprus

Germany

Slovenia

1Ernst & Young Eurozone Forecast June 2013 | Slovenia

HighlightsRecession will be deeper and longer, but a bailout should be avoided

• Following the rescue package for Cyprus, investors feared that Slovenia could be the next Eurozone country to require a bailout to help stabilize its banking sector. But we believe the country should be able to avoid a loan from the European Union (EU). In addition, the successful auction of €1.1b of treasury bills in April and the issue of €3.5b in bonds early in May, suggest that international investors now share this view.

• However, downside risks remain high, with continued market access likely to hinge on the Government’s ability to retain investor confidence by implementing plans to restructure the financial sector efficiently.

• Market concerns center on Slovenia’s troubled banking sector and the likely spillover to the public finances and the wider economy. Bank balance sheets have deteriorated markedly in recent years and the recapitalization needs of the three largest banks have been estimated by the regulatory authority at €1b in 2013 (around 3% of GDP).

• The Government recently announced a major restructuring of the banking sector and we estimate that the budget deficit will rise to about 9.5% of GDP this year. And with VAT due to increase in July, we now expect inflation to average more than 3% this year.

• Deleveraging in the public and private sectors will significantly dampen economic activity this year, amid tight financial conditions, rising unemployment and lackluster exports due to weak Eurozone demand. We expect the economy to contract by nearly 5% in 2013 and then by a further 3% in 2014.

• Depressed Eurozone markets mean that exports are set to fall again next year and will not return to sustained growth before 2016. Over the medium term, austerity plans rely on an improving trade balance to rekindle investment and growth. This year’s further widening of the current account surplus is an indicator of depressed domestic demand, rather than export-led recovery.

2 Ernst & Young Eurozone Forecast June 2013 | Slovenia

Financial stress makes sharp 5% GDP contraction likely this year …After Cyprus received the first tranche of its bailout in May, fears rose that Slovenia could be the next Eurozone country to require a bailout to help stabilize its banking sector. But we believe the country should be able to avoid an EU loan. In addition, the successful auction of €1.1b of treasury bills in April and the issue of €3.5b in bonds early in May that suggests that international investors currently agree. However, downside risks are high as confidence is fragile. Continued market access is likely to hinge on the success of the Government’s plan to restructure the country’s troubled financial sector and on the rest of the Eurozone backing the plan.

Bank balance sheets have deteriorated markedly in recent years due to asset quality problems in the corporate sector. Non-performing loans (NPLs) accounted for 14.4% of total loans in the banking system last year, while among the three largest banks the NPL ratio was over 20%. The recapitalization

needs of the three largest banks have been estimated by the regulatory authority at €1b in 2013, although this estimate could rise sharply as economic conditions deteriorate. A so-called “bad bank” has been created to clean up the balance sheets of financial institutions and restructure the highly indebted corporate sector. But a lack of operational transparency risks undermining its effectiveness.

The Government recently announced a major restructuring of the banking sector, beginning in June. It will move €3.3b of bad loans from the three largest banks to the newly created bad bank in return for state guaranteed bonds worth €1.1b. The banks will receive up to €0.9b in additional capital by the end of July, almost doubling the amount received since 2008. Their bad debts will still be almost 9% of the total, but this will be a lot lower than the present estimate of 25%. For the banking sector overall, transfers to the bad bank are expected to reduce NPLs to 10.4% of the total.

… lifting the fiscal deficit to nearly 10% Although government debt is fairly low by European standards, at around 50% of GDP in 2012, it is rising rapidly due to persistent large budget deficits. The authorities are pursuing an ambitious front-loaded fiscal consolidation strategy. They announced measures earlier this month including: an immediate €500m spending reduction, mostly through reducing the number and pay of public employees; the privatization of 15 large publicly owned businesses; and raising VAT from 20% to 22% in July. The European Commission is currently considering the plans. But restoring the public finances to a sustainable path may continue to prove difficult, due to the very weak economic backdrop and an over-reliance on temporary measures, such as wage cuts. Together with one-off bank recapitalization costs, which we assume will be around €1.5b this year, we expect the budget deficit to exceed 9.5% of GDP in 2013.

Recession will be deeper and longer, but a bailout should be avoided

Table 1 Slovenia (annual percentage changes unless specified)

2012 2013 2014 2015 2016 2017

GDP -2.2 -4.9 -2.9 1.1 2.8 3.4

Private consumption -2.9 -6.7 -2.5 2.7 5.1 4.7

Fixed investment -9.1 -11.1 -5.5 3.0 6.4 5.7

Stockbuilding (% of GDP) -0.3 0.2 2.0 1.5 -0.1 -0.7

Government consumption -1.6 -3.0 -2.0 0.1 2.2 3.0

Exports of goods and services 1.3 -2.5 -1.7 0.7 2.0 2.5

Imports of goods and services -3.4 -4.0 0.9 1.3 2.2 3.0

Consumer prices 2.6 2.4 2.0 2.1 2.2 2.5

Unemployment rate (level) 9.0 13.9 14.0 14.0 13.1 12.0

Current account balance (% of GDP) 2.5 3.9 2.1 1.6 1.5 1.1

Government budget (% of GDP) -4.0 -9.6 -4.4 -3.7 -3.9 -2.0

Government debt (% of GDP) 50.8 70.4 75.4 76.8 77.0 74.7

ECB main refinancing rate (%) 0.9 0.6 0.5 0.5 0.5 0.7

Euro effective exchange rate (1995 = 100) 115.5 118.5 115.6 112.0 111.1 110.9

Exchange rate ($ per €) 1.28 1.29 1.21 1.17 1.17 1.17

Source: Oxford Economics.

3Ernst & Young Eurozone Forecast June 2013 | Slovenia

Figure 1Real GDP growth

Figure 2Government budget balance

Source: Oxford Economics. Source: Oxford Economics.

And more tax increases, including a general “crisis tax” on incomes and a property levy, are due in 2014. But the planned privatization of state assets may also contain the rise in public debt, which is projected to increase to more than 70% of GDP after the bank restructuring measures.

Tax increases to raise inflationInflation slowed to 1.6% in April, but remained nearly half a point above the Eurozone average, having been below it a year earlier. This was a consequence of the increases in public service costs and withdrawal of subsidies made necessary by budget-balancing priorities. The Government announced recently that from July the rate of VAT will be increased from 20% to 22% and, as a result, we now expect inflation to average more than 3% for 2013 as a whole. Looking beyond the one-off tax hike, our forecast shows inflation staying at or above 2% through the forecast period, despite the severity of the downturn.

Gradual recovery to start in 2015 …Assuming that the Government proceeds with the planned reforms, we expect growth to resume from 2015, helped by the gradual improvement in the Eurozone economy and less onerous fiscal austerity. We expect GDP growth of about 1% in 2015, as consumption begins to stabilize and exports and investment start to grow again. The recovery should strengthen in 2016, as faster export growth is expected to boost the recovery of private sector incomes and spending, with GDP seen growing about 3% a year in 2016–17.

… helped by rising exportsThe current account surplus that opened up last year because of the steep decline in imports is set to rise to almost 4% of GDP this year and to persist through the forecast period, sustained by faster export growth from 2016. This will keep external debt low, but is symptomatic of depressed private sector expectations leading to subdued investment in 2013–15.

Forecast

-10

-5

0

5

10

15

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

Slovenia

Eurozone

% year

-12

-10

-8

-6

-4

-2

0

1995 1998 2001 2004 2007 2010 2013 2016-3.6

-3.0

-2.4

-1.8

-1.2

-0.6

0.0

€b % of GDP

% of GDP(right-hand side)

Forecast

€b(left-hand side)

0.6 2

4 Ernst & Young Eurozone Forecast June 2013 | Slovenia

Figure 3Current account balance

Source: Oxford Economics.

0

2

4

6

8

10

12

14

16

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

Forecast

Inflation

% year

Risks remain high …The downside risk to our 2013–16 growth forecasts remain high, arising from the possibility of a further credit tightening if delays or disruption to the reform plan increase concerns among international investors. The new ruling coalition has only a slim parliamentary majority and disruptions to the reform process could lead to significantly higher borrowing costs for the Government. This would quickly add to the debt burden, putting pressure on finances. Financing needs for the remainder of the year amount to about €2b, excluding bank recapitalization costs.

In this scenario, the downturn in business investment would be much more prolonged, and the slump in property and other asset prices would be deeper. And if the Government needed an EU-backed bailout, the possibility would arise that investment would actually recover more quickly, resulting in the external surplus eroding faster, but achieving faster GDP growth after the banks had been recapitalized.

… but crisis may prompt long-term changeThe corruption probes that contributed to the resignation of ex-Prime Minister Janez Jansa have also weakened the support for a number of prominent politicians in other parties. In the long term, this may help lead to improvements in governance and in the political independence of the administration and judiciary. And there are signs that key groups that have traditionally resisted structural change in the past, particularly trade union leaders, may be more willing to cooperate with reforms to wage bargaining and pensions, given the country’s increasingly dismal economic situation.

Recession will be deeper and longer, but a bailout should be avoided

Figure 4Inflation growth

Source: Oxford Economics.

US$b % of GDP

US$b (left-hand side)

-12

-9

-6

-3

0

3

6

9

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

1992 1995 1998 2001 2004 2007 2010 2013 2016

% of GDP(right-hand side)

Forecast

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