Executive summary 1

1. Scene setter: economic situation and outlook 3

2. Imbalances, risks, and adjustment 10

2.1. Interplay of banking sector and corporate sector restructuring 11

2.2. Efficiency and costs of State Owned and State Controlled Enterprises, and their impact on investment and business environment 23

2.3. Competitiveness, investment and the role of FDI 35

3. Other structural issues 47

3.1. Fiscal policy and taxation 49

3.2. Labour market, education and social policies 55

3.3. Business environment and Research & Development 61

3.4. Transportation, energy and environment 65

3.5. Public administration and civil justice 67

AA. Overview Table 70

AB. Standard Tables 78

LIST OF Tables

1.1. MIP scoreboard indicators - Slovenia 8

1.2. Key economic, financial and social indicators - Slovenia 9

2.1.1. Overview of executed recapitalisation measures and asset transfers to the BAMC 12

2.2.1. The network of state ownership and state control in Slovenia 24

2.2.2. Relative importance of SOEs/SCEs (as % of total NFCs) 25

2.2.3. Total fiscal and economic implications of financial and non-financial SOEs/ SCEs 31

AB.1. Macroeconomic indicators 78

AB.2. Financial market indicators 79

AB.3. Taxation indicators 80

AB.4. Labour market indicators 81

AB.5. Social indicators 82

AB.6. Product market performance and policy indicators 83

AB.7. Green Growth 84

LIST OF Graphs

1.1. Real GDP growth and contributions 3

1.2. Export market share 4

1.3. Export performance 4

1.4. Drivers of the trade balance surplus, 2007-2014 4

1.5. Current account 4

1.6. Net international investment position 5

1.7. Private non-financial sector debt-to-equity ratios in the EU (%) 6

1.8. Deleveraging contribution dynamics, debt-to-GDP change 6

1.9. Non-financial companies - change in investment 2008-13, % of value added 7

1.10. HICP and consumer confidence 7

2.1.1. Household deposit of sector - total deposits by type of bank 12

2.1.2. Deposit rates (< 1 year) 14

2.1.3. Deposit rates (> 1 year) 14

2.1.4. Total assets and loans of the Slovenian banking system 14

2.1.5. Composition of banks' liabilities 15

2.1.6. Net interest margin by bank 15

2.1.7. Growth rate of interest income and expenses of the banking sector 15

2.1.8. Change in stock of domestic credit and contributions 16

2.1.9. Credit growth — Total loans 16

2.1.10. Short-term interest rates (< 1 year) 16

2.1.11. Long-term interest rates (>1 year) 17

2.1.12. Indebtedness of the corporate sector 17

2.1.13. Cash flow capacity and profitability of the corporate sector 17

2.1.14. Credit growth — corporate loans (incl. SME) 18

2.1.15. Credit growth — foreign loans 18

2.1.16. New lending vs. prolongation 18

2.1.17. NPLs by type of bank 19

2.1.18. NPL ratios by type of bank 19

2.1.19. Structure of NPLs by bank (Q3 2014) 20

2.1.20. Coverage ratios by type of bank 20

2.2.1. Share of SOEs/SCEs in sectoral value added (as % of total sectoral value added), 2013 24

2.2.2. Employment, 2013 – public, private and SOEs/SCEs 25

2.2.3. Book value of equity of SOEs/SCEs in Europe (as % of GDP) 25

2.2.4. OECD indicators for product market regulation (2013) 26

2.2.5. Employment at SOEs/SCEs in Europe (as % of total employment) 27

2.2.6. Leverage ratio of SOEs/SCEs and all NFCs (excl. energy and public utilities sectors) 27

2.2.7. Profitability (ROCE) of SOEs/SCEs and foreign-owned companies relative to domestic privately owned companies (2004-2013 average) 28

2.2.8. Profitability (ROE) of SOEs/SCEs and foreign-owned companies relative to domestic privately owned companies (2004-2013 average) 28

2.2.9. Leverage ratio of SOEs/SCEs and foreign-owned companies relative to domestic privately owned companies (2013) 29

2.2.10. Total factor productivity of SOEs/ SCEs and foreign-owned companies relative to domestic privately owned companies (in %), 2004-2013 average 29

2.2.11. Profitability (ROE) of SOEs/ SCEs by sector in Slovenia and other CEE countries (aggregate), 2013 29

2.2.12. Costs per employee of SOEs/ SCEs and foreign-owned companies relative to domestic private owned companies (2004-2013 average) 30

2.2.13. Debt leverage ratio of SOEs/SCEs in Slovenia and other CEE countries (2013) 30

2.2.14. Labour productivity SOEs/ SCEs and foreign-owned companies relative to domestic privately owned companies (in %), 2004-2013 average 30

2.2.15. Total government deficit and deficit increasing state interventions related to SOEs/SCEs 32

2.2.16. Total government debt and debt increasing state interventions related to SOEs/SCEs 32

2.2.17. Subsidies to all NFCs relative to operating profit (EBITDA) and share of subsidies to SOEs/ SCEs 32

2.2.18. Other fixed assets of SOEs/ SCEs and foreign-owned companies relative to domestic privately owned companies (as % of total assets ), 2004-2013 average 33

2.2.19. Capital expenditure relative to operating profit (EBITDA) of SOEs/ SCEs and all NFCs 34

2.3.1. Real effective exchange rate deflated by ULC in total economy (ULCE) and in manufacturing (ULCM) 35

2.3.2. REER (ULCE) and new sectoral REER in Slovenia 36

2.3.3. Sectoral REER aggregate in SI and V4 36

2.3.4. Nominal Unit Labour Cost 36

2.3.5. SI NULC in tradable and non-tradable sectors 37

2.3.6. Productivity per hour worked 37

2.3.7. Nominal compensation per employee 38

2.3.8. Geographical and sectoral composition of nominal rate of change of goods exports 39

2.3.9. Density distributions of exports by quality 39

2.3.10. Non-cost competitiveness vis-à-vis EU28 39

2.3.11. Investment in the private sector 40

2.3.12. Private investment and private consumption 40

2.3.13. Potential output and components 41

2.3.14. Non-financial corporations savings and investment 41

2.3.15. GFCF by type 41

2.3.16. Investment by institutional sector 42

2.3.17. Non-residential investment and NFC debt 42

2.3.18. Inward FDI 43

2.3.19. FDI inflows 43

2.3.20. FDI inflows in Slovenia, Visegrád 4, EU 44

2.3.21. FDI stock per sector in Slovenia, 2013 44

2.3.22. Sectoral composition of greenfield FDI in Slovenia, 2011-2013 44

2.3.23. FDI stock in tradable and non-tradable sectors 45

2.3.24. Origin of inward FDI, stocks in 2013 45

2.3.25. FDI stocks in Slovenia, Visegrád 4, and the EU 45

3.1.1. Gross debt % of GDP — DSA analysis 50

3.1.2. Gross debt % of GDP — institutional scenario 50

3.1.3. Breakdown of the population by age groups in Slovenia 51

3.1.4. Sustainability of the pension system in Slovenia 52

3.2.1. Employment in tradable and non-tradable sectors 55

3.2.2. Long-term unemployment as % of active population 55

3.2.3. Employment rate of vulnerable groups of population in Slovenia and the EU28 56

3.2.4. Cyclicality of temporary employment 57

3.2.5. Percentage of low achievers on PISA tests in 2009 and 2012 in Slovenia 57

3.2.6. Public expenditure for formal education (EUR million) 58

3.2.7. The likelihood of the old-age poverty rate 59

3.2.8. Social exclusion indicators 59

3.3.1. Components of administrative burden in Slovenia 61

3.3.2. Willingness of banks to provide the loans in the last six months 62

3.3.3. Level of intra-EU establishment 63

3.3.4. R&D investment 63

3.5.1. Institutional strengths and weaknesses in Slovenia 67

3.5.2. Government effectiveness 68

3.5.3. Diversion of public funds 69

LIST OF Boxes

1.1. Economic surveillance process 8

2.1.1. Measures taken by the Bank of Slovenia to improve corporate governance and risk management in banks 13

2.1.2. Structure of debtor companies liable for the NPLs 21

3.3.1. Overview and general assessment of absorption capacity for EU funds 64

In 2014, the Slovenian economy rebounded strongly. After a cumulative decline of more than 9% between 2008 and 2013, real GDP is estimated to have grown by 2.6% in 2014. Growth has been predominantly export-driven but domestic demand has also begun to recover. The recovery in investment expenditure has been driven mainly by infrastructure construction financed through EU funds, while private sector investment remains subdued. Real GDP is expected to grow by 2.1% on average in 2015-16. The unemployment rate remains below the EU average, falling to 9.8% in 2014 and is expected to decline further. Public debt is forecast to stand at 83% of GDP in 2015, gradually increasing in the medium term.

In March 2014, the Commission concluded that Slovenia was continuing to experience excessive macroeconomic imbalances, which required specific monitoring and continued strong policy action. This Country Report assesses Slovenia's economy against the background of the Commission's Annual Growth Survey, which recommends three main pillars for the EU's economic and social policy in 2015: investment, structural reforms, and fiscal responsibility. In line with the Investment Plan for Europe, it also explores ways to maximise the impact of public resources and unlock private investment. Finally, it assesses Slovenia in the light of the findings of the 2015 Alert Mechanism Report, in which the Commission found it useful to examine further the persistence of imbalances or their unwinding. The main findings of the in-depth review contained in this country report are:

· The high level of non-performing loans and low credit demand from creditworthy firms may have implications for the viability of the banking sector. Although confidence in the banking sector has returned, credit growth remains negative and the banks' profitability and viability can be further enhanced. Non-performing loans to non-financial corporations are still higher than before the crisis. Continued weakness in the cash flow capacity of the firms constrains lending opportunities and poses further risks to the asset quality and profitability of the banking sector.

· High debt, deleveraging pressures and ongoing restructuring in the corporate sector adversely affect private investment and growth. The corporate sector has been deleveraging since the peak in 2010 but remains undercapitalised, which affects the sector's investment capacity. Low investment has implications on productivity and competiveness of the companies, their ability to innovate and also erodes Slovenia's potential growth.

· A high level of state involvement combined with weak corporate governance distorts resource allocation, and hampers investment and growth. The state is the largest employer, asset manager and corporate debtor in Slovenia. The state involvement in the economy has had significant fiscal and economic implications for Slovenia since the onset of the crisis. State-owned entities have underperformed compared to their privately owned peers in terms of productivity and profitability at both national and regional level.

· External competitiveness and external sustainability have improved considerably and risks appear to have subsided. Wage restraint since 2011 together with increased productivity and gains in non-cost competitiveness have helped to improve significantly Slovenia’s external performance and position in terms of flows and stocks.

· The large increase in public debt in recent years creates additional challenges. A prolonged recession coupled with significant bank recapitalisations has resulted in a sharp rise in public debt. Fiscal consolidation measures in recent years, particularly on the expenditure side, have been of a temporary nature and reform of the fiscal framework is lagging behind. Furthermore, the ageing population puts pressure on the sustainability of the pension and long-term care systems.

· Labour market reform has addressed segmentation and introduced greater flexibility. The labour market situation is showing signs of improvement but structural problems persist as regards to long-term unemployment and the low employment rates of low-skilled and older workers.

· An improved business environment will assist in attracting productive investment, including foreign direct investment. The business environment is hindered by high government involvement and regulation, which poses obstacles to the inflow of productive investment. The latter is important as a source of fresh equity and funding, technology transfer, infrastructure and trade development.

· There is a renewed commitment to fight corruption and increase the effectiveness of public administration and the judiciary. The government adopted a fresh two-year programme in January 2015, while the strategy for public administration is expected to be adopted in February 2015. The focus is now on prioritisation and implementation.

Overall, Slovenia has made some progress in addressing the 2014 country-specific recommendations. Policy measures to stabilise the banking sector have been implemented. The Bank Asset Management Company is now fully operational. The restructuring of four major state-owned banks and the wind-down of two smaller domestic banks are on track. A corporate restructuring master plan and a centralised task force were established. A new corporate governance code for state-owned enterprises was adopted. The Slovenian Sovereign Holding, responsible for the management and divestment of state assets, is now fully operational. A draft asset management strategy is yet to be approved by the Slovenian Parliament, and will be followed by the release of the divestment schedule for a number of well-targeted state assets. The privatisation programme is progressing, albeit with delays. The sale process for the two largest assets is expected to be signed by April 2015.

This country report highlights the policy challenges stemming from the analysis of macro-economic imbalances, namely:

· Boosting long-term profitability and reducing non-performing loans in the corporate sector will make for a healthier banking sector. There is scope for further consolidation of the banking sector, which could be facilitated through the continuation of the privatisation process.

· Further deleveraging of the corporate sector would help restore the conditions for a rebound of private investment. The swift restructuring of the corporate sector through the application of existing tools, including the Bank Asset Management Company and the new insolvency legislation, will boost the recovery of cash-flows in the corporate sector. Attracting fresh equity investment from abroad can help reduce the high debt leverage and restore creditworthiness, an important prerequisite for resolving non-performing loans and improving banks’ profitability.

· Further disentangling the complex network of state-owned enterprises would help mitigate future risks to public finances. Slovenia could take advantage from the current positive market momentum to divest selected state-owned enterprises. This would assist in attracting foreign direct investment and improving the economic outlook. Sound management and enhanced corporate governance policies for state-owned assets can help mitigate the risks of future state support.

· The right fiscal framework coupled with comprehensive expenditure reviews can help to enhance the sustainability of public finances. In particular, they help shift the focus of budgetary execution from temporary measures and linear across-the-board cuts to expenditure rationalisation and efficiency savings. The comprehensive review of expenditure in the health sector can provide a useful blueprint for future reviews in other key policy areas such as education. While one-off spending reviews can have a major impact, the maximum benefits are obtained when they become a regular part of the budget process.

· Attracting foreign direct investment will be essential in ensuring a sustainable recovery. The new government has set an ambitious target of reaching the EU average stock of foreign direct investment by 2017. The forthcoming strategy could include a coherent set of both facilitation and promotion measures, including substantially reducing the administrative burden on both local and foreign companies.

Growth performance

With a loss of more than 9% of GDP between 2008 and 2013, Slovenia experienced one of the largest economic contractions among euro area countries. A foreign-financed credit boom facilitated by the euro adoption fuelled aggressive leveraging of the corporate sector and a construction bubble. After a sharp contraction in 2009, the economy grew in 2010 and 2011, but entered a second recession in 2012. While a steep drop in investment was the initial cause of the downturn, consumption began to decline from 2012 onwards (Graph 1.1). Prior to the crisis, Slovenia missed an opportunity to improve the resilience of the economy to shocks and its response was insufficient. Slovenia therefore felt the effects of the crisis more than other Member States.

Graph 1.1: Real GDP growth and contributions

Source: European Commission.

In 2014, Slovenia began to emerge from the recession. According to the Commission 2015 winter forecast ("Commission Forecast" hereafter) real GDP is projected to have grown by 2.6% in 2014 (Graph 1.1). Growth has been predominantly export-driven but domestic demand has also started to show signs of recovery. Private consumption boosted by improving sentiment and decreasing unemployment (9.8% in 2014) has contributed to this improvement. The recovery in investment expenditure has been driven mainly by construction co-financed through EU funds. While potential growth has begun to recover, it remains significantly below pre-crisis levels, with labour and capital accumulation providing no contribution in 2014 (Graph 2.3.13).

Growth is expected to continue. In 2015, economic growth is forecast to decelerate to 1.8%, before picking up to 2.3% in 2016 (Graph 1.1). The deceleration in 2015 is expected to be driven by a slowdown in the growth of public investment. However, increasing private investment in equipment and machinery is expected to pick up progressively and support future growth. The acceleration in 2016 stems mainly from an assumed resumption in growth of public consumption.

Trade performance, current account and NIIP

On the export side, Slovenia has regained export market share since 2013. This trend strengthened in the first half of 2014 following the substantial market share losses suffered between 2008 and 2012 (Graph 1.2). Other indicators, such as the European Commission's export performance indicator, ([1]) offer a slightly more positive picture already as from 2010 (Graph 1.3). Despite a significant underperformance in 2009, export performance measured by this indicator evolved thereafter in line with the euro area and outperformed it in 2011. Even though Slovenia lagged behind peers such as the Czech Republic, Hungary, Poland and Slovakia between 2009 and 2012, the gap was reduced significantly in 2013.

Graph 1.2: Export market share

Source: European Commission, WTO.

Graph 1.3: Export performance

Visegrád 4 – export weighted average Source: European Commission.

The current account surplus widened to 4.8% of GDP in 2013, mainly due to the increase in the trade balance (Graph 1.5). While services make up most of the trade surplus, the goods balance also turned positive in 2012 and is expected to have increased further in 2014. The rebound in exports has not yet been matched by a comparable recovery of imports, due to weak domestic demand, especially investment. The change in the trade balance is therefore driven predominantly by an increase in exports, rather than by a fall in imports (Graph 1.4). The income balance remains in deficit at average levels for a converging economy with a relatively high share of foreign capital. The balance of current transfers continues to play a marginal role in the current account balance.

Graph 1.4: Drivers of the trade balance surplus, 2007-2014

Change in trade flows, current prices, 2007-2014(e). Source: European Commission.

Graph 1.5: Current account

Source: European Commission.

After years of deterioration, Slovenia's net international investment position (NIIP) has started to improve (Graph 1.6). From a moderate negative level of -17.1% of GDP in 2006, the NIIP deteriorated rapidly during the crisis, reaching its lowest level of -45.8% of GDP in 2012. The adjustment of the current account on the back of a rise in net exports helped to reverse the trend in 2013 and 2014. Driven by strong current account surpluses the NIIP is expected to continue to improve in 2015 and 2016. Two counteracting trends have changed the structure of the NIIP – the significant reduction in net foreign liabilities of monetary and financial institutions since the peak of the crisis (Section 2.1), and the increase in general government borrowing on the international markets to finance the high 2013 deficit. The general government deficit increased to 14.6% of GDP in 2013, of which 10.1% of GDP was related to bank recapitalisations. This is consequently reflected in the increasing proportion of government debt securities which now form the biggest component (-18.8% of GDP) of NIIP in relative terms. Foreign direct investment (FDI) is on the other hand limited to only -15.9% of GDP. In view of the negative NIIP, current account surpluses are required in order to improve Slovenia’s external position. The current account is expected to stabilise at around 6% in 2015 before starting to decline slowly, due to an expected progressive reduction in the trade balance surplus in line with accelerating domestic demand. Nevertheless, an elevated current account surplus is expected to persist as long as deleveraging continues.

Graph 1.6: Net international investment position

Source: European Commission.

Public sector debt has increased significantly from 22% of GDP in 2008 to 82% in 2014. While exceptional items, particularly bank recapitalisations, have contributed greatly to this increase, sustained primary deficits over the period have also played a part. On a no-policy-change assumption, public sector debt is expected to steadily increase to 87% of GDP in the medium term (i.e. until 2025). Fiscal discipline is required to reduce the debt-to-GDP ratio (see Section 3.1).

Private sector deleveraging

Private sector indebtedness is at the lower end of the scale in the euro area, reflecting one of the lowest levels of household debt, but relatively high corporate debt. Despite doubling in the 2000s, private debt remained at a comparatively low level of 103.6% of GDP in 2013. However, there are substantial differences between the corporate and household sectors. At 29.6% of GDP in 2013, Slovenia’s households had the 2nd lowest level of indebtedness in the euro area. Conversely, the indebtedness of Slovenia's corporates is considerably higher, at 74% of GDP in 2013. While this is still close to the euro area average, the ratio of the corporate debt to equity is relatively high (Graph 1.7). Further analysis of microeconomic data is required as corporate debt in Slovenia is unevenly distributed across firms and is high when compared to their earnings and cash flow capacity to repay (Section 2.1). Non-financial corporations began to deleverage actively ([2]) in 2010 and had reduced their indebtedness relative to GDP by 13 pps. by 2013.

Graph 1.7: Private non-financial sector debt-to-equity ratios in the EU (%)

Source: European Commission.

Debt in the corporate sector remains high relative to firms’ capacity to repay and is concentrated in a small number of large firms. About 100 firms with the largest excess debt ([3]) held 42% of the total excess debt in 2013 ([4]). The ratio of excess debt to net financial debt varies from sector to sector. Excess debt accounts for 92% of net financial debt in financial and insurance activities, and 78% in real estate activities (it is primarily unprofitable firms that contribute to the high figures), while manufacturing has one of the lowest figures at 26.2%. In addition, 90% of these over-indebted companies are focused on the domestic market and their capacity to repay the debt is thus dependent on a recovery in domestic demand ([5]).

Slovenia deleveraged actively, resulting in negative credit flows, but struggled against contracting GDP until 2013. The change in the debt-to-GDP ratio can be attributed to four main drivers: net credit flows (loan repayments and lack of new lending), real GDP growth, inflation through the GDP deflator and other changes such as valuation changes (Graph 1.8). Since the peak of indebtedness in 2010, Slovenia's corporations deleveraged actively resulting in negative credit flows but contracting GDP exerted upward pressure on the ratio. In 2014 this has changed (real GDP is estimated to have increased by 2.6%) and Slovenia is again benefiting from this deleveraging channel. In addition, valuation changes and restructuring have contributed positively to the corporate debt reduction. However, with inflation at historically low levels (0.4% in 2014 and forecast at -0.3% in 2015), the borrowers can no longer depend on inflation to reduce the real value of their debt.

Graph 1.8: Deleveraging contribution dynamics, debt-to-GDP change

Source: European Commission.

Active deleveraging has had a negative impact on domestic demand. Investment has been particularly affected in Slovenia. While the saving rate of non-financial corporations remained largely unchanged, investment took the biggest hit in Slovenia compared to the euro area (Graph 1.9). Unless reversed, this trend will have negative consequences on productivity and economic growth in the medium and long term (more information on investment in Section 2.3).

Deleveraging is expected to continue, albeit at a slower pace. Weak credit market conditions and the remaining high indebtedness of the corporate sector relative to earnings create pressure for further active deleveraging. This process is likely to be characterised by continued loan repayments and limited new lending activity. DG ECFIN estimates ([6]) that the corporate sector will keep facing deleveraging pressures in the short term. However, deleveraging needs of households appear limited and the household sector’s balance sheet is expected to stop contracting in 2015. Future GDP growth should contribute to reducing Slovenia's debt burden. This in turn should reduce the drag on aggregate demand and stress for asset markets.

Graph 1.9: Non-financial companies - change in investment 2008-13, % of value added

Source: European Commission.

Employment and social conditions

The labour market showed signs of improvement in 2014. After five years of rising unemployment, the trend started to reverse. However, structural challenges remain. Long-term unemployment increased in 2014 making up over half of the total unemployed. Youth unemployment rate stabilised marginally below the EU average. The number of people at risk of poverty or social exclusion has risen consistently since 2009.

Inflation

Three different inflationary patterns are observable over the years in Slovenia. Prior to the financial crisis, Slovenia had experienced increasing inflation, which remained consistently above the euro area average and peaked at 6.5% in the first quarter of 2008. Between 2009 and 2012, core inflation remained at low levels and developments in relation to the harmonised index of consumer prices (HICP) were mainly attributable to changes in energy and unprocessed food prices. In the following period core inflation stabilised, but since the third quarter of 2013 it has gradually declined reflecting weaker domestic demand and declining import prices. In 2014, the steep fall in the oil price and declining food prices had a significant impact in terms of driving headline inflation down. Taking into account the improving consumer confidence and its lagged correlation with the headline inflation, the decreasing trend in HICP is expected to bottom out only in the second quarter of 2015. Deflation of 0.3% is projected in 2015 before returning to a moderate inflation rate of 0.9% in 2016 as the economic recovery strengthens (Graph 1.10).

Graph 1.10: HICP and consumer confidence

Source: European Commission.

Table 1.1: MIP scoreboard indicators - Slovenia

Source: European Commission.

Box 1.1: Economic surveillance process The Commission’s Annual Growth Survey, adopted in November 2014, started the 2015 European Semester, proposing that the EU pursue an integrated approach to economic policy built around three main pillars: boosting investment, accelerating structural reforms and pursuing responsible growth-friendly fiscal consolidation. The Annual Growth Survey also presented the process of streamlining the European Semester to increase the effectiveness of economic policy coordination at the EU level through greater accountability and by encouraging greater ownership by all actors. In line with streamlining efforts this Country Report includes an In-Depth Review — as per Article 5 of Regulation no. 1176/2011 — to determine whether macroeconomic imbalances still exist, as announced in the Commission’s Alert Mechanism Report published on November 2014. Based on the 2014 IDR for Slovenia published in March 2014, the Commission concluded that Slovenia was experiencing excessive macroeconomic imbalances requiring decisive policy action, in particular the risk stemming from an economic structure characterised by weak corporate governance, high level of state involvement in the economy, losses in cost competitiveness, the corporate debt overhang, and the increase in government debt. This Country Report includes an assessment of progress towards the implementation of the 2014 Country-Specific Recommendations adopted by the Council in July 2014. The Country-Specific Recommendations for Slovenia concerned fiscal policy and long-term fiscal stability (including pension reform and long-term care); effective tailor-made active labour-market policy measures, skills mismatches, wages and labour market segmentation; restructuring of the banking and corporate sectors, including Slovenian Sovereign Holding; privatisation; selected aspects of the business environment; and fighting corruption.

Table 1.2: Key economic, financial and social indicators - Slovenia

Source: European Commission, ECB.

Balance sheet contraction, rising non-performing loans (NPLs), erosion of capital buffers and liquidity pressures affected the Slovenian banking system from the onset of the crisis. All Slovenian banks, large state-owned banks in particular, have suffered sizeable losses and have significantly shrunk their balance sheets since the beginning of the crisis in 2008. The first phase of deleveraging was triggered by the international financial crisis. Many elements specific to Slovenian, such as the high debt leverage of the corporate sector, the significant involvement of the state in the economy and shortcomings in risk management and corporate governance, were revealed and reinforced by the crisis, triggering a sharp increase in NPLs in banks. These credit quality trends, together with deteriorating collateral values, quickly eroded capital bases and market confidence.

State of play of banking and corporate restructuring

Following the extensive overhaul of the banking system in 2013 Slovenia took further measures to stabilise the banking sector in 2014. On 12 December 2013 the Slovenian authorities announced their strategy for the restructuring of the financial sector based on the outcome of the Asset Quality Review and Stress Test. The Stress Test identified capital deficits of up to EUR 4.8 billion, EUR 3.2 billion of which was provided by the state in December 2013. These measures were reinforced by further action designed to stabilise the banking sector in 2014, such as the further capital increase of Abanka with EUR 243 million in October and the recapitalisation of Banka Celje with EUR 190 million together with a transfer of assets of EUR 412 million (gross value) in December. Overall so far six banks have received capital amounting to EUR 3.6 billion (Table 2.1.1). Foreign banks that took part in the 2013 stress test exercise (UniCredit Bank, Raiffeisen Bank, Hypo Group Alpe Adria) have also substantially improved their capital positions mainly through reduction of risk-weighted assets and/or direct capital injections by their parent banks. Although the results of the ECB comprehensive assessment published in October 2014 identified a joint capital shortfall of EUR 65.3 million for both NKBM and NLB ([7]), no further support from the state was required as the exercise found that the measures taken to improve structural profitability and the retained earnings of the banks in 2014 were sufficient to cover the shortfalls identified. Bank of Slovenia has reacted to the shortcomings identified by the Asset Quality Review exercise of 2013 and has introduced two macro-prudential initiatives aimed at easing competition for deposits – (i) a cap on deposit interest rates introduced in 2012 and (ii) minimum requirements for the ratio of annual changes of the stocks of loans to non-bank deposits to slow the rapid decline in the LTD ratio (Box 2.1.1).

The Bank Asset Management Company (BAMC) has set out its strategy and business plan and is now fully operational. The BAMC has so far received assets with a total gross value of approximately EUR 5 billion (net value of EUR 1.7 billion) from four state-owned banks (Nova Ljubljanska Banka - NLB, Nova Kreditna Banka Maribor - NKBM, Abanka and Banka Celje) and two smaller domestic banks in wind-down - Probanka and Factor Banka (Table 2.1.1). Approximately two thirds of the exposures are in default. The objective of the BAMC for these loans will be to acquire the collateral (mostly real estate but also some equity and company assets). The remaining approximately 100 cases in the portfolio of the BAMC are companies with potentially viable core activities, which could be maintained if they were subject to an appropriate financial and operational restructuring.

Table 2.1.1: Overview of executed recapitalisation measures and asset transfers to the BAMC

Source: Bank of Slovenia, European Commission.

The restructuring of the highly leveraged corporate sector remains a key challenge for the banking sector and the Slovenian economy as a whole. The Ministry of Finance supported by the Bank of Slovenia has set up a comprehensive restructuring master plan. A task force has been established to monitor and coordinate the overall restructuring process, to facilitate the negotiation process between all stakeholders involved and to provide the necessary guidance and advice. The coordinating body of the task force is composed of representatives of the Ministry of Finance, the Bank of Slovenia, the Ministry of Economics, the Ministry of Justice and the BAMC. It meets twice a month.

Credit and financial developments since mid-2013

The restored confidence in the Slovenian banking system has eased liquidity pressures. Confidence in the major state-owned banks has returned and there has been an inflow of retail funds since the beginning of 2014 (Graph 2.1.1). The market exit of Probanka and Factor Banka, two smaller banks that were competing intensively for deposits until September 2013, could have relieved the competition on deposits. Since mid-2013 deposit rates decreased by approximately 150-200 basis points (Graph 2.1.2 and Graph 2.1.3). There are several reasons for the closing of the gap in interest rates for deposits between state-owned and foreign-owned banks, particularly the improved funding conditions of state-owned banks, the cap on deposit interest rates and the restoration of consumer confidence in state-owned banks.

Graph 2.1.1: Household deposit - total and by type of bank

Source: Bank of Slovenia, Fitch.

Policy measures taken in 2013 and 2014 have facilitated the deleveraging of banks' balance sheets. Since 2012, negative credit flows have led to a steady decline in the loan stock, in particular in the state-owned banks. The current deleveraging process has contributed to this decline. However, there are several one-off factors that have also affected the stock on an aggregate level. The commencement of the orderly winding down of Factor Banka and Probanka and the additional significant amount of provisions required as a result of the 2013 asset quality review further contributed to the strong decline in 2013.

Box 2.1.1: Measures taken by the Bank of Slovenia to improve corporate governance and risk management in banks Following the conclusion of the asset quality review (AQR) and the stress test carried out in 2013, which revealed serious shortcomings in the banks’ business processes and risk management practices, Bank of Slovenia asked all banks involved in the exercise to respond to the AQR findings that affected them. Three banks that benefited from state aid were asked to submit an action plan by the end of March 2014 to address the deficiencies identified in the AQR and to implement their plan before the end of 2014. Implementation of these action plans is being assessed by Bank of Slovenia in cooperation with the single supervisory mechanism (SSM). The banks have improved practices in many areas, especially underwriting standards and NPL work-out. Since December 2014, NPL and forbearance definitions are in line with EBA definitions in all banks. New and tighter corporate governance rules were introduced during 2014, in line with international standards. Further measures could be taken to address some shortcomings identified by the AQR in 2013 (e.g. on IT, data and quantitative aspects), but overall, risk management practices appear to have significantly improved during 2014 Bank of Slovenia has also introduced some additional regulations regarding banks’ corporate governance, relating to the membership and functioning of banks’ boards, strengthening the provisions on the management of credit, market and operational risks, on the internal control functions (i.e. internal audit, compliance and information security) and diligence of members of the management body, risk management and remuneration. Bank of Slovenia has also taken steps to improve its own effectiveness on banking supervision and in the area of corporate governance. In 2012, Bank of Slovenia requested an IMF review of its supervisory practices. On the basis of IMF’s recommendations, a detailed action plan was drawn up. In spring 2014, Bank of Slovenia carried out an internal reorganisation and again requested IMF technical assistance. Among other issues, this identified a lack of supervisory staff. A new central credit registry (CCR) for corporates and private persons is also being set up. This is expected to be operational from 2016 and will be connected to the other CCRs within the euro area to be used for micro- and macro-supervision and research purposes. During 2013 and 2014, with the instability in the banking sector and the AQR and stress test that followed, Bank of Slovenia’s on-site supervision activity was stopped due to lack of resources. On-site supervision activities will be resumed in 2015. Following a bilateral agreement, the SSM will also support Bank of Slovenia in monitoring non-systemic banks, which will certainly contribute to carrying out supervisory activity with adequate resources, based on high international standards. It will be important to monitor closely how the banks implement the new regulatory guidance on corporate governance and risk management and how they have addressed the shortcomings identified in the two AQRs to make sure the events of the recent past are not repeated.

The significant fall at the end of 2013 was driven by the transfers of NPLs from NLB and NKBM to the BAMC (Graph 2.1.4). The additional transfers to the BAMC from Abanka in October 2014 and Banka Celje in December 2014 further reduced the aggregate level across the system.

Graph 2.1.2: Deposit rates (< 1 year)

Source: Bank of Slovenia.

The improvement of the funding situation and the reduction of the loan books allowed banks to repay most of their ECB borrowing and a significant portion of their interbank debt (Graph 2.1.5). Slovenian banks participated in the September and December 2014 Targeted Longer Term Refinancing Operations (TLTROs) for EUR 706 million (71% of potential volume). The funds helped the banks to continue the early repayment of the three-year LTROs settled in 2011 and 2012, of which 90% have been repaid. NLB regained access to funding in the international capital markets in July 2014 supported by favourable market conditions ([8]).In view of the improved funding situation in the banking system the deleveraging pressure on domestic banks is expected to ease. Foreign banks have also deleveraged although their balance sheets have been reducing at a slower pace ([9]). Many foreign-owned banks (Raiffeisen Bank, Hypo Group Alpe Adria) have actively reduced their exposure to the Slovenian market and repaid part of the intra-group lending to their parent institutions (see the significant increase of foreign loans in foreign banks in Graph 2.1.15). Although loan to deposit ratios of foreign-owned banks have decreased faster than in domestically-owned banks they are still higher due to the outstanding stocks of intra-group funding.

Graph 2.1.3: Deposit rates (> 1 year)

Source: Bank of Slovenia.

Graph 2.1.4: Total assets and loans of the Slovenian banking system

Source: Bank of Slovenia.

Graph 2.1.5: Composition of banks' liabilities

Source: Bank of Slovenia.

After the significant losses of the past three years, the banking sector returned to profitability in 2014. Net interest margins and profitability have started to recover (Graph 2.1.6). The higher net interest margins are mainly driven by the sharp reduction of interest rates on non-banking deposits (Graph 2.1.7). The improved profitability can be attributed to the significantly lower level of impairments and provisions and the growth in net interest income. For NLB and NKBM some beneficial effects on interest income arose from the high yield (approximately 4%) on government and BAMC bonds that the banks received in December 2013 in the context of recapitalisations and asset transfers. However, this source of revenue is temporary as the bonds mature in 2015 and 2016. The government and BAMC bonds received by Abanka and Banka Celje in 2014 were issued at significantly lower yield in line with the market developments (approximately 1.5%).

Graph 2.1.6: Net interest margin by bank

Source: Fitch.

Graph 2.1.7: Growth rate of interest income and expenses of the banking sector

Source: Bank of Slovenia.

Remaining challenges

Lending to the real economy remains constrained. Credit growth in Slovenia is still negative (Graph 2.1.8), although that is due largely to the one-off transfer of NPLs to the BAMC. The negative credit growth is more pronounced for domestic-owned than for foreign-owned banks, partly because of the speed of deleveraging of domestic-owned banks but also due to differences in market behaviour and the banks' risk aversion (Graph 2.1.9). The negative trend in lending to non-financial corporates is closely linked to the low cash-flow capacity and high leverage of the Slovenian corporate sector, the remaining high level of corporate NPLs on banks' balance sheets and the ongoing financial and operational restructuring in the corporate sector. The number of creditworthy corporates requesting loans in the domestic market is low and competition for these clients is intense. Most of the nationally recognised, well-established and financially sound companies have access to financing abroad at more competitive rates, as loan rates (especially short-term) in Slovenia tend to be above those of their regional peers (Graph 2.1.10 and 2.1.11). Some of these companies also take the opportunity to tap international and domestic capital markets ([10]). Consequently, competition between domestic banks has further increased and has started to exert pressure on corporate lending rates, which could adversely affect banks' net interest margins and future profitability.

Graph 2.1.8: Change in stock of domestic credit and contributions

Source: Bank of Slovenia.

Graph 2.1.9: Credit growth — Total loans

Source: Bank of Slovenia.

Graph 2.1.10: Short-term interest rates (< 1 year)

Source: ECB.

Graph 2.1.11: Long-term interest rates (>1 year)

Source: ECB.

The high debt leverage of the corporate sector is adjusting, but profitability and creditworthiness of borrowers has not yet significantly improved. The leverage ratio ([11]) increased from a moderate multiple of 4.8 before the crisis (2007) to its peak of 6.7 in 2009 (Graph 2.1.12), also mirrored by an increase in the debt to total assets ratio. Deleveraging started in 2010 and has been progressing since then, albeit in different stages, which has created three different categories of debtors (Box 2.1.2). In 2010 and 2011, deleveraging was mainly driven by market exits (bankruptcies or firm takeovers). Since 2012 financial liabilities of ongoing businesses have been declining (by EUR 0.4 billion in 2012 and by a further EUR 0.5 billion in 2013) ([12]). The reduction of financial liabilities in viable firms is expected to have accelerated further in 2014 based on most recent data. Nevertheless, profit margins have not improved since their collapse during the crisis. This can be seen in terms of operational profitability (Earnings before interest, taxes, depreciation and amortisation - EBITDA margin ([13])), indicating that the capacity of the corporate sector to generate cash flows and repay debt has not yet fully recovered. It is also evident from net profit margins, which remain squeezed due to high debt service costs (Graph 2.1.13).

Graph 2.1.12: Indebtedness of the corporate sector

Source: AJPES, European Commission.

Graph 2.1.13: Cash flow capacity and profitability of the corporate sector

Source: the Agency of the Republic of Slovenia for Public Legal Records and Related Services (AJPES), European Commission.

Graph 2.1.14: Credit growth — corporate loans (incl. SME)

Source: Bank of Slovenia.

Graph 2.1.15: Credit growth — foreign loans

SID Banka not included Source: Bank of Slovenia.

The three major state-owned banks are particularly affected by the increased competition and the lack of good-quality credit demand. While state-owned banks are bound by the commitments stemming from the state aid restructuring procedures (i.e. minimum return on equity (ROE) on new loans, maximum cost income ratio), foreign-owned banks have more flexibility. As a consequence of the new risk management policy of state-owned banks, loans to clients rated below B can in practice only be provided if they are highly collateralised or secured with a guarantee (e.g. by another bank, a parent company, a subsidiary or the state). Various lending support schemes have been launched by SID Banka (the Slovenian development bank) to enhance lending to SMEs, but few companies appear to meet the criteria, so the funds remain largely undrawn (Section 2.3).

In the case of state-owned banks, lending has focused on the roll-over of stocks related to restructurings, with less new lending compared to foreign-owned banks (Graph 2.1.16). One reason may be that the focus of the domestically owned banks is the ongoing work-out of corporate NPLs which is resource-intensive. A proportion of the new lending from foreign-owned banks is not targeted at the local economy but is linked to the reduction of the intra-group lending from their parent institutions (Graph 2.1.15).

Graph 2.1.16: New lending vs. prolongation

M — Major state-owned banks, O — Other domestic banks, F — foreign-owned banks SID Banka is not included Source: Bank of Slovenia.

NPLs are still high compared to pre-crisis level, despite the transfers made by banks to the BAMC. In November 2014, the volume and level of NPLs in the banking system decreased to EUR 5.1 billion due to the transfer of NPLs to the BAMC and now stands at 13.1% based on data provided by the Bank of Slovenia. Nevertheless, the major state-owned banks have systematically higher NPL ratios than foreign-owned banks although the former have benefited from a transfer to the BAMC (Graph 2.1.18). The continuing high volume of NPLs in domestic banks (Graph 2.1.17) is the result of selective and only partial transfer of NPLs to the BAMC, a deteriorating quality of the domestic loan portfolio, the introduction of a stricter NPL definition (in line with EBA guidance) and poor asset quality in the foreign direct lending portfolios (which were not transferred to the BAMC). The increased restructuring efforts will not immediately impact the NPL levels as key credit risk indicators will only adjust once operational restructuring is implemented and this takes time. In addition, restructured loans have to remain classified as NPLs for at least one year after the restructuring is concluded. System-wide NPL ratios are also affected by the contraction of new lending and the subsequent reduction of loan stocks, particularly for banks that are winding down.

Graph 2.1.17: NPLs by type of bank

Q4 14 contains data until November 2014. Source: Bank of Slovenia.

Graph 2.1.18: NPL ratios by type of bank

Q4 14 contains data until November 2014. Source: Bank of Slovenia.

The majority of the NPLs are concentrated in the domestic corporate loan book. It is only in the state-owned banks and in the banks in wind-down that the proportion of foreign corporate NPLs remains above 30% (Graph 2.1.19). Foreign NPLs were not transferred to the BAMC and constitute about 22% of the total remaining stock of NPLs in all banks. They mainly consist of lending to companies outside Slovenia (mostly ex-Yugoslav countries, Bulgaria, Romania) but also lending to subsidiaries of the domestic banks in ex-Yugoslav countries, Bulgaria and Romania. Foreign NPLs are diverse in terms of sector and size and are often based on bilateral agreements. A systematic solution to restructuring these wide-ranging exposures would therefore be challenging and resource-intensive.

Coverage ratios close to 60% reinforce the capacity of banks to absorb some losses from their NPL portfolios. The relatively high coverage ratios show that the remaining stocks of NPLs are better provisioned than in the past three years and therefore should pose less of an imminent risk to the solvency of the banks (Graph 2.1.20). The large state-owned banks report the highest coverage ratios, mainly due to supervisory actions taken by the Bank of Slovenia.

Graph 2.1.19: Structure of NPLs by bank (Q3 2014)

Source: Bank of Slovenia.

Swift restructuring and work-out of the NPLs is crucial for enhancing long-term profitability and viability of the Slovenian banking system, boosting investment, strengthening domestic demand and supporting economic recovery. Enhanced cooperation amongst the different stakeholders, availability of working capital financing and fresh equity for the companies undergoing restructuring are particularly helpful for speeding up the work-out process. The BAMC and the bigger domestic banks follow a long-term value-based approach to restructuring. Smaller domestically owned banks which are in the process of winding down (Factor and Probanka), as well as some of the foreign-owned banks which have started to reduce their exposure to the Slovenian market, have a shorter time horizon and seek a quick exit. This may present challenges when negotiating restructuring plans for companies. The BAMC has no lending capacity and domestic banks are reluctant or unable to provide working capital to companies undergoing restructuring as they are constrained by stricter lending and risk management policies. Alternative sources of financing like asset backed securities or corporate bonds could be further developed (Section 3.3). Fresh equity needs to be available to support deleveraging. Debt-to-equity swaps driven by the BAMC will further increase the level of state ownership in the economy. Privately-based structured solutions, such as the establishment of special purpose vehicles (SPVs), could provide an alternative solution. The role of the recently established corporate restructuring task force is to monitor and coordinate the overall restructuring process and to provide the necessary guidance and provide solutions to outstanding issues.

Graph 2.1.20: Coverage ratios by type of bank

Q4 14 contains data until November 2014. Source: Bank of Slovenia.

Reinforcing long-term profitability and reducing non-performing loans in the corporate segment are key to further stabilising the banking sector. The ongoing restructuring and rationalisation of the major state-owned banks provides an opportunity to reduce the cost base in a sustainable manner. Furthermore, there could be scope to increase the non-interest income of banks. Macro-prudential measures introduced by the Bank of Slovenia (Box 2.1.1) are supposed to improve the quality of lending activity, though it is still too early to assess the impact of these measures. The swift restructuring of the corporate sector by making full use of all existing tools, such as the BAMC and the new insolvency legislation, could boost the recovery of the cash-flow capacity of the corporate sector, which is an important prerequisite for enhancing the profitability of banks.

Further consolidation and enhanced corporate governance of the banking sector could be facilitated through the continuation of the privatisation process. The share of state-owned and state controlled banks in Slovenia has been high and has increased even further after the crisis as a result of the banking sector restructuring. More than 60% of Slovenian banks' assets are in the hands of state-owned banks. As a result of weak corporate governance and interconnectedness with other state-owned and state-controlled enterprises, Slovenian state-owned banks suffered significant losses during the crisis and experienced systematically higher NPL ratios compared to foreign-owned peers (Graph 2.1.18). The rehabilitation of the banking sector had important fiscal implications for Slovenia, amounting to more than EUR 5.7 billion from 2007 to date (Section 2.2). Majority of these state interventions were capital injections covering past losses with a direct negative impact on both public debt and deficit (approx. EUR 4 billion), while the remaining were linked to setting up the BAMC ([14]) (EUR 1.7 billion in equity and bonds). Although risk management in state-owned banks has been improving over the past year, the state does not have the same incentive structure, economies of scale and expertise (e.g. risk modelling, IT, data collection) that a large international group can offer to its subsidiaries. Slovenia has committed to reduce the share of state ownership in the banking sector. Continuous progress in this area would further help to halt the negative feedback loop between the sovereign and the banking system.

Box 3.1.2: Structure of debtor companies liable for the NPLs Three main categories of debtor companies liable for NPLs can be identified: The first category consists of construction and infrastructure companies, where bankruptcy rates have already peaked and most of the inefficient firms have exited the market. The majority of these exposures have been transferred to the BAMC and a large proportion of the losses have already been recognised by banks. The BAMC needs to enforce the collateral of these loans, realise any possible gains and complete the insolvency procedures. The recovery value obtained by the BAMC, and subsequently the state, will mainly depend on how efficiently the stakeholders and the courts manage the insolvency procedures. The second category consists of highly leveraged financial holdings, management buy-out companies and other highly leveraged medium-to-large size Slovenian companies. The latter include a small number (up to 100) that have a high value and are economically important (2014 in-depth review: approximately 90 % of debt carry-over is concentrated in just a handful of companies), which are mostly reliant on domestic demand, with some state-owned or state-controlled exporters as an exception (e.g. Cimos, Elan). In several cases, these companies have used a relatively large amount of (or exclusively) debt financing to acquire stakes in various businesses and have placed this debt on the balance sheet of the acquired companies. The subsidiary businesses are mostly domestically focused and many of them might have viable core activities. Many of the exposures in this category (both holdings and large companies) have been transferred to the BAMC, though some remain with the banks as a result of not having qualified for transfer. The BAMC and the corporate restructuring task-force should focus on swift financial and operational restructuring of viable companies, which will be crucial for the recovery of investment and of domestic demand in Slovenia. The third category includes NPLs of other large corporates and SMEs with sound core business activities but which, during the boom years, expanded their activities in non-core areas such as real estate or tourism. This category also includes suppliers to companies in the second category that have suffered from reduced orders. Some of the exposures in this category have been transferred to the BAMC, but most of them are still on the banks’ balance sheets, either because they did not qualify for a transfer (e.g. exposures were too small or still performing) or they are with banks that have not (yet) transferred assets to the BAMC. Due to their size, the work-out of many of these companies has yet to begin, and needs to be a priority of the ongoing restructuring efforts. There is more to be done here than in the case of the large companies and holdings, and this will most likely continue to take up significant management resources of the banks.

The state involvement in the economy remains high and it has incurred significant fiscal and economic implications for Slovenia amounting to over EUR 13 billion since the onset of the crisis. The state is the largest employer, asset manager and corporate debtor in Slovenia. State-owned enterprises and state-controlled enterprises (SOEs/SCEs) ([15]) employ one fifth of the employees working in non-financial companies (NFCs), and hold approximately one third of the total corporate assets and the total outstanding corporate debt. In the period from 2007 to 2013 SOEs/SCEs significantly underperformed compared to their privately owned peers in terms of productivity and profitability at both national and peer country level. Negative spill-overs from the high level of state involvement in the economy and inefficient corporate governance in SOEs/SCEs distort resource allocation, harm the business environment and hamper private investment and growth. As a result, the corporate sector remains undercapitalised and the resolution of NPLs is progressing slowly, which in turn delays recovery in the banking sector. This section analyses the complex nexus of state-owned banks, insurance companies and NFCs and the impact on the Slovenian economy.

Importance of SOEs and SCEs in the Slovenian economy

A complex network of directly and indirectly state-owned or state controlled banks, NFCs, insurance companies and investment funds continues to weigh on the economy. At the end of 2014, 642 SOEs/SCEs were identified as linked to the state via a complex cross-ownership structure. State control is exercised in several ways. Most of these 642 companies (62% in terms of book value of assets) are directly controlled by the Republic of Slovenia, through a single entity – the Slovenian Sovereign Holding (SSH), or quasi-directly through the municipalities or the various state management funds (KAD, PDP, DSU, Modra Zavarovalnica) ([16]). The SSH was recently established (2014) with the aim of consolidating and managing all state assets under one structure, and allowing for the privatisation of some of these assets. Another 32% are indirectly controlled through the BAMC, the banks, the insurance companies, and other financial companies which are all fully and directly owned by the Republic of Slovenia. While the corporate restructuring is ongoing, the state influence in this category of indirect ownership is likely to increase further through debt-to-equity swaps in the banks and the BAMC. The remaining 6% of SOEs/SCEs are controlled through other SOEs/SCEs and their subsidiaries (Table 2.2.1).

The state is the largest asset manager and corporate debt holder in Slovenia. Although SOEs/SCEs represent only about 1% of the total number of companies in Slovenia, they are highly significant from an economic perspective ([17]) and are bigger in size compared to their privately owned peers (Table 2.2.2). SOEs/SCEs account for one third of the assets, a quarter of the value added, over 40% of the equity value and one third of the financial debt obligations of NFCs. SOEs/SCEs presence is particularly strong not only in transport, energy and public utilities, but also in other sectors where state involvement is less pronounced in peer countries (Graph 2.2.1) such as consumer staples, chemical industry, manufacturing, tourism and leisure ([18]). The state is the largest corporate debt holder in Slovenia through its prevalent ownership of the banking system (direct owner of more than 60% of the banking assets as of end 2013). The state also manages 88% of the pension assets and 60% of all insurance liabilities. In various cases, the state is present as both an equity and debt holder. The conflict between the two mandates in particular in distressed companies requires coordination in order to minimise the risks and maximise the returns for the state.

Table 2.2.1: The network of state ownership and state control in Slovenia

Source: Chamber of Commerce of Slovenia, European Commission.

Graph 2.2.1: Share of SOEs/SCEs in sectoral value added (as % of total sectoral value added), 2013

Source: Orbis database and European Commission calculations.

One third of the workforce in Slovenia is employed by the state. SOEs/SCEs employ one fifth (19%) of all the workers in NFCs (approximately 80 000), and roughly additional 15 000 employees in the financial sector. Together with the 160 000 employees in the public sector, this amounts to 33% (approximately 255 000) of total employment in Slovenia (Graph 2.2.2).

Graph 2.2.2: Employment, 2013 – public, private and SOEs/SCEs

Notes: The employment data for SOEs/SCEs includes the total number of employees in these companies without applying the proportion corresponding to the share of state ownership. Source: National Statistical office of Slovenia, The Agency of the Republic of Slovenia for Public Legal Records and Related Services (AJPES), European Commission calculations.

Table 2.2.2: Relative importance of SOEs/SCEs (as % of total NFCs)

Note: The table covers only 561 out of the total 642 companies as it excludes the banks, financial services, insurance and asset management companies (27), as well as companies in insolvency (27), newly established companies in 2014 (26) and one other company for which financial accounts were not available. The importance of state ownership in the banking sector is described in Section 2.1. Source: The Agency of the Republic of Slovenia for Public Legal Records and Related Services (AJPES), Chamber of Commerce of Slovenia, European Commission.

Graph 2.2.3: Book value of equity of SOEs/SCEs in Europe (as % of GDP)

Source: 2012 OECD data on size and sectoral distribution of SOEs, European Commission calculations.

The level of state involvement in Slovenia is amongst the highest in Europe. The book value of equity of SOEs/SCEs relative to GDP (Graph 2.2.3) is the highest in Europe if majority state-owned companies (over 50%) are taken into account and the second highest if minority stakes are also included (between 10% and 50%), while their share in terms of employment is the third highest in both cases (Graph 2.2.5). According to a set of OECD soft indicators ([19]), the extent to which the state owns, controls, or is involved in business in Slovenia (state control) is above the average in the EU or in Slovenia's Central and Eastern European (CEE) peers (Graph 2.2.5), particularly when it comes to government involvement in the network industries (equity shares in electricity, gas, rail, transport, air transport, postal services and telecommunications). Slovenia scores second worst in terms of involvement of the state in business operation (the extent and type of price controls and regulation) and the use of command and control regulation by the government (the extent to which government uses coercive as opposed to incentives based regulation in general and in specific sector, such as road freight, retail trade, air transport, railways, professional service). Moreover, free market principles such as price liberalisation and competitive decision-making based on incentives appear also to be distorted relative to peers.

Graph 2.2.4: OECD indicators for product market regulation (2013)

Source: 2013 Indicators of product market regulation compiled by OECD. The graphs display different indicators (meaning described in the title of the graphs) on a scale from 0 – least restrictive state involvement/ control, to 6 - most restrictive state involvement/ control.

Graph 2.2.5: Employment at SOEs/SCEs in Europe (as % of total employment)

Source: 2012 OECD data on size and sectoral distribution of SOEs, European Commission calculations.

SOEs/SCEs' financial performance and productivity ([20])

SOEs/SCEs in Slovenia continue to be highly leveraged and many of them remain at risk of default. The debt leverage of SOEs/SCEs has been higher than the debt leverage of all corporates since the onset of the crisis (Graph 2.2.6). Based on aggregated data, the leverage ratio ([21]) of SOEs/SCEs stood at 7.2 in 2013, above the 6.1 average for all corporates. More significant differences in the debt leverage of SOEs/SCEs emerge at sector level. In 14 sectors out of 22 SOEs/SCEs are highly leveraged (Table 2.2.2). Particularly exposed are companies in the mining, apparel & wood production, real estate and financial services sectors ([22]), as their operating profit ([23]) has been negative for a prolonged period and hence they are at risk of default.

Graph 2.2.6: Leverage ratio of SOEs/SCEs and all NFCs (excl. energy and public utilities sectors)

Source: The Agency of the Republic of Slovenia for Public Legal Records and Related Services (AJPES), Chamber of Commerce of Slovenia calculations.

Based on aggregated industry data from company accounts in 2013 SOEs/SCEs generated net losses in certain sectors. On average SOEs/SCEs posted weaker financial results mainly due to the higher net financial losses resulting from the impairments of their non-core assets (e.g. stakes in non-core subsidiaries). Gross losses were concentrated in the financial services and the metal processing industries and accounted for 64% of the total losses generated by SOEs/SCEs. Gross profits were mainly generated by the energy, chemical industry, and transport & storage industries (70% of total profits of SOEs/SCEs).

Graph 2.2.7: Profitability (ROCE) of SOEs/SCEs and foreign-owned companies relative to domestic privately owned companies (2004-2013 average)

Source: Orbis database and European Commission calculations.

Compared to their privately owned peers in Slovenia and in other CEE countries, SOEs/SCEs are less efficient in deploying their resources (capital employed). In 2013, profitability of SOEs/SCEs in terms of return on equity (ROE) ([24]) and return on capital employed (ROCE) ([25]) was lower than that of their privately owned peers – both domestic and foreign-owned. Taking profitability of domestic privately owned companies in Slovenia as a benchmark, SOEs/SCEs underperform, while foreign-owned enterprises outperform in some sectors (Graphs 2.2.7 and 2.2.8). Relative to SOEs/SCEs in most other CEE countries, Slovenian SOEs/SCEs also underperform on the basis of industry-level comparison in all sectors except for energy (Graph 2.2.8).

SOEs/SCEs are amongst the companies with the highest debt leverage relative to peers in Slovenia and in other CEE countries. SOEs/SCEs are more indebted than their privately owned peers in almost all sectors apart from the chemical and pharmaceutical sector. Foreign-owned enterprises on the contrary are less indebted than domestic privately owned companies in Slovenia in all sectors reviewed (Graph 2.2.9). Slovenian SOEs/SCEs appear to be more indebted relative to the SOEs/SCEs in most other CEE countries, based on industry-level data (Graph 2.2.9).

Graph 2.2.8: Profitability (ROE) of SOEs/SCEs and foreign-owned companies relative to domestic privately owned companies (2004-2013 average)

Source: Orbis database and European Commission calculations.

SOEs/SCEs are less productive than their peers in Slovenia and in other CEE countries. Based on total factor productivity (TFP) estimations ([26]) for SOEs/SCEs and foreign-owned companies in Slovenia, relative to domestic privately owned companies, underperformance of SOEs/SCEs is observed in the majority of the sectors (Graph 2.2.10).

Graph 2.2.9: Leverage ratio of SOEs/SCEs and foreign-owned companies relative to domestic privately owned companies (2013)

Source: Orbis database and European Commission calculations.

Given that SOEs/SCEs account for a large proportion of sectoral value added in some of these sectors (e.g. the chemical industry and postal services & ICT as described in Table 2.2.2), underperformance of those enterprises can have substantial economic repercussions.

Graph 2.2.10: Total factor productivity of SOEs/ SCEs and foreign-owned companies relative to domestic privately owned companies (in %), 2004-2013 average

Source: Orbis database and European Commission.

Graph 2.2.11: Profitability (ROE) of SOEs/ SCEs by sector in Slovenia and other CEE countries (aggregate), 2013

Source: Orbis database and European Commission calculations.

Foreign-owned companies in Slovenia seem to be more efficient and competitive than SOEs/SCEs. While labour productivity of SOEs/SCEs seems to be lower than among foreign-owned peers in most of the sectors examined, apart from tourism and other services (Graph 2.2.14), the costs of labour per head are higher than those paid by private peers and similar to those paid by foreign companies (Graph 2.2.12). This indicates lower efficiency and competitiveness of SOEs/SCEs relative to their foreign-owned and privately owned peers.

Graph 2.2.12: Costs per employee of SOEs/ SCEs and foreign-owned companies relative to domestic private owned companies (2004-2013 average)

Source: Orbis database and European Commission calculations.

Graph 2.2.13: Debt leverage ratio of SOEs/SCEs in Slovenia and other CEE countries (2013)

Notes: Due to negative value of the denominator (EBITDA) the estimates for Romania and Bulgaria are not relevant. Source: Orbis database and European Commission calculations.

Graph 2.2.14: Labour productivity SOEs/ SCEs and foreign-owned companies relative to domestic privately owned companies (in %), 2004-2013 average

Source: Orbis database and European Commission calculations.

Fiscal and economic implications of state ownership in Slovenia

The total fiscal and economic implications of state involvement in the economy for the period 2007-2014 are estimated at over EUR 13 billion or just over one third of 2013 GDP. The total fiscal and economic implications of SOEs/SCEs is considered as the sum of a number of transactions estimated in the following categories: (i) state interventions related to the rehabilitation of the banking sector ([27]), (ii) foregone profits of SOEs/SCEs when compared to overall profitability achieved for all NFCs by sector ([28]), (iii) subsidies paid by the state to companies which either became insolvent, or need external support to maintain operational profitability, (iv) equity increases of SOEs/SCEs paid directly by the state, (v) drawn guarantees, and (vi) debt assumptions by the state. The potential future fiscal implications stemming from the drawing of outstanding guarantees and other contingent liabilities are not included in the number. While by far the largest portion of the costs is due to financial sector stabilisation measures (44% of total and 16% of GDP), considerable amount was also associated with wider economic implications in terms of foregone profits of SOEs/SCEs compared to their private peers (38% of total and 14% of GDP). The former has no direct impact on public finances and is estimated just to demonstrate the amount of lost value added for the state and the economy. EUR 8.3 billion (62% of the total and 22% of GDP) have direct budgetary impact – either through increase of government deficit, debt or both in most of the cases (Table 2.2.3).

Table 2.2.3: Total fiscal and economic implications of financial and non-financial SOEs/ SCEs

Source: The Agency of the Republic of Slovenia for Public Legal Records and Related Services (AJPES), Ministry of Finance database, Chamber of Commerce of Slovenia calculations, European Commission calculations.

One third of the increase of public debt from 2007 to 2014 can be attributed to state interventions related to financial and non-financial SOEs/SCEs. Slovenia's gross consolidated government debt almost quadrupled from 2007 to 2014 (from EUR 7.9 billion to EUR 30.3 billion at the end of 2014). In terms of GDP it increased from 22.7% to 82.2%. One third of this increase (EUR 8 billion or 21 percentage points) was due to costs related to SOEs/SCEs, such as capital injections, debt forgiveness, and drawn guarantees, as well as EUR 1.5 billion of BAMC bonds issued to enable the transfer of NPLs to the BAMC (Graph 2.2.16). In addition, government deficit was also negatively impacted, particularly by the recapitalisations of the state-owned and state-controlled banks during the crisis (Graph 2.2.15).

SOEs/SCEs continue to pose considerable fiscal risks. About EUR 6.4 billion of contingent liabilities to the state budget are currently outstanding in the form of guarantees (18% of 2013 GDP). The significant state involvement in the economy in terms of SOEs/SCEs' high share in total assets, equity and liabilities of the corporate sector, particularly in the banking and insurance sector, increase the risks to public finances in the future.

Graph 2.2.15: Total government deficit and deficit increasing state interventions related to SOEs/SCEs

Source: The Agency of the Republic of Slovenia for Public Legal Records and Related Services (AJPES), Ministry of Finance database, Chamber of Commerce of Slovenia calculations, European Commission.

A large part of the profitability of SOEs/SCEs and the corporate sector as a whole is supported by soft budget constraints ([29]) in the form of subsidies. The Slovenian economy is increasingly supported by various forms of subsidies, which is a source of moral hazard at management level and may adversely distort decision-making in companies, particularly decisions related to investment. In the period 2007-2013 the inflow of subsidies to the corporate sector amounted to approximately EUR 400 million per annum. In several sectors, the proportion of subsidies is greater than 20 % of operating profits (EBITDA). These sectors are agriculture (50%), mining (78%), public utilities (26%), media (60%) and public administration, education and health (21%). SOEs/SCEs received one third of all subsidies in 2013. One of the main beneficiaries of the subsidies was the Slovenian Railway holding (accounting for approximately 50% of all subsidies).

Graph 2.2.16: Total government debt and debt increasing state interventions related to SOEs/SCEs

The graph assumes that debt is issued in the same year as interventions take place. Source: The Agency of the Republic of Slovenia for Public Legal Records and Related Services (AJPES), Ministry of Finance database, Chamber of Commerce of Slovenia calculations, European Commission.

Graph 2.2.17: Subsidies to all NFCs relative to operating profit (EBITDA) and share of subsidies to SOEs/ SCEs

Source: The Agency of the Republic of Slovenia for Public Legal Records and Related Services (AJPES), Ministry of Finance database, Chamber of Commerce of Slovenia calculations.

Soft budget constraints combined with a limited strategic and financial management capacity have distorted resource allocation and negatively affected the profitability of SOEs/ SCEs. In line with the higher debt leverage, capital expenditure at SOEs/SCEs was higher than at all corporates (Graph 2.2.19) relative to both operating profit and sales. This should have translated into higher profitability of SOEs/SCEs compared to all corporates. Instead, available financing has been channelled to unproductive investments – i.e. less profitable (or loss-making) non-core activities as evidenced by the higher proportion of non-core assets on the balance sheet of SOEs/SCEs compared to private peers (Graph 2.2.18). As these investments are less profitable than the core activities of the parent company, the overall profitability (ROE) is negatively affected through the impairments of these non-core assets. The highest level of non-core investment of SOEs/SCEs is in financial and insurance activities, which includes financial holding companies, in professional, scientific and technical activities, and in consumer staples and retail.

Graph 2.2.18: Other fixed assets of SOEs/ SCEs and foreign-owned companies relative to domestic privately owned companies (as % of total assets ), 2004-2013 average

Note: Other fixed assets are balance sheet items, which include investments in financial assets, not related to the core business of the company and loans to subsidiaries. Source: Orbis database and European Commission calculations.

SOEs/SCEs Corporate governance framework and privatisation in Slovenia

Sound management and enhanced corporate governance policies for SOEs/SCEs can assist in mitigating the risks of future state support on public finances. The level of state support provided to SOEs/SCEs in Slovenia has been considerably above the EU average in recent years. SOEs/SCEs have commenced the deleveraging of non-core assets accumulated during the boom, which will weigh on their profitability in the coming years. In parallel to addressing these legacy issues, the focus should shift to enhancing the core business of SOEs/SCEs and identifying sectors where state involvement is not necessary. Slovenia could further benefit from the strong momentum and return of confidence after the restructuring of the banking sector in 2013 and 2014 in order to accelerate the privatisation process.

A new corporate governance code for SOEs/SCEs was adopted in December. The new framework is reportedly in line with the basic recommendations of international practice in that it (i) ensures that SOEs/SCEs and private companies operate on an equal footing (ii) enhances the separation of the functions of the state from its capacity as an owner (iii) applies across the spectrum of SOEs/SCEs (with limited exceptions) under the 'comply or explain' principle (iv) reinstates the roles of the company bodies, in particular the supervisory board, and the company's position as regards the different stakeholders, (v) realises the principles of transparency and touches upon a number of long-standing issues such as the remuneration and bonuses of the company boards. Contrary to its predecessor, the new code does not exclude the parallel application of other corporate governance frameworks (e.g. that of listed companies), thus eliminating the cases of privileged or otherwise differentiated treatment of SOEs/SCEs in comparison with privately held companies. Finally, corporate governance of SOEs/SCEs is explicitly connected to the goals of the forthcoming strategy on state assets, which will ensure consistent treatment of SOEs/SCEs.

Graph 2.2.19: Capital expenditure relative to operating profit (EBITDA) of SOEs/ SCEs and all NFCs

Source: The Agency of the Republic of Slovenia for Public Legal Records and Related Services (AJPES), Ministry of Finance database, Chamber of Commerce of Slovenia calculations.

The Slovenian Sovereign Holding (SSH), in charge of the management and divestment of state assets is fully operational but its asset management strategy is still to be approved. In June 2014, the ex-SOD fund was transformed into SSH following the amendment of its articles of association, in accordance with the new law adopted in late March 2014. In order to fulfil its mandate, SSH requires a strategy reflecting the country's objectives and specifying the classification of state assets in strategic, important and portfolio investments. The statutory deadline laid down in the law for the government to table its proposal in parliament for that strategy and for a new supervisory board for SSH (July 2014) has passed. A plan for a new privatisation cycle, expected by November 2014 is also missing in the absence of the strategy. A draft strategy entered intergovernmental consultations in January 2015 and is expected to be approved by the Parliament in March 2015. Within one month of the strategy being adopted, SSH will set up the annual asset management plan, which will include the new divestment schedule for additional state assets. A new supervisory board is expected to be appointed by the Parliament in the coming months after the Ministry of Finance completes the evaluation of the candidates in February 2015. A number of measures have been taken to make SSH operational, such as the adoption of an asset management policy in December 2014, which establishes the principles and operational procedures of the SSH. Other functional aspects regarding the establishment of the SSH, e.g. required corporate transactions and legal transformations provided for in the law, are also on track.

Slovenia could further benefit from the strong momentum and return of confidence after the restructuring of the banking sector in order to accelerate the privatisation process. The privatisation programme is slowly progressing. A list of fifteen companies was compiled in 2013 for a first cycle of expedited privatisation, out of which three companies have been divested through privatisation and one company has been acquired by its creditors through a debt-to-equity swap executed as part of the restructuring process. Amongst the companies that were privatised, the sale of the airport, Aerodrom Ljubljana, was the largest transaction and was completed in October 2014. The sale process for the biggest assets on the list, Telekom Slovenije (the largest telecom and the sole owner of the telecommunication network in Slovenia) and NKBM (the second largest bank, owning 11% of total banking assets) is ongoing, albeit with some delays, and is expected to be concluded in April and March 2015 respectively.

The asset management plan could enhance the transparency and credibility of the privatisation process. As Slovenia prepares a new cycle of privatisations it is important that the list of companies is consistent with the SSH's priorities and strategy. The privatisation of selected SOEs/SCEs in a transparent manner can assist in attracting FDI, and improve the outlook for the Slovenian economy. Furthermore, any proceeds from the process can assist in reducing public sector debt and enhancing the future sustainability of debt.

Price and cost competitiveness

Since 2013, Slovenia has been performing relatively well on external markets, reflecting recent competitiveness gains. While some external price and cost competitiveness has been lost due to wage increases between 2008 and 2010, the most recent data and a new sectoral Real Effective Exchange Rate (REER) database show relatively positive competitiveness trends, mainly owing to REER depreciation in the tradable sectors.

The moderation in prices and costs after 2012 has contributed to Slovenia’s improved export performance. The traditional indicator of price and cost competitiveness at the macroeconomic level, REER deflated by unit labour costs in total economy, shows a steady retreat from the significant appreciation between 2007 and 2010 (Graph 2.3.1 – left). The appreciation suggested a substantial loss in cost competitiveness, which may have been partly reflected in the loss of market share in the period 2009-12. The subsequent REER depreciation could partially explain the improvement in Slovenia’s export performance since 2013, as competitiveness shifts tend to have a lagged effect on trade performance.

Rapid aggregate wage growth coupled with stagnating productivity and labour hoarding had previously contributed to generating imbalances. While part of the REER appreciation was due to rapid wage growth, the surge in the trend in 2009 was largely caused by an unexpected drop in production and a resulting decline in productivity per employee. Collapsing economic activity combined with labour hoarding as workers were kept on the job through work support schemes weighed heavily on firms’ profitability, mainly in the non‑tradable sectors. The tradable sectors adjusted quickly so as to safeguard their competitiveness. For example, REER based on the unit labour cost in the manufacturing sector has remained broadly stable over the last 15 years (Graph 2.3.1 – right).

A measure of competitiveness based on sectoral unit labour costs provides a more granular representation of competitiveness developments. It shows that Slovenia made considerable gains in price and cost competitiveness in the pre-crisis period but confirms deterioration in competitiveness in the run-up to the crisis that is now reversing (Graph 2.3.2). This new REER indicator aggregates competitiveness at sectoral level to obtain an economy-wide measure of competitiveness, which captures heterogeneous dynamics among sectors. It controls for the main limitation of the traditional REER, which confounds changes in the sectorial structure with changes in the unit labour cost per sector and does not account for the influence of global technological developments on different sectors.

Graph 2.3.1: Real effective exchange rate deflated by ULC in total economy (ULCE) and in manufacturing (ULCM)

Index 2000 = 100 Source: European Commission.

Graph 2.3.2: REER (ULCE) and new sectoral REER in Slovenia

Index 2000 = 100 Source: European Commission.

Slovenia's cost competitiveness has evolved more favourably than that of most of its peers (Graph 3.3.3). While this new indicator ([30]) is available only until 2011, it is expected to have further improved beyond this horizon as a result of favourable productivity developments and very limited wage growth since 2011. In addition, Bank of Slovenia ([31]) estimated an equilibrium competitiveness indicator based on unit labour costs for Slovenia vis-à-vis EA-12 and compared it with those of its main trading partners. According to this indicator based on unit labour costs, price and cost competitiveness has substantially improved since 2010. A recent extension of this analysis confirms that the competitive position of Slovenia returned to equilibrium in 2014.

The Nominal Unit Labour Cost (NULC) index is once again approaching the euro area average (Graph 2.3.4). This follows a period of decoupling due to the acceleration in wage growth at a time of no additional productivity gains. The three years (2008-10) with flat hourly productivity and growing wages adversely impacted on Slovenia’s price and cost competitiveness vis-à-vis the euro area. Nevertheless, Slovenia’s NULCs still grew slower than those of most of its peers.

Graph 2.3.3: Sectoral REER aggregate in SI and V4

Index 2000=100 Source: European Commission.

Graph 2.3.4: Nominal Unit Labour Cost

Index 2002 = 100 Source: European Commision.

While NULCs in the tradable sectors adjusted quickly and safeguarded their competitiveness, the adjustment in the non-tradable sectors started later and is taking more time. Non-tradable sectors (real estate activities, construction, public administration, defence, education and health, and scientific, administrative and support services) were the main contributors to the increase in the NULC but they have very little impact on the external competitiveness of the Slovenian economy. Developments in the tradable sectors were more favourable also compared to the peers and the euro area. Increases in productivity and wages in the tradable sector (until 2007) inevitably translated into increases in wages in the non-tradable and less productive sectors; this fuelled inflation and led to an accelerating NULC. Such an evolution is part of the convergence process and is in line with the Balassa-Samuelson effect (Graph 2.3.5). The protracted correction of unit labour costs in the non-tradable and protected sectors could pose certain risks whereby their higher costs filter through to the tradable ones and affect their external competitiveness. These risks are present in particular during boom periods.

Graph 2.3.5: SI NULC in tradable and non-tradable sectors

Tradable sectors ISIC A, C, G-I, J. Index 2000=100 Source: European Commission.

Slovenia’s labour productivity continues to grow faster than the EU average (Graph 2.3.6). Productivity gains were achieved mainly in the tradable sectors. By composition, they are positively reflected in the recent trends in unit labour costs. Productivity measured in terms of GDP per hour worked improved continuously over the last decade with the exception of stagnation around the crisis years. Although productivity per person employed dropped in 2009 as production contracted during the crisis, growth of productivity per hour worked remained broadly in line with its Visegrád 4 peers both before and after the crisis and consistently considerably outpaced than the EU and euro area averages. Labour productivity per hour worked provides a better picture of productivity developments in the economy, as it eliminates differences in the full-time/part-time composition of the workforce across countries and years (it eliminates the impact of the widespread use of short-time work support schemes during the crisis in Slovenia, whereby headcounts were maintained but hours worked decreased).

Graph 2.3.6: Productivity per hour worked

Index 2000=100 Source: European Commission.

Recent wage growth has been moderate and supportive of competitiveness (Graph 2.3.7). Even though wage growth significantly outpaced the EU and euro area average between 2000 and 2008, it remained broadly in line with productivity developments and the need for convergence. The main notable exceptions are the high increases in 2008, partially attributable to the payment of wage disparities in the public sector and the indexation of wages to relatively high inflation in the previous year; and in 2010, resulting from a large increase in the minimum wage.

While still comparatively high, recent growth of the minimum wage has been limited. The level of the minimum wage in relation to average gross monthly earnings remains the highest in the EU. This is partly due to the design of the minimum wage-setting system, which includes various allowances (e.g. for night work, overtime) and a global indexation encompassing all of these components and not just basic pay. In addition, since 2008 the minimum wage increased by 33% while the gross wages per employee by 9%. The short distance of the minimum wage from the average wage is also related to the low level of wage dispersion in the country. ([32]) In 2014 the minimum gross wage was EUR 789.15, having grown by 0.7% from the previous year, while the ratio of the minimum wage to average gross monthly earnings was 51.4%, the highest in the EU. This is also reflected in high relative labour costs for minimum wage workers that may relate to the low employment level of the least skilled workers (Section 3.2). ([33]) In January 2015, the minimum wage was increased by 0.2%. In the future, the ratio between the minimum and the average wage is expected to decrease.

Graph 2.3.7: Nominal compensation per employee

Source: European Commission.

There have been some changes to the wage-setting system, yet excluding the minimum wage. The Social Agreement, which the new government signed with the social partners in January 2015, will be valid until 2016. The agreement establishes collective agreements as the basis for private sector wage setting, while inflation and a share of sectoral productivity will be taken into account in bipartite wage negotiations. The Social Agreement also indicates that public sector wage growth has to lag behind private sector wage growth. It does however not involve any change to the setting of the minimum wage. A contribution to the continuity of wage moderation comes from further reductions in the public wage bill, adopted in December 2014 following an agreement between the government and trade unions. The agreement extends to 2015 the savings measures adopted in 2012 and 2013, and also introduces additional measures. In 2013, the total paybill in the public sector decreased by 4.1% compared to 2012 and the number of people employed in the public sector fell by 1.5%. According to the first estimates of the government, an additional EUR 36 million in savings, including reduced performance bonuses, could be achieved in 2015 with respect to 2014.

Non-cost competitiveness

Price and cost competitiveness can only partially explain export performance. There is evidence that non-price factors are very important, particularly in countries that have been through a real convergence process. These factors include product and geographical specialisation, developments in quality of products, notably through research and innovation processes, consumer preferences in the importing countries, as well as the ease of doing business (efficiency of public administration, taxation policies, regulation, capital and labour market conditions, access to finance and investment, etc.)

Trade developments in Slovenia have been largely driven by its geographical and product specialisation (Graph 2.3.78). Slovenia’s exporters enjoyed particular geographical advantages before 2008, as their target markets were dynamic at the time (mainly euro area and Balkans). They also managed to gain significant market share in new products. Nevertheless, with the onset of the crisis, Slovenia lacked the necessary dynamism to enter new markets and lost market share. Since 2013, Slovenia has managed to regain market share as well as benefit slightly from the geographical orientation. Overall product specialisation has been slightly negative or neutral.

Graph 2.3.8: Geographical and sectoral composition of nominal rate of change of goods exports

Source: European Commission.

The composition of Slovenia’s exports has improved in the last decade. The proportion of high-technology products in Slovenia's exports has progressively increased (Graph 2.3.9). This indicates that Slovenian exports are able to compete in the segment of higher value added products as the quality of exports has been improving over time.

An increase in the technological content and quality of exports has boosted export performance. The quality of exports has been improving relative to other trading partners. Slovenia’s quality index (Graph 2.3.10) estimates how Slovenian exports compete on the EU market relative to the exports of other Member States. The EU market captures more than 75% of Slovenian exports, thus it is important to benchmark how well these products are accepted compared to the exports from other Member States. The quality index of Slovenia has been improving since 2006. However it remained below the physical unit labour cost (the share of unit labour cost required to produce the value of exports) until 2012. A discrepancy between the physical unit labour cost and the quality index appeared in 2010, when the minimum wage increased substantially. Since then the physical unit labour cost has moderated and adjusted to the quality of exports.

Graph 2.3.9: Density distributions of exports by quality

Source: European Commission, Orbis, COMEXT.

Graph 2.3.10: Non-cost competitiveness vis-à-vis EU28

Source: European Commission, IPTS institute, COMEXT.

Non-cost competitiveness could improve further through productive investment in innovative technologies and products. The forthcoming Smart Specialisation strategy (Section 3.3) could serve as a platform for channelling EU funds into further improvement of non-cost competitiveness. Also, the current business environment needs to adjust to support competitiveness improvements. Major weaknesses stem from the developments in the financial sector, the slow privatisation process, lengthy administrative procedures and the risk of corruption (Sections 3.3 and 3.5).

Investment dynamics

Private investment decreased dramatically in 2009/2010 and since then it has not recovered (Graph 2.3.11). This is not only due to the crisis, but also because of the highly indebted corporate sector, significant state involvement in the economy, and an unsupportive business environment. Companies, struggling to repay their debts, have been underinvesting compared to the historical average and peers in the region. Weakness in investment warrants special attention not only because of the impact on domestic demand and short-term economic outlook but also because shortfalls in investment are detrimental for the future potential growth of the Slovenian economy.

Graph 2.3.11: Investment in the private sector

Source: European Commission.

The magnitude of the drop in investment is not in line with the development observed in aggregate demand. While domestic and external demand fell considerably during the crisis, neither private consumption nor exports decreased as much as investment (Graph 2.3.12). Despite rising unemployment and wage restraint in the post-crisis years, private consumption modestly increased in nominal terms and is projected to grow in the short term. Exports contracted in 2009 but grew thereafter, yet this has not led to a significant pick-up in investment among the exporting companies. Private investment remains 40% below its pre-crisis peak ([34]) and is projected to increase only marginally by 2016. This creates substantial macroeconomic costs. Through its direct impact on aggregate demand, lack of investment translates into reduced GDP growth. In addition, such development considerably reduces Slovenia's ability to grow in the medium and long term.

Graph 2.3.12: Private investment and private consumption

Source: European Commission.

Low investment has eroded Slovenia's potential growth. The Commission’s estimates for the euro area indicate that a 5 percentage point reduction in the investment rate leads to a reduction in potential growth of nearly 0.5%. Slovenia’s potential output has substantially dropped since 2009 (Graph 2.3.13). The Commission estimates potential growth in 2014 at ½%, compared to 3-4% between 2000 and 2008. This is primarily due to a large reduction in the contribution from capital accumulation, and secondarily due to lower total factor productivity. While Slovenia’s potential growth is projected to gradually recover, it is expected to remain at a relatively low level over the medium term, restrained by protracted low capital accumulation as well as sluggish total factor productivity (TFP). TFP growth is an essential driver of long-term growth, capturing efficiency gains in the overall use of economic resources and reflec