EUROPEAN COMMISSION Brussels, 27.2.2019 SWD(2019) 1023 final COMMISSION STAFF WORKING DOCUMENT Country Report Slovenia 2019 Accompanying the document COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE EUROPEAN COUNCIL, THE COUNCIL, THE EUROPEAN CENTRAL BANK AND THE EUROGROUP 2019 European Semester: Assessment of progress on structural reforms, prevention and correction of macroeconomic imbalances, and results of in-depth reviews under Regulation (EU) No 1176/2011 {COM(2019) 150 final}



Contents Executive summary 1.Economic situation and outlook 2.Progress with country-specific recommendations 3.Reform priorities 3.1.Public finances and taxation 3.2.Financial sector 3.3.Labour market, education and social policies 3.4. Competitiveness reforms and investment Annex A: Overview Table Annex B: Commission Debt Sustainability Analysis and Fiscal Risks Annex C: Standard Tables Annex D: Investment Guidance on Cohesion Policy Funding 2021-2027 for Slovenia References LIST OF Tables Table 1.1:Key economic and financial indicators Table 2.1:Assessment of 2018 Country-Specific Recommendations (CSRs) Table 3.2.1:Financial soundness indicators - all banks in Slovenia

Table C.1:Financial market indicators Table C.2:Headline Social Scoreboard indicators Table C.3:Labour market and education indicators Table C.4:Social inclusion and health indicators Table C.5:Product market performance and policy indicators Table C.6:Green growth LIST OF Graphs Graph 1.1: Composition of GDP growth Graph 1.2: Composition of potential growth Graph 1.3: Labour market developments in Slovenia Graph 1.4: Export market shares Graph 1.5: Net International Investment Position (NIIP) by sector Graph 1.6: Debt decomposition Graph 1.7: Change in pro capita GDP from 2007 to 2016 Graph 2.1: Level of implementation of 2011-2018 CSRs Graph 3.1.1: Gross debt as % of GDP - Debt Sustainability Analysis Graph 1: Distributional (on the left) and labour supply (on the right) effects for both scenarios Graph 3.3.1: Activity rate by age and educational attainment in 2017 Graph 3.3.2: Reasons for inactivity by age and sex, 2016

Graph 3.3.3: Labour shortages, Slovenia 2008-2018 Graph 3.3.4: At risk of poverty or social exclusion rate and its components Graph 3.4.1: Labour productivity and total factor productivity (TFP), Slovenia and Euro area Graph 3.4.2: Investment by type Graph 3.4.3: R&D funding LIST OF Boxes Box 2.1: EU funds and programmes contribute to addressing structural challenges and to fostering growth and competitiveness in Slovenia Box 3.1.1: Shifting taxation from labour to immovable property Box 3.3.1: Monitoring performance in light of the European Pillar of Social Rights Box 3.4.1: Barriers to investment in Slovenia Executive summary Slovenia’s economy, currently experiencing a robust growth, can be made more resilient to future shocks by increasing investment and addressing the challenges related to its ageing population ( ). The economy is growing strongly and remains competitive internationally. Investment is growing, but it is still below the EU average as a share of GDP, which slows down Slovenia’s convergence in terms of productivity. Social indicators generally signal progress, while inequality (between both citizens and regions) is below the EU and OECD average. The banking sector has improved further, also thanks to the favourable economic climate. Structural reforms of the pension, healthcare and long-term care systems are becoming increasingly urgent if Slovenia is to ensure that it remains on a sustainable growth path. In 2018, Slovenia’s economy continued to grow strongly. After achieving a growth rate of 4.9 % in 2017, GDP is expected to have expanded robustly in 2018 with growth of 4.4 %. Economic growth is expected to slow to 3.1 % in 2019 and 2.8 % in 2020, closer to Slovenia’s potential growth. Although the expected slowdown is not dramatic, it is nevertheless an indication that the favourable economic climate of recent years is unlikely to continue. Economic growth is mostly driven by investments. The main drivers of private investment are expected to be: fully or almost fully employed production facilities, increasing labour costs and better availability of funding. The unemployment rate continues to decline towards its pre-crisis level. Helped by economic growth, the unemployment rate fell to 5.6 % in 2018, and is expected to fall further in 2019 and 2020. The rate of long-term unemployment was less than 3 % at the end of 2018, which is still above the pre-crisis level but below the average rates in the EU (3.4 % in 2017) and the euro area (4.4 %). The inflation rate stabilised at 1.9 % in 2018. Energy and fuel prices were the main drivers of the increase in inflation. As nominal compensation (i.e. without controlling for inflation) per employee is projected to have increased by 3.9 %, real wages will have increased by about 2 % in 2018. Fiscal policy is becoming pro-cyclical. In 2017, the general government balance turned positive, (i.e. government revenues exceeded government spending), rising from a negative balance of 1.9 % of GDP in 2016 to a positive balance of 0.1 % of GDP in 2017. The government balance is expected to have increased to 0.8 % of GDP in 2018. Public debt is forecast to decrease further to 62.5 % of GDP in 2020, from a peak of 82.6 % in 2015, thanks primarily to the economic recovery and active debt management to reduce interest payments. However, the structural deficit, that is if taking Slovenia’s position in the business cycle into account, deteriorated from 0.4 % in 2017 to 0.5 % in 2018, and is expected to deteriorate further in 2019. Temporary consolidation measures are now expiring and a substantial pay rise in the public sector was agreed. The Fiscal Council repeatedly stated that the intended fiscal policy would be pro-cyclical.

Focusing investment ( ) on skills, environmental, transport and energy infrastructure, as well as on research and development would strengthen competitiveness and productivity. Investment as a share of GDP in Slovenia remains below the EU average. Skills constraints and a slow digital transformation limit productivity growth, while insufficient environmental infrastructure, lacking sustainable transport connections and a low share of green energy hinder economic development in less developed regions. The underused labour potential of older workers is a challenge to inclusive growth. Population ageing calls for significant investments in measures to ease pressure on the healthcare and long-term care systems. The research, development and innovation ecosystem remains inefficient. There are only weak links between businesses and research institutions. Annex D identifies key priorities for support by the European Regional Development Fund, the European Social Fund Plus and the Cohesion Fund over 2021-2027 in Slovenia, building on the analysis of investment needs and challenges outlined in this report. Overall, Slovenia has made limited progress in addressing the 2018 country-specific recommendations ( ). There has been some progress in the following areas. ·Alternative sources of financing for fast-growing companies - Slovenia is preparing further EU-funded instruments to improve equity funding. ·Barriers for market entry and administrative burden - The Investment Promotion Act brings improvements but administrative burden and regulatory restrictiveness remain problems. ·Privatisation - Slovenia made an important step in carrying out privatisations by privatising 65 % of the shares of its largest bank, Nova Ljubljanska Banka (NLB), which was until then fully owned by the state, and launching the sales process for Abanka, the third largest Slovenian bank. There has been limited progress in the following areas. ·Older and low skilled workers - The Slovenian government continued its efforts to increase the employability of low-skilled and older workers through lifelong learning and activation measures. However, participation in adult learning is still low, especially for this target group. ·Public procurement - Slovenia has adopted an action plan to professionalise procurement further, but the situation remains unchanged as regards competition and independent oversight. There has been no progress in the following areas. ·Healthcare - Slovenia has not proposed any clearly specified measure to address the Country-Specific Recommendations. However, as announced by the authorities, the adoption of the draft healthcare act will follow by the end of 2019. ·Long-term care - No concrete measures have been taken, and there is no agreed timetable for a concrete legislative proposal. A two-year pilot project has been initiated in 2018. ·Pensions - No concrete measures have been taken to ensure the long-term sustainability and adequacy of the pension system, whether by increasing the statutory retirement age or by restricting early retirement. Regarding progress towards its national targets under the Europe 2020 strategy, Slovenia has already achieved – or is well on track to achieving – national targets for the early school leaving rate, tertiary educational attainment, energy efficiency and greenhouse gas emissions. However, Slovenia is moving away from the 2020 renewable energy target and the R&D spending target (in 2017, Slovenia's overall R&D intensity was 1.86 % of GDP, a significant decline from its 2013 value of 2.58 % of GDP). The employment rate is now moving closer to the target. Key structural issues analysed in this report, which point to particular challenges for Slovenia’s economy, are the following. ·Slovenia is performing well on most indicators of the Social Scoreboard supporting the European Pillar of Social Rights. Income inequality is low. The education and training system is generally performing well, but fairness in the system could be improved. The risk of poverty and social exclusion has decreased in recent years. However, the labour market participation of older workers and low-skilled is low and the old-age poverty still remains a challenge. ·The ageing of the population is putting a strain on the pension, healthcare and long-term care systems. Age-related expenditure is expected to increase by six percentage points of GDP between 2016 and 2070, one of the highest increases in the EU. The main driver of this is pension expenditure, with the total amount spent on public pensions expected to increase from 11 % of GDP in 2020 to 15.6 % in 2050. This increase can partially be explained by the early exit from the labour force. However, ensuring adequate pensions remains a challenge, as some pension recipients are still at or below the poverty line. Financing for the healthcare system is currently highly cyclical and inadequate to face the expected cost increases from the ageing of population and technological change. Waiting times and public procurement in healthcare are still inefficient despite recent efforts to improve it. The authorities have announced that the adoption of the draft Healthcare Act will follow by the end of 2019. Slovenia does not have an overarching law that covers long-term care. ·Inactivity rates of older and less skilled workers are high while labour shortages are emerging. The inactivity rate of 55-64 year-olds is significantly higher than the EU average as is their unemployment rate. Long-term unemployed people over 50 represent a substantial share of the total number. This means that a significant part of the workforce is losing contact with the work environment. A mismatch between the skills young people acquire at school or in tertiary education and the skills sought after by employers may be contributing to the emerging labour shortages. ·The situation of the Slovenian banking sector has improved significantly, but challenges remain and new risks emerge. Thanks to the steady decline in non-performing loans, banks’ profitability, solvency and asset quality have improved. Still, banks need to find new sources of income and control costs to remain profitable. House prices are growing fast but household debt and stock of loans to the construction sector remain low. Strong growth in consumer lending raises credit risk and led Bank of Slovenia to issue specific recommendations. With the partial privatisation of NLB in November 2018 and the initiation of the privatisation of the third largest bank, Abanka, by mid-2019 Slovenia is making good progress with privatisation in the banking sector. However, the state still plays a dominant role in many sectors. This carries a risk of distortion in competition and resource allocation. ·Slovenia’s small and medium-sized enterprises (SMEs) rely extensively on bank credit for their external financing. Slovenia’s venture capital market is still less developed than those of other Central and Eastern European countries. The market capitalisation of the national stock exchange is low and shrinking. Public financial instruments heavily depend on EU funding. The lack of alternative sources of finance, combined with limited financial and investment literacy among many SMEs, makes Slovenia’s SMEs less resilient if bank credit becomes more expensive or less available in the future.

·Although the business environment is improving, restrictive regulations and administrative burden remain, as well as certain weaknesses in public procurement remain. Regulatory restrictions, including for key professions, and administrative burdens are still perceived as obstacles to investment, and are considered to be one of the most problematic factors when doing business in Slovenia. Often lengthy commercial court proceedings could influence the readiness of companies to enter the market or invest. There is further scope to improve competition, transparency and independent oversight in public procurement. The share of procurement procedures for which only one bid was received remains high as does the share of procurement done without a call for tenders. Strengthening safeguards against bid rigging and corruption would also reduce the risk of unnecessarily high procurement costs. 1. Economic situation and outlook GDP growth In 2018, Slovenia’s GDP is assumed to have grown by 4.4 %, following the 4.9 % annual growth recorded in 2017. Over the first three quarters of 2018, investments grew by 11.0 % compared to the same period in 2017. Investment growth was particularly strong in non-residential construction (19.5 %) and in machinery and equipment (8.6 %). Investment in residential construction grew by 5.0 %. During the same period, private consumption increased by 1.8 %, despite relatively strong growth in households’ disposable income. Exports increased by 8.3 %, slightly less than imports which grew by 8.5 %. Graph 1.1:Composition of GDP growth Source: European Commission Winter 2019 forecast Economic growth is forecast to slow down to 3.1 % in 2019 and 2.8 % in 2020. The growth composition is expected to shift more towards domestic demand, with net exports making a negative contribution by 2020 (Graph 1.1). In the medium term, growing employment and rising wages are expected to continue to support private consumption. Investment is expected to be driven by high capacity utilisation rates and a tightening labour market. Amid high-income growth, high household savings and rapidly rising residential real estate prices, residential investment growth is forecast to remain strong over the forecast horizon. Risks are mainly related to the external environment. Graph 1.2:Composition of potential growth Source: European Commission Autumn 2018 forecast Slovenia’s potential growth is rapidly recovering. After the crisis, the country’s growth potential was held back by low investments and low total factor productivity growth. In 2018, investment had a positive impact on potential growth for the first time in several years, and total factor productivity also contributed positively (Graph 1.2). In the coming years, labour’s contribution to growth will diminish as the population ages and therefore the availability of labour diminishes. Overall, potential growth is currently expected to stabilise at 3 %. Inflation Inflation remains moderate. In 2018, it reached 1.9 %. Over the coming years, inflation is expected to moderately increase, driven by energy prices and expected wage growth. As the labour market becomes tighter and wage growth continues, it is expected that core inflation will reach 1.8 % by 2020 — driven mainly by the price increase in services. Labour market The robust economic growth of recent years has also boosted the labour market. Employment growth was sustained (2.9 % in 2017), with job creation across most sectors. The unemployment rate continued to decline, falling from 8.0 % in 2016 to 6.6 % in 2017. In the same period, the activity rate increased from 76.2 % to 78.6 % (See Graph 1.3). Graph 1.3:Labour market developments in Slovenia Source: Eurostat Despite these positive developments, structural challenges remain. The working-age population is shrinking as a result of demographic change. This could hamper economic growth in the future. It also poses challenges to the sustainability and adequacy of the pension, health care and long-term care systems. In addition, labour-market participation remains low for older workers, in particular those with lower levels of education. The tightening labour market is putting some upward pressure on wages, although wage growth remains somewhat lower than expected. Nominal compensation per employee increased by 3.2 % and by 1.5 % in real (GDP deflated) terms (remaining somewhat below productivity growth) in 2017. This growth rate is projected to reach 3.3 % in 2018 and 2019. Nominal compensation per employee increased in 2017 the most in the finance and business services sector (4.6 %) and in the building and construction sector (4.3 %). Despite increasing shortages being reported, the industry sector exhibited the lowest increase in nominal compensation per employee (2.9 %). Social developments Inequality in Slovenia is low and the share of people at risk of poverty and social exclusion has decreased, but remains high for the elderly. The at-risk-of-poverty or social exclusion rate for people over 65 was 18.3 % in 2017, above the all-age-groups rate of 17.1 %. Inequality, as measured by the ratio of incomes of the richest 20 % of households compared to the incomes of the poorest 20 % of households, continued to decrease and remains among the lowest in the EU. Competitiveness

Sloveniaʼs competitiveness continued to improve in 2017. After a small loss of export market share in 2015, Sloveniaʼs export market share increased by 6.8 pps in 2016 and 5.6 pps in 2017. (Graph 1.4). This increase was driven by increases in both the export of goods and services. Combined with modest productivity growth, the nominal wage growth led to an increase in nominal unit labour costs of 1.3 % in 2017. The effect on cost competitiveness appears to be limited, as nominal wage growth in 2017 remains only slightly above the benchmark indicator for cost competitiveness in both 2017 and 2018 ( ). Unit labour costs are expected to grow faster between 2019 and 2020. Higher unit labour costs and less demand for exports are expected to contribute to somewhat slower export growth. However, Slovenia’s export market shares should continue improving in 2019 and remain stable in 2020. Imports are forecast to grow faster than exports due to the stronger domestic demand. Graph 1.4:Export market shares Source: Eurostat External position Sloveniaʼs current account has been in surplus since 2011, reaching 7.2 % in 2017. While both goods and services balances are in surplus, the surplus in services is especially strong. The current account surplus is higher than might be expected based on the economic fundamentals and also considering the cyclical position of the economy. The surplus is expected to gradually decline over the medium term, as investment and consumption increase. Graph 1.5:Net International Investment Position (NIIP) by sector Source: Eurostat The high current account surplus has contributed to the improvement of the net international investment position. The banking sector, which previously had a large negative position, has now built up net foreign assets. Non-financial corporations and the government have also lowered their liabilities (Graph 1.5). Liabilities associated with foreign direct investments are comparatively small. The net international investment position is expected to further improve thanks to the current account surplus and fall in government debt. Financial sector Slovenia's financial sector has a relatively stable funding basis and abundant liquidity. However, this liquidity exerts considerable pressure on profitability. The growing maturity mismatch between long-term loans and sight deposits exposes banks to a sudden rise in interest rates. The Slovenian state still plays a substantial role in the financial sector despite some significant divestments in the last quarter of 2018 and the future privatisations planned for 2019. Private debt The deleveraging process appears to have come to an end as credit flow from banks to the domestic economy has become positive again. Since the indebtedness ratio peaked in 2010 (at 125.4 % of GDP), private sector debt decreased to 82.5 % of GDP in 2017 (Graph 1.6) and is now below both prudential and fundamental benchmarks ( ). Both profits and wages are increasing, while domestic and export demand are forecast to grow and credit remains relatively inexpensive. Graph 1.6:Debt decomposition Source: Eurostat Housing market Increases in the prices of real estate reflect the recovery of the Slovenian economy. The robust GDP growth is being supported by employment, private consumption, consumer confidence, and bank loans to households, which are all co-dependent factors. The favourable economic situation led to increasing demand for real estate but supply has not responded. House prices have therefore been increasing strongly since summer 2016, reaching 13.4 % growth in the first half of 2018. While the prices of existing dwellings grew at 11.7 %, those of new dwellings rocketed in price by 26.8 %. Slovenia has now the highest growth in house prices of all EU Member States. Despite the strong increase in house prices, there is no indication of a new real estate bubble. House price growth seems mainly linked to the current limited supply of new residential real estate that is pushing up prices up. It is expected that with an increase in construction activity residential real estate price dynamics could moderate substantially in the near future. Low household debt, moderate growth of housing loans and a low stock of loans to the construction sector indicate that there is no sign of increased risk to the banking system. Although the aggregate valuation gap indicates that prices were undervalued in 2017, the recovery pace should be carefully monitored. Risks could increase in the event of excessive optimism about further growth in real estate prices. The Bank of Slovenia already issued two macro-prudential recommendations for the housing loans sector at the end of 2016 and has extended them in late 2018. Up to now, both of these recommendations seem to be effective. However, it is important that banks continue to maintain high credit standards in their housing loans. Regional disparities While not as pronounced as in other EU Member States, disparities exist between Slovene regions. Slovenia has two cohesion regions, less developed East Slovenia and more developed West Slovenia with GDP per head of EUR 16 000 and EUR 23 400 respectively, the latter just below the EU average (Statistical Office of the Republic of Slovenia). Slovenia’s economic structure differs between its regions with high employment shares in agriculture and manufacturing in the East and a comparatively stronger service sector in its capital and the West (European Commission, 2017a) (see sections 3.1 and 3.3). At the level of statistical regions, a downward convergence trend can be observed since 2007, with more developed regions experiencing a sizeable reduction in GDP per capita, while less developed ones managed to stay at approximately the same levels. The latter can also be attributed to targeted investments in less developed regions, including through EU funds, which remain key for ensuring convergence.

Labour market and socio-economic conditions vary between regions. Unemployment rates are below the EU average with low differences between East and West Slovenia. West Slovenia, however, shows significantly higher employment rates in high-technology and knowledge-intensive services sectors as compared to East. The share of the population with tertiary education is quite high (46.4 %) and well above the EU average (39.9 %). Nevertheless, there are significant disparities between cities/urban centres on one hand and smaller towns/rural areas on the other. Socio-economic indicators show a major divide between the growing capital that alone attracts skilled people in higher value-added sectors and the rest of the country where gains in employment are concentrated in lower-value-added sectors amid outward migration. Yet even the attractive capital region is facing the challenges of declining labour productivity and capacity constraints linked to a shortage of skills. Such inequalities can be tackled through bottom-up initiatives, utilising the community led local development approach, targeting socio-economically deprived persons/areas. Graph 1.7:Change in pro capita GDP from 2007 to 2016 Source: Eurostat Public finances indicators The general government overall balance is expected to stay in surplus for the third year in a row. In 2017, the general government balance turned positive, moving from -1.9 % of GDP in 2016 to 0.1 % of GDP. The ad-hoc forecast () predicts a surplus of 0.8 % of GDP for 2018, mainly due to strong revenue growth, reduced interest expenditure and low absorption of EU funds. Social transfers and compensation of public employees are expected to grow firmly in 2019, driven by a continuing relaxation in temporary restrictive measures and negotiations with trade unions. At the same time, public investment is projected to increase, supported by the improved take-up of EU funds. Taking all this into account, the government surplus is forecast to slightly decline to 0.7 % of GDP in 2019. In structural terms, Slovenia’s fiscal position is expected to worsen to -0.6 % of GDP in 2019 and stay unchanged in 2020, indicating that the country is engaged in a pro-cyclical fiscal policy. The debt-to-GDP ratio continues to decline. Supported by the economic recovery and active debt management, public debt is forecast to come down steadily to 62.5 % of GDP in 2020. Nevertheless, the long-term perspective is more challenging, as government expenditure is forecast to increase over the longer term, given that expenditure on pensions, health care and long-term care will increase due to the ageing of the population. Table 1.1:Key economic and financial indicators Source: Eurostat and European Central Bank as of 31/01/2019, where available; European Commission for forecast figures (Winter forecast 2019 for real GDP and HIPC, Autumn forecast otherwise) 2. Progress with country-specific recommendations Since the start of the European Semester in 2011, 88 % of all country-specific recommendations addressed to Slovenia have recorded at least ‘some progress' (see Graph 2.1). However, one out of nine CSRs have recorded no or only limited progress in the implementation. Graph 2.1:Level of implementation of 2011-2018 CSRs Source: European Commission In 2018, the political process in Slovenia was stalled by the snap elections held on 3 June 2018 and the difficult process of forming a new government. The new coalition government was endorsed by the parliament only on 13 September 2018. Since the resignation of the previous prime minister on 14 March 2018, neither the caretaker government nor the new government has tabled any major policy reforms relevant to the implementation of the 2018 CSRs ( ). The coalition agreement addresses a number of the issues discussed in the CSRs but is not sufficiently precise in terms of substance and timing to conclude on progress in the implementation of the CSRs and is neither politically nor legally binding. The public debt to GDP ratio was reduced but pressure on public finance in the long term remains. After the almost fourfold increase up to 82.6 % in 2015, public debt has decreased significantly since then and is expected to have been at 69.9 % of GDP in 2018. In parallel, the fiscal framework has been strengthened. Some measures have been taken to address the increase in age-related expenditure, but the pressure on the long-term sustainability of public finance remains significant. At the same time, temporary measures to contain public expenditure are expiring, leading to a pro-cyclical fiscal policy. The situation of the Slovenian banking sector improved significantly. Thanks to the improved macro-economic environment and robust policy measures, the banking sector has improved dramatically since 2014. The non-performing loans ratio declined sharply to 7.4 % in June 2018, down from 11.4 % one year earlier. At the same time, profitability increased and the average capital adequacy ratio is solid (18.8 % in June 2018) despite renewed credit growth. The partial privatisation of NLB carried out in 2018 and the plan to privatise Abanka in the first half of 2019 represent important steps to ensure the long-term viability of the sector. Measures have been adopted to improve the employability of lowskilled and older workers. Since 2011 the Council has recommended that Slovenia should take measures to increase the employability of low-skilled and older workers. The 2013 labour market reform and targeted active labour market policies somewhat increased employment opportunities for older and low-skilled workers, but their participation rate remains low. The Slovenian authorities have taken action to improve the business environment. They reduced administrative burden, removed some restrictions in regulated professions, and ensured better governance of state-owned enterprises. A comprehensive corporate governance system for state-owned enterprises has been put in place in recent years. Between 2010 and 2018, Slovenia reduced the number of regulated professions from 323 to 215; however, the initially fast progress in this area slowed down in recent years. In 2017, the planning and construction legislation was overhauled to reduce the previously high burden resulting from spatial and urban planning. Slovenia also uses national and EU funding to provide alternative funding for SMEs and fast growing companies. Table 2.1:Assessment of 2018 Country-Specific Recommendations (CSRs) Source: European Union Slovenia has made limited progress in addressing the first of the 2018 CSRs. The government continued its efforts to increase the employability of low-skilled and older workers through lifelong learning and activation measures. It announced that a new draft Healthcare Act should be adopted by the government by the end of 2019, but it is still open how it should be financed. While a two-year pilot project has been initiated in 2018, there are no plans to table a legislative proposal on long-term care in 2019. No concrete measures have been taken to ensure the long-term sustainability and adequacy of the pension system. Slovenia has made some progress in addressing the second of the 2018 CSRs. Some progress has been made in implementing key equity funding support schemes. The so-called "Single Document" and the Investment Promotion Act has brought some progress in reducing barriers and administrative burdens and to stimulate domestic and international investments. The 2018 Action Plan on Professionalisation is a good basis for further professionalising public procurement in Slovenia, while overall progress is only limited due to a lack of action as regards competition, independent oversight and health sector tender aggregation. With the sale of 65 % in Nova Ljubljanska Banka (NLB) and the launch of the selling process for Abanka, Slovenia has made some progress in the execution of its privatisation plans.

Slovenia's draft budgetary plan for 2019 would not ensure that the nominal growth rate of net primary government expenditure does not exceed 3.1 % in 2019. This draft budgetary plan was transmitted to the European Commission on 15 October and is based on a ‘no-policy-change’ assumption. The government plans to prepare updated budget in the first quarter of 2019. Box 2.1: EU funds and programmes contribute to addressing structural challenges and to fostering growth and competitiveness in Slovenia Slovenia is a relatively large beneficiary of EU solidarity with EU investments representing almost 40 % of all national public investment. The financial allocation from European Structural and Investment Funds (ESI Funds) aimed to support Slovenia in facing development challenges, amounts to EUR 3.9 billion in the current Multiannual Financial Framework, equivalent to around 1.4 % of the GDP annually. The additional national co-financing of around EUR 1 billion brings the budget to EUR 5 billion. By the end of 2018, around EUR 2.8 billion were already allocated to specific projects. In addition, EUR 332 million were allocated to specific projects on strategic transport networks through a dedicated EU funding instrument, the Connecting Europe Facility. Furthermore, numerous Slovenian research institutions, innovative firms and individual researchers benefited from other EU funding instruments, notably Horizon 2020 which provided around EUR 210 million. EU funding has helped to address policy challenges identified in the 2018 CSRs. ESI Funds support competence centres for skills development in niche areas with the biggest potential for raising the international competitiveness of the economy. ESI funds also play a key role in enhancing the implementation of the European Pillar of Social Rights, with targeted investments in services and infrastructure designed to enhance the access to affordable, sustainable and high quality healthcare, long-term care and social care. In addition, European Social Fund supports tailor-made social inclusion and activation programmes for the most vulnerable groups, in particular older, low-skilled or long-term unemployed workers. ESI Funds supported closer collaboration between business and research institutions, and R&D investments in the private sector with direct support for nearly 6000 enterprises. Infrastructure in Slovenia was also improved, namely, 13 km of new motorways were constructed, the projects for more than 51 000 tonnes of CO2 equivalent reduction have been decided, additional capacity of 26 megawatt of renewable energy capacity has already been contracted, and more than 300 000 persons will be served by improved wastewater treatment. In addition, the Commission can provide tailor-made technical support upon a Member State's request via the Structural Reform Support Programme to help Member States implement growth-sustaining reforms to address challenges identified in the European Semester process or other national reforms. Slovenia, for example, received support from the Commission to assess and improve the performance of its health system, to prepare work for the pending long-term care reform, and to provide better protection for children in need with the development of a feasibility study for setting up a House of Children. Support is also being provided to Slovenia to attract foreign direct investment, as well as to enhance the performance of state owned enterprises. In addition, the Commission is assisting the authorities in their efforts to increase the awareness of capital market financing possibilities, in particular on initial public offerings and to develop the national capital markets. In 2018, preparatory work started to enhance the efficiency of the bank supervision system with a view to improving financial stability and macro-prudential policy design. EU funding contributes to mobilisation of public and private investment through grants and financial instruments. Around EUR 306 million (7.8 % of the total) is earmarked to be delivered in the form of loans, microloans, portfolio guarantees and equity. The investments carried out via Financial instruments will be focused on R&D, SMEs, energy efficiency, urban development, processing of agricultural products and development of non-agricultural and forestry activities in rural areas. In Slovenia, the overall volume of operations backed by the European Investment Plan's European Fund for Strategic Investments (EFSI) by December 2018 amounts to EUR 161 million, which is set to trigger a total of EUR 941 million in additional private and public investments. EU actions strengthen national, regional and local authorities and the civil society. EUR 209 million (from ESIF) have been allocated for strengthening the capacity of public administrations at different levels by prompting close cooperation with stakeholders. The Regions in industrial transition action helps to address specific challenges, such as low skills-base, high unit labour costs and deindustrialisation. https://cohesiondata.ec.europa.eu/countries/SI 3. Reform priorities 3.1.Public finances and taxation 3.1.1.FISCAL POLICY The general government headline balance turned positive in 2017 but the structural deficit has been declining since then. In 2017, the budget reached a surplus of 0.1 % of GDP, up from a deficit of -1.9 % of GDP in 2016. According to the ad-hoc forecast, the surplus accelerated further to 0.8 % of GDP in 2018 and is expected to decline slightly to 0.7 % of GDP in 2019. In structural terms, the government balance is forecast to have reached a structural deficit of 0.5 % of GDP in 2018. The structural deficit is expected to worsen further to 0.6 % of GDP in 2019 ( ). Taking Slovenia’s position in the economic cycle into account, this indicates a pro-cyclical fiscal policy and a missed opportunity to strengthen fiscal sustainability. Expenditure pressures continue to build up. Over the course of 2018 and 2019, previously introduced temporary consolidation measures in the field of public-sector pay and social allowances have been gradually relaxed. In addition, Slovenian authorities and trade unions reached agreement on a substantial pay rise amounting to EUR 308m in 2019-2020 in November 2018. Therefore, after recording high growth in 2018, social transfers and compensation of employees are projected to further increase in 2019. Recurrent taxation of immovable property and capital is below the EU average while the tax burden on labour is relatively high. Recurrent taxation of immovable property is considered to be less distortive to economic growth than labour taxes. However, the share of recurrent tax revenues from immovable property to GDP is around three times lower in Slovenia compared to the EU average (0.5 % of GDP compared to an EU average of 1.6 % in 2017). A larger fraction (around 70 % according to OECD data) of property tax burden is borne by businesses. In terms of revenues from capital taxes relative to GDP, Slovenia ranks among the lowest in the EU (4.3 % of GDP compared to an EU average of 8.6 % in 2017). At the same time, secondary earners with low wages face high labour tax rates, decreasing their work incentives ( ). A new reform on real estate tax is planned for 2020 with the aim to relieve businesses and to link the tax base to the properties’ market value in a budget neutral way, using a mass valuation system. The Mass Valuation Act was adopted and is expected to be applied to all properties in mid-2019. Box 3.1.1 discusses the simulation results of an increase in real estate tax for households, compensated by a revenue-neutral reduction in tax burden on labour and a strengthening of the social safety net. 3.1.2.FISCAL FRAMEWORK The Fiscal Council warns of non-compliance with fiscal rules in the years 2018 to 2021. The Fiscal Council assessed that most fiscal rules were respected in 2017 and that the fiscal policy was appropriate (Fiscal Council, 2018a). However, after examining the 2018 stability programme drafted based on unchanged policies, it called on the government to take additional measures to avoid non-compliance with the fiscal rules in the years 2018 to 2021. According to the Fiscal Council, the coalition agreement fails to address adequately long-term risks to fiscal sustainability. The Fiscal Council warned in autumn 2018, and again in January 2019, that, if implemented as agreed, the fiscal policy of the new government would be pro-cyclical (Fiscal Council, 2018b; Fiscal Council, 2019). 3.1.3.DEBT SUSTAINABILITY ANALYSIS and Fiscal risks Government debt has been gradually decreasing from its peak of 82.6 % of GDP in 2015. Since 2016, Slovenia has been extending the maturity of its debt portfolio and executing cross-currency liability management transactions, thus, benefiting from the low interest rate environment. Due to this, Slovenia could reduce its implicit interest rate to below 3 % of GDP by the end of 2018 from 4.1 % of GDP in 2015. Because of strong economic growth, reduced interest expenditure, and the 2017 primary surplus, the debt-to-GDP ratio declined from 74.1 % of GDP in 2017 to 69.9 % of GDP in 2018. Based on the ad-hoc forecast, the debt ratio will stand at 66.2 % of GDP in 2019. The outlook for fiscal sustainability appears sound in the short term. The short-term risks of fiscal stress in the short term, as indicated by the sustainability gap indicator S0, are low, with both fiscal and financial competitiveness sub-indices far below the critical thresholds. Overall, Slovenia is deemed to face medium fiscal sustainability risks in the medium term. The sustainability gap indicator S1 points to medium risks, mainly due to the projected increase in age-related public spending ( ). According to this indicator, a cumulative gradual improvement in the structural primary balance of 0.2 percentage points of GDP, relative to the baseline scenario, would be required over 5 years to reach the debt ratio of 60 % of GDP by 2033 ( ). At the same time, the debt sustainability analysis points to low risks over the medium term. Under the baseline scenario of no-policy-change ( ), the government debt level is expected to decline until 2027, thanks to the projected fiscal effort and a favourable differential between the implicit interest rate on government debt and the growth rate of the economy (snowball effect). As ageing costs start outpacing these two positive effects, debt is projected to increase again in 2028 and 2029, but stay well below the 60 % government debt-to-GDP ratio reference value. If Slovenia was to adhere to the fiscal rules under the Stability and Growth Pact ( ), the debt-to-GDP ratio would lie 15 percentage points below the baseline projection in 2029. By contrast, government debt in 2029 would exceed the 60 % of GDP threshold if the structural primary balance converges to its historical average (Graph 3.1.1) ( ). Graph 3.1.1:Gross debt as % of GDP - Debt Sustainability Analysis Source: European Commission The projected increase in age-related expenditure poses a challenge to the sustainability of Slovenia’s public finances in the long term. Age-related public spending is expected to rise from 21.9 % of GDP in 2016 to 28.2 % of GDP in 2070, strongly affecting the sustainability gap indicator S2. The S2 indicator shows that a fiscal adjustment of 5.5 percentage points of GDP is required to ensure the debt-to-GDP ratio stabilises in the long term ( ). This result is primarily due to the projected increase in spending on pensions (contributing 3.3 pps of GDP to the increase), health care (0.8 pps of GDP) and long-term care (0.7 pps of GDP). Slovenia is considered at medium risk in the baseline long-term projections. However, the more adverse scenarios (including greater spending on health care and long-term care, historical patterns for structural primary balance or higher life expectancy) indicate high long-term fiscal sustainability risks to be borne by future generations. 3.1.4.PENSION SYSTEM The 2012 pension reform brought tangible benefits, but population ageing puts considerable pressure on the sustainability and adequacy of the pension system. The pension reform (ZPIZ-2) ( ) has temporarily slowed down the increase ( ) in the number of old-age pensioners. It also decreased the number of other types of pensioners ( ). The current rules are expected to keep the pension system relatively stable over the next 10years but the long-term sustainability of the pension system is not ensured. In 2017, the previous government reached a consensus with the social partners on key starting-points for the modernisation of the pension and disability insurance system. They agreed upon the broad outline of a pension reform to be adopted by 2020. The outline includes measures to achieve a sustainable and transparent pension system, which will also provide adequate pensions in the long run. The work priorities for the government published in January 2019 refer only to an update of the White Paper and the “drafting of core points of departure” for a reform but do not provide a time line.

Long-term projections indicate that pension spending will soon start increasing again and that the ratio of the active working population to pensioners will deteriorate faster. Gross public pension expenditure, as a share of GDP, will rise from 11 % in 2020 to 15.6 % in 2050. This shows that expenditure on pensions will increase at one of the fastest rate among all EU countries (European Commission, 2018b). This can mostly be explained by (i) early exit from the labour force, itself largely a result of previous pension legislation, and (ii) the retirement of the most sizeable generations, which will also enjoy longer retirement due to increased longevity (IMAD and MoLFSAEO, 2018). Previous financial consolidation measures heavily affected the level of current and future pensions and the minimum income provision for older people. The challenge to ensure adequate pensions is especially significant for people with incomplete or short working careers, those working in intermittent jobs, and the self-employed. As the number of people working part-time or on fixed-term labour contracts increased during the economic crisis, pension adequacy might become even more critical in the future (European Commission and Social Protection Committee, 2018). The at-risk-of-poverty rate (AROPE) ( ) among those over 65 remains above the EU average, mostly due to relatively low pensions (see Section 3.3.3). At present, the replacement ratio of pension income to income before retirement is below the EU average. The Slovenian pension system produces a lower aggregate replacement ratio (0.47 compared with the EU average of 0.58). And even though total household savings are high compared to other EU countries, Slovenes save relatively little for old age (IMAD and MoLFSAEO, 2018). The act Amending the Pension and Disability Insurance Act in 2017 (ZPIZ-2C) increased the minimum old-age and disability pension to EUR 500 per month for pensioners who had fulfilled the full retirement conditions. This amount slightly exceeds the income threshold for entitlement to income supplement, thus ensuring basic social security for this group of pensioners. (European Commission, 2018b) The number of pensioners affected by this reform was estimated at 45 291 (46 % of all pensioners with a pension between EUR 400 and EUR 500) (European Commission and Social Protection Committee, 2018). Data on the working years of younger generations reveal substantially lower values of pension base. Younger generations will have accrued a lower number of working years at retirement age and consequently receive lower pensions. (European Commission and Social Protection Committee, 2018). The low number of accrued working years is even more of a concern for non-standard workers, whose lower density of work (compared to standard employment) is an additional problem. Relatively short insurance periods have negative consequences for the long-term social security of workers on fixed-term contracts (including casual and seasonal workers, temporary agency workers, workers on civil contracts, etc.). Student work now qualifies as a pension insurance period, but the insurance base is low. Self-employed workers face challenges for the adequacy of their pensions if they only pay minimum contributions. Self-employed people ( ) in Slovenia are insured against all risks and at the same rates as employees on permanent full-time employment contracts and their employers. However, almost 70 % of the self-employed pay social security contributions at the minimum base and will be entitled to the minimum old-age pension only (European Commission and Social Protection Committee, 2018). 3.1.5.HEALTH CARE AND LONG-TERM CARE The projected increase in healthcare spending threatens the long-term fiscal sustainability of the system. In 2017, Slovenia spent 8.0 % of GDP on healthcare, which is below the EU average of 9.6 %. However, driven by changes in demographic structure, public spending on health care is projected to increase by 18% or 1.0 pp. of GDP, more than the 13% average increase in the EU (0.9 pps) according to the ‘AWG reference scenario’ (European Commission, 2017a). When taking into account the impact of non-demographic drivers on future spending growth (‘AWG risk scenario’), healthcare expenditure is expected to increase by 2 pps of GDP from now until 2070 (EU: 1.6 pps). The share of government budget funding for healthcare is one of the lowest in the EU but healthcare financing is still highly pro-cyclical. General national and municipal-level taxation represents only 6 % of current health expenditure. Transitioning towards a system that is less reliant on contributions could improve the future stability of healthcare financing. The Slovenian authorities are currently preparing a policy reform to avoid further strain in the financing of the system, but no act has been adopted yet. The services intend to update a new draft Health Care and Health Insurance Act and the draft Long Term Care Act and to consult on them publicly before submitting them to the parliament in 2019. The authorities plan to focus on efficiency and effectiveness of healthcare. They aim to reduce waiting times and to improve the efficiency and effectiveness of the public health network (the management of healthcare institutions, quality and safety in healthcare and in long-term care for the elderly and decent ageing). The financing of the reform remains the main unresolved issue. Amenable mortality levels are in general low, but challenges remain. Life expectancy at birth remain one of the best in the EU. On the other hand, preventable mortality and obesity rates are above the EU average with evident differences between NUTS 3 regions. Mortality from liver cirrhosis in men is among the highest in Europe. In the elderly population, healthy life years at the age of 65 are below EU average. In 2016, healthy life years were 8 pps below the EU average for women and 6 pps below the EU average for men (IMAD, 2018). Investments in modernising health infrastructure, such as addressing disparities between regions in terms of hospital beds per population ratio, services for prevention, screening and early diagnosis at the primary care level, specialised diagnostic and treatment programmes at outpatient and palliative care can improve efficiency in healthcare. EU funds are supporting health promotion activities to reduce health inequalities at community level and promote healthy lifestyles. An ageing population and a growing burden of chronic diseases is expected to boost demand for a more efficient mix of care models. Provision of acute care hospitals beds is above the EU average (422 beds per 100 000 inhabitants in 2015 versus 402 in the EU) However, the occupancy rate of acute care hospital beds is below average (68.8 % in Slovenia compared to 76.8 % in the EU). This points to excess capacity, suggesting there is room to improve efficiency with the existing infrastructure ( ). The proportion of surgical procedures conducted as day cases is extremely low compared to the EU average (9.7 % versus 32.3 % in 2015). Moreover, there may be scope to increase medical equipment if the lack of such equipment contributes to excessive waiting times for diagnostics ( ). Attracting physicians to primary care remains difficult. Although there has been a steady increase in recent years, the number of physicians and the share of general practitioners are still below the EU average (19 % versus 23 % in the EU). The uneven geographic distribution of doctors and difficulties in recruiting and retaining doctors in all areas are significant policy issues. Slovenia does not have enough healthcare personnel, which makes it a priority for the country to use its available resources as effectively as possible, for example through training, research opportunities and e-health solutions. Public procurement aggregation in Slovenia's health sector remains underdeveloped ( ). In 2018, not much progress was made to improve procurement aggregation, besides the extension of a database on prices. The reason for this was a lack of staff. Slovenia has not yet set up a dedicated central purchasing body for health sector procurement, which would bring about a higher level of professionalisation. This would make it possible to organise centralised procurement procedures and to advise individual hospitals on procurement procedures for very technical supplies. The lack of a proper procurement strategy for the health sector limits Slovenia's ability to harmonise tenders, share expertise for tenders and effectively mitigate the risk of bid-rigging. The services envisage the creation of a health technology assessment agency. Health technology assessment would be an asset in the efficient allocation of resources and could help to determine which benefits should be covered by the Health Insurance Institute of Slovenia. Only certain mechanisms of it are used during regular assessments within the Agency for Medicinal Products and Medical Devices of the Republic of Slovenia, the Health Insurance Institute of Slovenia and the Health Council. Waiting times for medical treatment depend on efficient healthcare services. The share of unmet need due to waiting times is broadly in line with the EU average. However, waiting times have increased markedly in Slovenia (see also box 3.3.1). The share of people reporting waiting times for some specialist services increased from 6 % in 2007 to 13 % in 2015 (OECD/European Observatory on Health systems and Policies, 2017). Moreover, only about 67 % of patients aged 65 and over were operated on within 2 days of their admission for a hip fracture, below the EU average of 77 %. Information and communications technology could improve nationwide access to information, including the monitoring of waiting times for a broad set of services. In 2014, the share of Slovenes reporting depression was above the EU average. National reports suggest an increasing trend of mental health incidents in children and young people in recent years ( ). Reports also suggest overcrowding in social-welfare institutions. In March 2018, national authorities started to follow up on these issues with the adoption of a Resolution on a National Mental Health Programme 2018-2028. Due to population ageing, the number of elderly needing long-term care (LTC) has been increasing, and will continue to increase. In 2015, there were more than 61 000 recipients of long-term care ( ). The provision of services is quite fragmented, as only recipients in institutional setting receive integrated long-term care. The rest are in home care (OECD/European Commission 2018). It has been estimated (Majcen et al., 2016) that, in addition to home and institutional care, there were 104 000 people receiving informal care in Slovenia, and that the care needs of 35 500 were unmet. There is also a discrepancy between urban and rural areas. Rural areas frequently do not provide sufficient institutional care or home care, while urban areas tend to offer a wide range of services. The coalition agreement mentions the establishment of an autonomous, integrated and sustainable LTC system one of the main goals of the new government. To date, there is still no single, overarching legislative act in Slovenia that covers LTC. The current fragmented system in Slovenia results in financing challenges, risks of inefficiencies and may cause difficulties for users (European Commission, 2018b). In 2020, the government intends to put forward a unified legislative act on LTC with a comprehensive description of the services to be provided. However, at present, the financing of the services still needs to be agreed at inter-ministerial level. There will also be accompanying measures such as training of staff, use of information and communication technologies, promotion of social inclusion and elderly employability programmes to achieve a higher quality of life for the elderly and help them stay at home as long as possible. There is also a plan to set up a real estate strategy to take care of the specific needs of an ageing population. A two-year pilot project was launched in 2018 to help prepare concrete measures to reform LTC. Its main objective is to assess solutions proposed in a draft legislative act on LTC in three environments (urban, semi-rural and rural) and to show their advantages and shortcomings in practice. The project therefore aims to establish a single entry point for the LTC system in Slovenia that will provide an affordable, accessible and fair service to the population. It will also offer training and support coordination between service providers, non-governmental organisations, volunteers and local communities. 3.1.6.State OWNED ENTREPRISES

The performance of state-owned enterprises further improved in 2017. In 2017, the performance of state-owned enterprises, that are fully managed by the Slovenian Sovereign Holding (SSH), exceeded the targets set in the management acts, with a 6.5 % net return on equity on an aggregated basis (SSH, 2018). While the return on equity increased by 0.6 pps to 6.3 % for the ‘strategic companies’ ( ), it decreased by 1 pp. to 8.9 % for the rest of the portfolio. The sale of 65 % of the shares in NLB on the stock market in autumn 2018 is a significant step in the reduction of state ownership in the banking sector. Until that sale, NLB was fully state-owned and the state still remains the largest individual shareholder. With the sale, which had been long delayed, Slovenia has fulfilled the first set of commitments (as amended in 2018) given to the European Commission in reaction to the state aid provided to NLB in 2013. SSH intends to proceed with the privatisation according to the strategy and in line with the commitments given by Slovenia to the European Commission. This means that the remaining proportion of shares (of up to 75 % minus one share) will be sold before the end of 2019. As a next step, Abanka, the third largest bank in Slovenia, will be privatised in 2019. The sales process was already launched in October 2018. The privatisation of this fully state-owned bank should be completed in 2019. Box 3.1.1: Shifting taxation from labour to immovable property The European Commission Joint Research Centre conducted simulations of the effects of a tax shift from labour to immovable property in Slovenia. The simulations are based on the EUROMOD model using 2016 EU-SILC data ( I ). The key assumption is an increase in the revenues from recurrent taxation of immovable property from currently 0.5 % of GDP to the EU average of 1.6 % of GDP (European Commission, 2018c). In addition, the households’ share in the revenues from recurrent property taxation is set to rise from around 30 % to 50 %, in line with the government’s intention to reduce the burden on businesses (as indicated in the released blueprint for the new recurrent property tax). The simulation estimates the distributional and labour supply ( II ) effects of two hypothetical scenarios to use the extra revenues for: (i) a refundable means-tested benefit for residents with low incomes (‘Scenario 1’) ( III ); (ii) a refundable lump-sum reduction in employees’ social insurance contributions (SIC) for active employees older than 55 or with low incomes (‘Scenario 2’) ( IV ). Both scenarios would result in a revenue-neutral reform. Scenario 1 reduces the tax burden on labour for employees and strengthens the social support for vulnerable groups, i.e. pensioners (see section 3.1.4.). The results reveal a strong positive distributional effect as the increase in disposable income caused by the means-tested benefit more than offsets the reduction caused by the higher tax rate on immovable property for lower-income households. Inequality as measured by the S80/S20 quintile ratio decreases by 1.9 % (Graph 1). In terms of labour supply, Scenario 1 shows a shift to part-time work (increase by 0.6 %) while the labour market participation remains broadly unchanged (decrease by 0.05 %). This result could be explained by employees’ decision to substitute work time for leisure (income effect) combined with the choice of inactive people not eligible for the benefit to take-up work (substitution effect). In Scenario 2, the impact on labour supply is positive, especially for singles, with their labour market participation and total hours worked rising by 0.4 % (see section 3.3.3.). At the same time, the inequality decreases, although only slightly compared to Scenario 1. Overall, both scenarios show a positive impact of a revenue-neutral tax shift from labour to immovable property, with a positive distributional effect in Scenario 1 and a favourable labour supply outcome in Scenario 2. 3.2. Financial sector 3.2.1.BANKING SECTOR Table 3.2.1:Financial soundness indicators - all banks in Slovenia Source: European Central Bank - Consolidated Banking Data (CBD2); own calculations The situation of the Slovenian banking sector has improved significantly, due to improved profitability, solvency and asset quality. The return on equity reached 9.1 % in 2017, up from 7.8 % in 2016, mainly because of lower impairments, downward revaluations of fixed assets held by the banks. However, profitability might come under pressure when the current release of provisions ends. The average capital adequacy ratio remains stable (18.8 % in June 2018) despite renewed credit growth. Credit to households continued to grow at a sustained year-on-year rate of 6.8 % in September 2018, while lending to non-financial corporations has slowed down to a rate of around 2.0 %. With a loan-to-deposit ratio of 75.5 % in June 2018, banks benefit from a substantial excess of deposits over loans. This ensures a relatively stable funding basis and abundant liquidity. However, the growing maturity mismatch between long-term loans and sight deposits makes banks vulnerable to a sudden rise in interest rates. To maintain profitability, banks must control costs and find new sources of income. Current profitability is mainly driven by lower impairments and by releasing previous impairments. This is bound to change as new lending progressively generates new impairments. Bank profitability is also likely to come under pressure from persistently low interest rates and increases in compliance, prudential, supervisory, and investment costs. One possible strategy to offset these negative factors is to focus on fee income and to develop new lending products and services, while enforcing strict and prudent risk management practices. Banks could also opt for partnerships or acquisitions to reduce their costs and achieve economies of scale. Strong consumer lending growth raises credit risk, and has led the Bank of Slovenia to issue specific recommendations. Consumer lending grew by 11.6 % year-on-year in September 2018, partly driven by the pushy behaviour of some medium-sized banks underwriting non-purpose-specific consumer loans of longer maturities. To prevent the relaxation of credit standards and to improve banks’ resilience, the Bank of Slovenia decided on 22 October 2018 to expand the existing macroprudential recommendation for housing loans to all consumer loans. Concretely, banks are invited to cap the loan-to-value ratio at 80 %, the debt service-to-income ratio at between 50 % and 67 % and the loan maturity at 120 months. In the event of increased risks to financial stability, the Bank of Slovenia stands ready to introduce binding macroprudential instruments if necessary. The non-performing loans (NPLs) ratio has improved further and reached 7.4 % in June 2018, down from 11.4 % one year earlier. The segment of the credit portfolio most heavily burdened with NPLs is non-financial corporations, despite improving credit quality (according to the European Central Bank respectively for 33 %, 30 %, 10 % and 10 % of the reduction in non-performing exposures in 2017). Banks were also more active in reducing non-performing exposures to non-residents in 2017 than in previous years. After several years of moderate losses, the state-owned Bank Asset Management Company (BAMC) made a profit of EUR 67 million in 2017 and EUR 20 million in the first half of 2018. This translates into an average annual ROE of 27 %. Between its inception in 2013 and October 2018, the BAMC, which bought up bad loans from the country's banks in 2013 and 2014, generated cumulative cash flows of EUR 1.5 billion, representing nearly 72 % of the transfer value of its assets. The last bonds issued to finance asset transfers were repaid in December 2017 and refinanced by bank loans. In June 2018, the BAMC managed to sell 56 % of the initial EUR 2 billion of assets transferred to it. Its objective is to reduce its assets to EUR 100 million by the end of its mandate in December 2022. Still, the BAMC is confronted with a number of challenges. For example, achieving the cost efficiency ratio set by the government will become more and more difficult as residual assets are more costly to manage. In addition, keeping skilled staff with knowledge of the files in a company with a short life expectancy is challenging as their competences can sometimes be better remunerated elsewhere. The stake of the Slovenian state in the financial sector has recently decreased; however it remains substantial, in particular in insurance. The Slovenian state controls a significant share of the financial sector through its stakes in NLB, Abanka-Celje and Sava Re. It has recently made steps in the right direction such as the sale of NLB shares in 2018, the commitment to reduce state ownership to 25 % plus one share by the end of 2019 and the privatisation of Abanka-Celje in 2019 (see Section 3.1.6.). In the insurance sector, the stake of the state is 60 %, an unusually high share in such a non-strategic sector, making Slovenia an outlier in the EU. Two attempts by a foreign insurance group to increase its stake in Sava Re were rejected. As demonstrated by the crisis that hit Slovenia in 2013, maintaining a high level of state involvement may entail risks in the long run for financial stability, economic efficiency and public finances. 3.2.2.Access to finance for Small and Medium-sized companies Internal finance and bank credit conditions are satisfactory for Slovenian businesses. Slovenian businesses, notably SMEs, heavily rely on bank credit ( ) and internal finance to cover their funding needs (EIB, 2018; SAFE, 2018). While larger Slovenian businesses do not perceive funding as a major constraint, the situation for SMEs is more nuanced ( ). Banks in Slovenia remain cautious when lending to SMEs. High guarantee requirements by banks remain an issue (Bank of Slovenia, Survey 01/2018). A lack of equity funding options in Slovenia is a risk for the prospective financing of debt-leveraged firms and might constrain the growth of innovative businesses. Access to alternative finance is slowly improving in Slovenia, though from a very low level. Equity funding represents only a minor share of financial resources available to SMEs. Private equity in Slovenia amounts to only 0.05 % of GDP compared to 0.2 % in Central and Eastern Europe and 0.44 % on average across the EU (Invest Europe CEE, 2018). The country ranked among the lowest of EU Member States in terms of venture capital share of GDP (Invest Europe, 2017). While many SMEs consider equity capital as relevant, few really use it (SAFE, 2018) ( ). The limited and underdeveloped capital market, combined with the unfavourable framework conditions, hampers inflows of equity and venture capital into the country. This type of funding is particularly important for innovative start-ups in high tech and high growth sectors (see Section 3.4.2). The role of capital markets in financing the Slovenian economy is limited and falling. Despite the favourable economic conditions, the market capitalisation of the Ljubljana Stock Exchange is low and the number of stocks listed there has actually fallen (IMAD, 2018). To address this, the Ljubljana Stock Exchange, following the initiative of the Securities Market Regulator (ATVP), has provided tailored technical assistance and advisory support on listings and the issuance of bonds to SMEs (Ljubljana Stock Exchange, 2018). Development of the local capital market could be stimulated by growth funds, further listings (including of state-owned enterprises), and a pension reform (including long-term supplementary savings), resulting in more equity investments by pension funds. The lack of financial and investment literacy in SMEs remains an issue. Despite advice and training offered by public institutions, SMEs' access to finance is still hindered by a lack of financial and investment literacy and of support in the process of applying for bank loans, public financial incentives and alternative financial sources (European Commission, 2018i). Slovenia offers various finance schemes for businesses, notably SMEs. These schemes provide, for example, microloans or guarantees ( ) and also create or participate in new instruments to support business funding. They are backed, directly or indirectly, by EU funds, including the cross-border Central Europe Fund of Funds. Implementation of most of them is ongoing so that it is too early to assess their impact. Slovenia is strong in blockchain-based financial technology solutions and has started to work on a corresponding regulatory framework. Slovenian companies have had a high success rate on several international crowdfunding platforms, notably Kickstarter. Over 300 SMEs have raised around EUR 8.8 million in recent years (European Commission, 2018i). Slovenian companies also raised significant funding through initial coin offerings in the last 2 years. In 2017, around 5 % of funds raised in global initial coin offerings went to Slovenian projects. The government is actively promoting block-chain technologies ( ) and has adopted an action plan in May 2018. It is now preparing a regulatory framework for investor protection in this area.

Broader use of financial instruments for EU funds presents untapped potential to improve Slovenia’s funding system. With a wide portfolio of different products, EU funds are helping to diversify financial markets and improve the capacities of commercial banks, through which the instruments are delivered. Broader use of financial instruments for revenue generating or cost-saving activities in the future could result in better access to financial markets. It could also make it easier to find the optimal financing mix to address regional disparities. 3.3. Labour market, education and social policies 3.3.1.Employment Labour market performance continues to improve, although certain challenges remain. Activity and employment rates continued to increase in 2018 and are currently at 79.7 % and 75.5 % respectively (Q3 2018). The unemployment rate is at 5.2 % (Q3 2018), close to the pre-crisis level. However, the activity and employment rates of older workers (aged 55-64) remain well below the EU average, despite increases in recent years. This is particularly the case for low-skilled older workers, who had an activity rate of 29.4 % (EU: 47.4 %) and an employment rate of 26.6 % (EU: 42.3 %) in 2017. Long-term unemployment is still above pre-crisis levels and almost half of the unemployed aged over 50 have been out of the labour market for 2 years or more. Although it had been decreasing in previous years, long-term unemployment remained at 3.1 % ( ) in 2017, still accounting for almost half of total unemployment. More than 40 % of the long-term unemployed are older than 50 years of age. Further targeted investments in training could help to improve the weak employment situation of low-skilled and older workers. Graph 3.3.1:Activity rate by age and educational attainment in 2017 Source: Eurostat The main reason for the inactivity of older people appears to be early retirement. According to self-declared reasons for not seeking work based on the Labour Force Survey (Graph 3.3.2), the main reason for the inactivity of older people (aged 55-64) in 2016 was early retirement. The inactivity in this age category therefore has a direct negative impact on the sustainability of the pension system (European Commission (2018a). In the age category 45-54, disability or illness were also mentioned as reasons by a large share of the inactive. For younger people (25-34), education was the main reason for inactivity of men, whereas for women personal, family, or care responsibilities were also mentioned. The latter also remain important reasons for inactivity of women in the older age categories (35-54). Graph 3.3.2:Reasons for inactivity by age and sex, 2016 Source: European Commission The government intends to focus its efforts on reducing the low employment rate of workers in the age categories 45-54 and 55-64. Inactivity of people in these age categories has a direct negative impact on the sustainability of the pension system. Government efforts intend to increase the employment rate through additional activation measures to incentivise older workers to work longer. The government also seeks to identify and discontinue any remaining bridges, which induce people to go from long-term sick leave or long-term unemployment directly into retirement (see European Commission, 2017b). Different structures and funding needs in Public Employment Service offices are one of the challenges in Slovenia. Good coordination between local offices and a less central approach in setting measures could improve effectiveness. Project-based financing remains a challenge, as it leaves many offices with budgetary constraints and a fluctuating number of counsellors. The changing labour market situation requires a rich and stable pool of counsellors in local offices to guarantee services to the unemployed. An integrated approach that also involves the support of social services, developed with the help of the European Social Fund, should have a positive impact when it is launched. Graph 3.3.3:Labour shortages, Slovenia 2008-2018 Source: Eurostat In order to reduce long-term unemployment, the focus group of Employ.me 2017/2019 ( ), the active labour market policy programme, was expanded last year. Persons older than 50 and persons aged over 30 ( ) may now be included in subsidised employment immediately after having registered as unemployed, rather than after having been registered for at least 6 months as was previously the case (MOLFSAEO, 2018). In December 2018, the Slovenian parliament adopted an act to increase the minimum wage gradually to EUR 700 net in 2020. The minimum wage will increase from EUR 638 at present to EUR 667 in 2019 and to EUR 700 in 2020. In addition, bonuses, which are currently included in the minimum wage, would be excluded as of 1 January 2020. The provisions will ensure that the minimum wage will be at least 20 % above minimum living expenses and will not exceed them by more than 40 %. While this measure would help those in low-paid jobs and increase their purchasing power, there is a risk that it may create inflexibility in the labour market and reduce the number of (new) job creations, in particular when the business climate is less favourable. Participation in adult learning by low-skilled people, older workers and the inactive is below the EU average. In 2017, 12 % of adults participated in learning, which is 1.1 pps above the EU average. However, the share of low-qualified adults participating in learning (as percentage of all low-qualified adults) was 2.9 % in 2017 below the EU average of 4.3 %. The 2016 Adult Education Survey shows that 97.5 % of older workers and 95.9 % of low-skilled workers were not willing to participate in adult learning and training activities. To address falling participation in adult learning, the government adopted a new Adult Education Act in 2018. The Act establishes educational guidance in adult learning as a public service in support of lifelong learning participation, self-directed learning as well as the validation and recognition of prior learning. Professional counsellors can help adults identify learning needs, develop a career plan, find relevant programmes and financial support, and achieve completion (OECD, 2018). Encouraging participation in adult education – in particular of low-skilled, older and inactive workers – is also a promising way to fill shortages in some occupations, presenting opportunities for the long-term unemployed to return to the labour market. The share of employees in temporary and precarious jobs remains above the EU average. The share of temporary contracts was at 14.6 % in 2017, while the EU average was at 11.3 %. At the same time, the transition rate from temporary to permanent contracts has increased by 2.5 pps since 2007 and was relatively high at 38.4 % in 2017. Nevertheless, the share of involuntary temporary employees was 9.4 %, above the EU average of 7.8 % (2017). Moreover, the share of employees with a precarious job ( ) was 5.1 % in 2017, more than double the EU average of 2.3 %. 3.3.2.EDUCATION AND SKILLS Slovenia has a generally well performing education system, but it could be improved in certain areas and sustained for the future. Slovenian students in general education perform well in international comparisons. Socio-economic status is comparatively less important for education outcomes (European Commission 2018b). Its importance, however, grows with the level of education (Cankar et al., 2017) and there are visible disparities when looking at pupil underachievement rates, especially when comparing the top and bottom socioeconomic quartiles (European Commission 2018d). Literacy among young people has improved significantly and is high by international standards, though performance of boys in reading literacy is still a concern. At 4.3 %, the proportion of early school leavers is the second lowest in the EU. The rate of over 4-year-olds participating in early childhood education and care is increasing slowly but continuously (European Commission, 2018e). It stood at 90.9 % in 2017, still 4.4 pps below the EU average. There is also a need to review general school curricula and improve the situation of teachers to attract a sufficient number of qualified students to choose pedagogical studies (OECD 2018). Slovenia’s teachers are relatively old with 38 % of teachers aged over 50. Education spending as a share of GDP decreased during the crisis, but it remains above the EU average. Between 2010 and 2015, expenditure per student in primary and secondary education fell by 13 %, one of the highest decreases among OECD countries. Expenditure per student in tertiary education only increased by 1 %, compared to an average increase of 11 % across OECD countries (OECD, 2018). The government aims to keep the share of education financing at a stable 6 % of GDP in the future, 0.5 pps below the share of 2013. Reforms on higher education financing continue, but a more substantial legislative overhaul has been postponed. Although participation in tertiary education is widespread, inequalities in access persist. In 2017, 46.4 % of 30-34-year-olds had obtained tertiary education, above the 40 % national target and the EU average (39.9 %). However, the gender gap in Slovenia in 2017 was 24.1 pps, the biggest in the EU. Access to higher education is particularly difficult for those with a weak socioeconomic background: only 2.9 % of new tertiary entrants are from parents of low attainment. The European Centre for the Development of Vocational Training (Cedefop) has forecast a significant further shift to high qualifications by 2025.

The Apprenticeship Act, in force since December 2017, is trying to link education and practical experience. By October 2018, only 186 out of approximately 12 000 students in vocational education and training are enrolled in one of the eight different programmes that link work experience with classroom education. 20 % of the curriculum is flexible, making the apprenticeship adjustable to labour market demands. According to the Ministry of Education, the main disincentive for higher participation in vocational education and training or apprenticeship is low wages. Young people lack digital skills. The International Computer and Information Literacy results from 2013 show that only 16 % of pupils in primary school acquire the necessary digital skills to use information and communications technology for collecting and processing data and solving problems independently (Ministry of Education, 2018). In addition, only around 5.5 % of high school students met all the digital skills targets (National Examination Centre RIC, 2016; Ministry of Education, 2018). Knowledge and skills are insufficiently adjusted to the current and future needs of the economy. The structure of students enrolled in educational programmes and the skills of workers are adjusting only slowly to labour market changes. Reading, mathematical and digital skills of older generations as well as of people with a low level of education are relatively poor (Government of Republic of Slovenia, 2017). According to a 2017 business survey, 64 % of companies in Slovenia encounter difficulties when searching for adequately skilled personnel (SPIRIT, 2017). Differences in unemployment rates between sectors are relatively large compared to other EU countries, which could point at sectoral mismatches in supply of and demand for labour. Stronger links between employers and the education sector and investments in a better alignment of education curricula with labour market needs could contribute to reinforce the labour market relevance of skills in the working-age population and a better match in labour demand and supply. 3.3.3.SOCIAL POLICY The share of people at risk of poverty or social exclusion has decreased. The at-risk-of-poverty or social exclusion rate (AROPE) decreased by 1.3 pps to 17.1 % in 2017 (Graph 3.3.4). For people aged over 65, the AROPE was 18.3 % and approaching the EU average (18.1 %). However, this rate was higher for elderly women (22.9 %; EU average 20.5 %). After 2 years of increases, monetary poverty for the elderly fell by 1.2 pps to 16.4 % but remains above the EU average (14.6 %) as does the poverty gap for this age group (17.9 %; EU average: 16.7 %). Inequality as measured by the ratio of incomes of the richest 20 % of households compared to the poorest 20 % of households, continued to decrease and remains among the lowest in the EU. In spite of this, the in-work at-risk-of-poverty rate was 6.6 % for people aged 18-64 in 2017 which was relatively low. Graph 3.3.4:At risk of poverty or social exclusion rate and its components Source: European Commission 3.3.4.Investment Increased investment in skills, education and training and social inclusion policies is important to improve Slovenia’s productivity and long-term inclusive growth. The employment situation of low-skilled and older workers remains weak, and there are shortages in more and more segments of the labour market. To address these challenges, a better alignment of education curricula with labour market needs is needed as well as investments in training and social activation measures for the currently not or not fully used labour potential and in a better training and education infrastructure. Matching investments in social inclusion, in the capacity of public services and the availability of child, health and long-term care services ( ) are necessary to ensure long-term inclusive growth. The decrease of social benefits when taking up employment could reduce work incentives. According to a benchmarking exercise in the area of minimum income schemes conducted within the Social Protection Committee, Slovenia performs around the EU average for the indicators related to adequacy of the minimum income benefits (see draft Joint Employment Report 2018), which was increased by EUR 95,22 in the last year. However, inactivity traps in Slovenia are relatively large, especially for single parents and one-earner married couples with children. The major part of the inactivity trap is attributable to the withdrawal or reduction of social assistance, family and housing benefits when taking up employment, and only a minor share results from increased income tax and social security contributions. Reducing the inactivity trap is particularly important given the ageing of the population in Slovenia (OECD, 2018). Box 3.3.1: Monitoring performance in light of the European Pillar of Social Rights The European Pillar of Social Rights is designed as a compass for a renewed process of upward convergence towards better working and living conditions in the European Union ( V ). It sets out twenty essential principles and rights in the areas of equal opportunities and access to the labour market; fair working conditions; and social protection and inclusion. Slovenia is performing well on most indicators of the Social Scoreboard supporting the European Pillar of Social Rights. The labour market continues to improve, as illustrated by a rising employment and falling unemployment rate. However , labour market participation of older workers remains low, reflecting possibilities for early retirement. The education system is generally performing well. Although the at-risk-of-poverty or social exclusion rate has decreased over the last years, old-ag e poverty remains frequent particularly for elderly women, reflecting challenges regarding the adequacy of the pension system . As illustrated by the Social Scoreboard, the level of net earnings of workers and the self reported unmet needs for medical care are further points of attention. Increasing the low employment and activity rates of older workers and in particular those with lower skills levels remains challenging. After 8 years of falling participation in adult learning, the situation stabilised but remains especially critical among older workers and the low-skilled. Active labour market policies under evaluation performed rather well, if judged by labour market impact and cost-effectiveness. However, participation of unemployed in active labour market policies remains very low. Slovenia is making progress in improving childcare and support to children. Both the at-risk-of-poverty or social exclusion rate as well as monetary poverty for children younger than 18 years are well below the EU average. Participation of children younger than three in formal childcare is also above average compared to other Member States and has increased further in the last year. New positive steps to promote child well-being were taken also with the adoption of new Family Code and a new Resolution on Family Policy. However, Slovenia has yet to adopt a new National Programme for Children as the old one expired in 2016. 3.4. Competitiveness reforms and investment 3.4.1.productivity growth Investments in R&D, digitalisation and infrastructure, in particular related to transport and rail, would help the convergence process. Slovenia’s growth potential would benefit if the trend of declining investment into research, development and innovation could be reversed. Investments in the digitalisation of Slovenia's firms, which are active in more traditional sectors, as well as in the uptake of e-government solutions are also important to ensure that Slovenia remains competitive. Bottlenecks in infrastructure, in particular rail transport, continue to adversely impact on the economy and the society as a whole. Graph 3.4.1:Labour productivity and total factor productivity (TFP), Slovenia and Euro area Source: Eurostat Labour productivity is slowly converging to the euro area driven by total factor productivity (TFP), as recent reforms are starting to pay off. Slovenia's labour productivity in purchasing power standard relative to the EU went from 76.1 % to 80.5 % of the EU average between 2000 and 2017. After falling by more than in the euro area during the crisis, Slovenia's labour productivity has been growing faster than the euro area since 2015, but the pace of convergence with the euro area remains slow. Labour productivity is driven primarily by fast growth in TFP, a sign that the economy is gaining efficiency, although the low TFP growth of medium and large-sized state-owned enterprises still weighs on aggregate productivity (European Commission 2018b). Investment fell rapidly during the crisis and remains below the euro area average as a share of GDP, although it is now recovering slightly. Investment averaged over 26 % of GDP in 2000-2005, well above the euro area average of 22 %. After increasing rapidly in the run-up to the crisis, it fell rapidly thereafter. In 2017, although continuing to grow, the level of investment was still well below the euro area average (18.5 % vs 20.5 % of GDP). In particular, private investment was below the euro area average while public investment was slightly above. Construction investment suffered the most during the crisis, both for dwellings and, even more so for other buildings and structures. Investment in machinery and equipment also fell. Investment in information and communication technology fell from 2 % of GDP on average in 2000-2005 (0.9 % of GDP in the euro area) to 0.8 % of GDP in 2017 (0.7 % of GDP in the euro area). Investment in intellectual property products had been rather stable but is now substantially lower than in the euro area (3.0 % vs 3.9 % of GDP). The 2018 Investment Promotion Act harmonizes support for domestic and foreign investments and facilitates investments that are deemed strategic. Graph 3.4.2:Investment by type Source: Eurostat Inward foreign direct investment (IFDI) remains comparatively low. For a small open economy like Slovenia, IFDI is a key driver of productivity growth. Slovenia's stock of IFDI as a share of GDP was 31.8 % at the end of 2016. In most similar EU Member States this rate is much higher, up to 80 % of GDP and more. Furthermore, the distribution of IFDI (in value terms) within Slovenia contributes to regional disparities as nearly 61 % of all IFDI is concentrated in the Osrednjeslovenska region while at least 8 of the regions are under 5 % (Bank of Slovenia, 2016). Most of Slovenia’s regions thus benefit only very marginally from the productivity spillover effects of IFDI. Research and development Slovenia is a strong innovator but recent progress was limited and weaknesses persist. According to the 2017 summary innovation performance index Slovenia falls in the category of strong innovators with a score just below the EU average. More importantly, its performance change from 2010 to 2017 was rather moderate, with an increase of only about 1.4 % (European Commission, 2018f). One of the main weaknesses is the reduced and inefficient R&D expenditure in the public sector. Slovenia is also relatively weak in terms of the effects of innovation activity on competitiveness. This weakness is reflected particularly in the low shares of exports of knowledge-intensive services and of persons employed in high-growth enterprises.

Innovation performance across Slovenia's regions is uneven. East Slovenia is a moderate innovator, though it has improved its innovation performance over time. In contrast, West Slovenia is a strong innovator albeit with a decreasing innovation performance. Slovenia has not yet reached the R&D-intensity target of 3.0 % of GDP. Slovenia’s investment in R&D is slightly below the EU average and remains dependent on EU funds, with the European Regional and Development Funds (ERDF) providing 33.9 % of public R&D expenditure. In 2017, Slovenia's overall R&D intensity was 1.86 % of GDP, a significant decline from its 2013 value of 2.58 %. This decline was mainly caused by a decrease in business enterprise expenditure on R&D from a peak of 1.98 % of GDP in 2013 to 1.39 % of GDP in 2017. In addition to grants, the Slovenian government strongly relies on tax incentives to promote R&D in firms. R&D tax incentives accounted for 63 % of total government support for business expenditure for R&D in 2015 (OECD, 2017a). Public R&D expenditure fell to its lowest level ever at 0.47 % of GDP in 2017, down from a peak of 0.66 % of GDP in 2010. This decline is mostly due to fiscal consolidation and the cyclical nature of EU funds. The efficiency of Slovenia’s public R&D spending and the quality of its research system remain relatively low. The Slovenian Research Agency is responsible for the allocation of funding based on research excellence criteria. Looking at scientific excellence (as measured by the share of publications among the top 10 % most cited worldwide), Slovenia lags behind the EU average, and ranks only 17th among EU Member States. However, the share of international co-publications in the total number of publications was 58.8 % in 2017 and exceeded the EU average (49.4 %). Slovenia achieved compound growth in international co-publications of 4.5 % between 2010 and 2016. Graph 3.4.3:R&D funding Source: Eurostat Support for young researchers has declined and Slovenia has problems attracting foreign research talent. Slovenia's education system performs well in producing science and engineering graduates and doctoral graduates. Yet, the decline in public investment in R&D has also been felt in a reduction of funding for young researchers. In 2017, the Slovenian Research Agency provided funds for 840 young people involved in doctoral studies (European Commission, 2017b). The number of researchers (full-time equivalents) employed by the public sector (whether in government or higher educations) per thousand active population has declined from 4.3 in 2011 to 3.7 in 2016. There is little influx of foreign researchers and academics. This is partially due to the public sector employer system and the old-fashioned habilitation system in universities. Slovenia attracts a lower share of international students at all levels of tertiary education, especially at the doctoral level: less than 9 % of Slovene doctoral students are international compared to an OECD average of 25.7 % (OECD, 2017b). International mobility or mobility between academia and industry are not incentivised. These are key obstacles to the attraction and re-integration of talent and to the much-needed openness of Slovenia’s research and innovation system (European Commission, 2018b). The share of innovative enterprises in Slovenia is decreasing and lags behind the EU average. In the period 2014-2016, 40 % of all enterprises in Slovenia carried out innovation activities, and this share was 6 pps higher in the period 2012-2014. Looking at the shares per enterprise segment, only about 34 % of small companies carried out innovation activities, while the share rises to 80 % in large ones (Statistical Office of the Republic of Slovenia). The employment share in fast-growing firms within innovative sectors is well below the EU average. In Slovenia, only 3.2 % of the workforce was employed in fast-growing firms in innovative sectors, whereas the EU average was 4.8 %. This indicates at a lack of dynamism, which is especially pronounced in innovative parts of the economy (European Commission, 2018i). Most SMEs in Slovenia have a low innovation capacity. They tend to be poorly integrated in domestic, regional or international clusters, with a low potential to attract critical mass investment and to develop large-scale innovations. A lack of sufficiently equipped R&D units in SMEs (low absorption capacity) seriously limits the opportunities for science-industry cooperation. Only 19.9 % of Slovenian enterprises are engaged in co-operations with government, public or private research institutions. 14.4 % of Slovenian enterprises co-operate with higher education institutions (European Commission, 2014). The research interests in most of Slovenia’s (small) firms lie in cost reduction and relatively routine improvements in their processes. Their “R&D” or development departments mostly perform routine procedures, such as quality control and testing. Investing in knowledge is not seen as part of their competitive strategy. In contrast, firms from the highly impactful medium-and high-tech segments (e.g. the automotive sector, machinery) are more intensively involved in science-industry links. Finding business and research partners can be a challenge due to small market size. Slovenia recognizes this shortcoming by taking part in several interregional innovation actions. These include the Interregional innovation pilot project (Sustainable buildings - Smart campus pilot project), the Industrial transition project focusing on addressing challenges of skills mismatches, modernisation and adaptation to new technologies, and the Smart Specialization Cooperation in Central Europe project. At the same time, Slovenia performs well in delivering projects within the cross-border programmes and macro-regional strategies. Slovenia could benefit from further possibilities, such as further enhancing transnational partnerships for SMEs by participating in business networks. The Slovenian smart specialisation strategy aims at tackling many of these challenges inter alia by establishing Strategic research and innovation partnerships (SRIPs). It was adopted in 2015 and governs the delivery of almost EUR 1 billion of EU funds. It aims to develop top-level conditions for creativity and innovation in several niche areas. SRIPs have been established around nine focus areas of the strategy. Through SRIPs, the governance of smart specialisation is entrusted to around 700 non-governmental stakeholders (including knowledge, institutions, businesses, NGOs etc.) which paves the path for a structural transformation empowering and strengthening the innovation ecosystem of Slovenia. SRIPs have already helped to improve the internationalisation and networking of Slovene research and innovation stakeholders through their participation in thematic smart specialisation platforms. For example, Slovenia is co-leading the thematic area ‘SME integration to Industry 4.0’ through the ‘Factories of the Future’ SRIP, and the thematic area ‘Digitalisation and Safety for Tourism’, through the ‘Sustainable Tourism’ SRIP, and is a partner in ot