Report from the Commission - Convergence report 2006 on Slovenia (prepared in accordance with Article 122(2) of the Treaty at the request of Slovenia) {SEC(2006) 615}
Date: 2006-05-16
Institutions: European Commission
Subjects: Economic and Monetary Union, European Commission, Slovenia, convergence criteria, economic convergence, report

COMMISSION OF THE EUROPEAN COMMUNITIES 

Brussels, 16.5.2006 
COM(2006) 224 final 

REPORT FROM THE COMMISSION 

CONVERGENCE REPORT 2006 ON SLOVENIA 

(prepared in accordance with Article 122(2) of the Treaty at the request of Slovenia) 

[SEC(2006) 615] 

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1. 

PURPOSE OF THE REPORT 

Article 122(2) of the Treaty requires the Commission  and the ECB to report to the 
Council,  at  least  once  every  two  years,  or  at  the  request  of  a  Member  State  with  a 
derogation,  on  the  progress  made  in  the  fulfilment  by  the  Member  States  of  their 
obligations regarding the achievement of economic and monetary union.  

This report has been prepared at the request of Slovenia, submitted on 2 March 2006. 
A more detailed assessment of the state of convergence in Slovenia is provided in a 
technical annex to this report (SEC(2006) xxx).  

The content of the reports prepared by the Commission and the ECB is governed by 
Article  121(1)  of  the  Treaty.  This  Article  requires  that  the  reports  include  an 
examination of the compatibility of national legislation, including the statutes of its 
national central bank, and Articles 108 and 109 of the Treaty and the Statute of the 
ESCB and of the ECB. The reports also have to examine the achievement of a high 
degree of sustainable convergence in the Member State concerned by reference to the 
fulfilment of the convergence criteria (price stability, government budgetary position, 
exchange  rate  stability,  long-term  interest  rates),  and  take  account  of  several  other 
factors mentioned in the final sub-paragraph of Article 121(1). The four convergence 
criteria are developed further in a Protocol annexed to the Treaty (Protocol No 21 on 
the convergence criteria). 

2. 

LEGAL COMPATIBILITY 

In its 2004 Convergence Report (COM(2004) 690), the Commission concluded that, 
as  regards  central  bank  integration  into  the  ESCB  at  the  time  of  euro  adoption, 
legislation  in  Slovenia,  in  particular  the  Bank  of  Slovenia  Act,  was  not  fully 
compatible  with  Article  109  of  the  EC  Treaty  and  the  ESCB/ECB  Statute.  In 
addition,  the  correction  of  some  residual  imperfections  was  recommended,  in 
particular with respect to the Bank’s objectives as well as in the field of personal and 
institutional independence. 

The incompatibilities have been removed by an amendment to the Bank of Slovenia 
Act  adopted  by  the  Slovenian  Parliament  on  30  March  2006.  In  particular,  the 
amendment clarifies that the Bank of Slovenia competences in the area of monetary 
functions,  operations  and  instruments  shall  be  transferred  to  the  ESCB  as  from  the 
date  of  the  introduction  of  the  euro  in  Slovenia.  Moreover,  the  possibility  for  the 
Government  of  being  involved  in  the  management  of  the  Bank's  foreign  exchange 
assets  has  been  removed.  With  respect  to  the  identified  imperfections,  the  grounds 
for dismissal of the members of the Governing Board of the Bank of Slovenia have 
been aligned with those stipulated in the ESCB/ECB Statute. Finally, the objectives 
of the Bank of Slovenia have been amended and reflect the wording of Article 105(1) 
of  the  EC  Treaty  more  accurately.  In  particular,  the  Bank's  secondary  objective 
(supporting the general economic policy in accordance with the objectives set in the 
EC Treaty) is now clearly subordinated to the primary one (price stability). However, 
the third objective (linked to financial stability in line with the principles of an open 
market economy and free competition) is not clearly subordinated to the primary and 
secondary ones, which constitutes a residual imperfection.  

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Legislation  in  Slovenia,  in  particular  the  Bank  of  Slovenia  Act,  is  compatible  with 
the requirements of the EC Treaty and the ESCB/ECB Statute.  

3. 

PRICE STABILITY 

Evolution of the reference value  

Slovenia  did  not  fulfil  the  criterion  on  price  stability  in  the  2004  Convergence 
Report. The average inflation rate in Slovenia during the 12 months to August 2004 
was 4.1 percent, above the reference value of 2.4 percent.  

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declined 

Slovenia
Reference value

approached 

Chart 1.  HICP Inflation
 (12-m moving average)

The  12-month  average  inflation, 
which is used for the convergence 
assessment, 
from 
8.6 percent  in  2001  to  2.3 percent 
in  March  2006.  As  a  result,  it 
progressively 
the 
reference  value  and  reached  it  for 
the  first  time  in  November  2005. 
The  12-month  average  inflation 
was  below  the  reference  value 
since  January  2006.  In  March 
2006,  the  reference  value  was 
2.6 percent, calculated as the average of the 12-month average inflation rates in the 
three  best-performing  Member  States  (Sweden,  Finland  and  Poland)  plus 
1.5 percentage points. The corresponding inflation rate in Slovenia was 2.3 percent, 
0.3 percentage points below the reference value.  

Source:  Eurostat, Commission services

EC Spring 2006 Forecast

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Underlying factors and sustainability 

Inflation in Slovenia increased to around 9 percent between mid-1999 and mid-2000, 
mainly due to the impact of the introduction of the value-added tax. Inflation started 
to  fall  again  in  the  second  half  of  2001,  when  also  a  new  medium-term  monetary 
policy  framework  was  adopted  by  the  Bank  of  Slovenia.  Its  main  objective  was  to 
secure an early euro area entry by decreasing inflation and progressively stabilizing 
the  exchange  rate.  Since  2003,  the  disinflation  process  has  been  underpinned  by  a 
coordinated policy approach of the Slovenian Government and the Bank of Slovenia. 
An effective control of administered prices, wage moderation in the public sector and 
a stabilisation of the exchange rate since mid-2004 reinforced the  credibility of the 
disinflation  process,  which  in  turn  translated  into  wage  moderation  in  the  private 
sector. Disinflation in recent years was also supported by a prudent policy mix and 
by  growth  below  potential  between  2001  and  2003.  However,  the  progressive 
lowering of unemployment rates since 2003, in line with the economic upturn, was 
not  associated  with  increased  wage  and  price  pressures,  which  signals  that  the 
decrease  in  inflation  was  rather  driven  by  factors  which  should  be  expected  to 
underpin a low inflationary environment also in the medium term.  

Inflation performance in 2005 was affected by a favourable development of prices of 
certain categories of goods, mostly reflecting a favourable impact of EU accession, 
which helped to outweigh a large negative impact of the increase of oil prices on the 

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world  markets.  While  EU  accession  also  contributed  to  increasing  the  level  of 
competition on the domestic markets with permanent effects on inflation, part at least 
of the favourable impact on price developments is expected to progressively fade out. 

In spite of this, the outlook for inflation in the remainder of 2006 remains favourable. 
The  expected  easing  of  the  negative  effects  of  the  external  environment  on  energy 
prices will be broadly compensated by a slow pick-up in non-energy related inflation 
from exceptionally low levels in 2005. At the same time, the decline in the growth 
rate of unit labour costs observed since 2002 is expected to continue also in 2006 and 
average  inflation  is  forecast  to  slightly  decrease  from  2.5  percent  in  2005  to  2.4 
percent in 2006. 

In a longer-term perspective, the final convergence of domestic interest rates to the 
euro  area  level  and  the  possibility  of  an  increase  of  the  value-added  tax  rate 
envisaged  in  2007  represent  risk  factors  to  inflation.  Slovenia  therefore  needs  to 
remain  vigilant  to  protect  its  low  inflationary  environment  and  a  favourable 
competitiveness  position.  A  more  ambitious  fiscal  policy  stance  would  help  to 
mitigate risks to inflation and wage moderation should be continued beyond 2006.  

Slovenia has respected the reference value for inflation since November 2005 and is 
likely to continue to do so in the months ahead. Slovenia fulfils the criterion on price 
stability.  

4. 

GOVERNMENT BUDGETARY POSITION 

In  the  2004  Convergence  Report,  the  Commission  stated  that  Slovenia  was  not 
subject  to  a  Council  decision  on  the  existence  of  an  excessive  deficit  and  that  it 
fulfilled the criterion on the government budgetary position.  

Public finances in Slovenia worsened in 2000-2001 and the 2001 general government 
deficit reached a high of 4.3 percent of GDP. Following a correction in 2002-2003, 
the  general  government  deficit  has  stayed  below  the  3 percent  of  GDP  threshold 
since 2002. 

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underpinned 

Chart 2. Slovenia: Government balance
(in percent of GDP) 

A  reinforced  commitment 
to  fiscal  discipline  and 
economic  recovery  since 
a 
2004 
further  reduction  of  the 
general government deficit 
to  2.3  and  1.8 percent  of 
in 
respectively, 
GDP, 
and  2005.  The 
2004 
commitment 
the 
of 
to  a  sound 
government 
budgetary policy was most 
apparent  in  2004  when  a 
shortfall  from  value-added  tax  resources  prompted  cuts  in  expenditures  in  order  to 
respect the deficit target.  

Source : Commission services

Cyclically adjusted balance

Government balance

(*) Spring Forecast

Reference value

2006(*)

2003

2004

2005

2000

2001

2002

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-3.0

-2.5

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Slovenia  targets  a  general  government  deficit  of  1.8 percent  of  GDP  in  2006, 
somewhat below the Commission services' spring 2006 forecast. No deficit reduction 
compared  to  2005  is  planned.  On  the  contrary,  in  view  of  the  expected  favourable 
economic environment,  the  structural  deficit,  which  stood  at  1.4 percent  of  GDP  in 
2005,  is  expected  to  deteriorate  to  1.8 percent  of  GDP.  At  the  same  time,  it  is 
expected to stay below the minimal benchmark of 1.9 percent set in the Stability and 
Growth  Pact  for  providing  a  safety  margin  against  breaching  the  3 percent  of  GDP 
reference value under normal macroeconomic fluctuations.  

The general government debt has been lingering at slightly below 30 percent of GDP 
since 2000. At the end of 2005, the gross debt accounted for 29.1 percent of GDP, 
down  from  29.5 percent  in  2004.  The  general  government  debt  is  expected  to  stay 
below 30 percent of GDP over the medium term. 

According to the December 2005 convergence programme, the budgetary strategy is 
to gradually reduce the general government deficit to 1 percent of GDP in 2008. The 
programme announced tax reform measures leading to a drop in the share of revenue 
as a percentage of GDP by 1.8 percentage points, and expenditure cuts, resulting in a 
decline  in  the  expenditure  ratio  by  2.5 percentage  points  of  GDP.  Some  concrete 
measures  that  would  underpin  this  consolidation  have  been  specified  in  the  latest 
update of the Convergence programme, while further measures are being considered.  

The  Council  examined  the  updated  convergence  programme  of  Slovenia  on  14 
February 2006. It regarded the budgetary strategy as having set plausible targets and 
saw the risks to the budgetary projections in the programme to be broadly balanced. 
Slovenia  is,  however,  considered  to  be  at  high  risk  as  regards  long-term 
sustainability.  According  to  the  current  projections  based  on  existing  measures, 
Slovenia  appears  at  high  risk  with  regard  to  the  long-term  sustainability  of  public 
finance  due  to  a  substantial  rise  in  age-related  expenditures.  The  Council  therefore 
invited  Slovenia  to  step-up  the  budgetary  consolidation,  especially  by  frontloading 
the  adjustment  effort  and  to  undertake  measures  to  improve  the  long-term 
sustainability of public finances. 

Slovenia is not subject to a Council decision on the existence of an excessive deficit 
and fulfils the criterion on the government budgetary position. 

5. 

EXCHANGE RATE STABILITY 

In  the  2004  Convergence  Report  Slovenia  was  assessed  not  to  fulfil  the  exchange 
rate criterion. By the time of the examination, the country had been participating in 
ERM II for two months.  

Chart 3.  SIT: Spread vs central rate
 (as percent)

The  two-year  period  relevant  for 
the  assessment  of  exchange  rate 
stability extends from May 2004 to 
April 2006. Slovenia entered ERM 
II  on  28  June  2004  and  has  so  far 
spent  22  months  in  ERM  II.  The 
ERM  II  central  parity  retained  for 
the tolar corresponds to the market 

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May-04

Sep-04

Jan-05 May-05

Sep-05

Jan-06 May-06

Source:  ECB, Commission services

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exchange  rate  on  the  last  trading  date  before  the  decision  on  ERM  II  entry.  As  the 
long-standing policy of continuous tolar depreciation went on until ERM II entry, the 
tolar-euro  exchange  rate  in  the  two  months  prior  to  ERM  II  entry  moved  from 
0.45 percent above the future central rate at the beginning of May 2004 to the central 
rate on 25 June 2004. Inside ERM II, the tolar-euro exchange rate has stayed close to 
the  central  rate  with  maximum  deviations  of  0.16 percent  on  the  depreciation  side 
and  0.10 percent  on  the  appreciation  side  of  the  fluctuation  band.  The  average 
absolute  deviation  of  the  tolar-euro  exchange  rate  from  the  central  parity  in  the 
period covered by this assessment was 0.08 percent. 

Exchange rate stability within ERM II has been achieved in the presence of a stable 
interest rate differential vis-à-vis the euro area slightly below 2 percentage points for 
most of the period under examination. Following policy rates increases by the ECB 
since  December  2005  and  interest  rate  cuts  by  the  Bank  of  Slovenia  since  January 
2006, the differential recently decreased to below 1 percentage point. Together with 
a  likely  decrease  in  the  risk  premium  of  Slovenian  assets  in  ERM  II,  the  positive 
interest rate differential helped to underpin the strength of the tolar. 

The  stability  of  the  tolar-euro  exchange  rate  has  been  supported  by  an  agreement 
concluded in 2001 between the Bank of Slovenia and most of the commercial banks 
on  co-operation  in  interventions  on  the  foreign  exchange  market.  The  Bank  of 
Slovenia  has  in  particular  used  the  foreign  exchange  swap  facility  to  maintain  the 
remarkable  stability  of  the  tolar-euro  exchange  rate  inside  ERM  II.  As  the  ERM  II 
central  parity  played  well  its  role  of  anchoring  financial  markets  expectations,  the 
"price interventions" also inherent to this agreement (when the central bank sets the 
base exchange rate at which the commercial banks participating in the agreement are 
obliged to trade) have not been used since the first month following ERM II entry. 
The  transition  to  the  new  system  did  require  a  temporary  direct  intervention  in  the 
foreign exchange markets in order to signal the effective change to the exchange rate 
regime. As the tolar stabilized in early July 2004, no further direct interventions have 
been necessary inside ERM II.  

The  tolar  has  remained  very  close  to  the  ERM  II  central  rate  for  the  two  years 
covered  by  this  assessment.  There  has  been  no  devaluation  of  the  tolar's  central 
parity inside ERM II on the initiative of Slovenia. By the time of a possible Council 
decision  in  July  2006,  the  tolar  will  have  participated  in  ERM  II  for  more  than  24 
months. Slovenia fulfils the exchange rate criterion. 

6. 

LONG-TERM INTEREST RATES 

In the 2004 Convergence Report Slovenia fulfilled the criterion on the convergence 
of interest rates. The average long-term interest rate in Slovenia in the year to August 
2004 was 5.1 percent, below the reference value of 6.4 percent. 

The  spread  vis-à-vis  euro  area  average  long-term  interest  rates  had  been  declining 
markedly  between  mid-2002  and  end-2004  mainly  reflecting  a  gradual  decrease  in 
Slovenian  inflation  rates  accompanied  by  a  reduction  in  short-term  policy  rates, 
decreasing  country-risk  premia  and  the  perspective  of  euro  area  accession.  Since 
ERM II entry in June 2004, the spread has remained between 10 and 70 basis points. 

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Chart 4.  Long-term interest rates
 (12-month moving averages)

The twelve-month moving average 
long-term  interest  rate  relevant  for 
the  assessment  of 
the  Treaty 
criterion  has  continued  to  decline 
over  the  whole  assessment  period. 
In  March  2006,  the  latest  date  for 
the 
which  data  are  available, 
reference  value,  given  by 
the 
average  of  long-term  interest  rates 
in  Sweden,  Finland  and  Poland 
plus  2 percentage  points  stood  at 
5.9 percent.  The 
twelve-month 
moving  average  of  the  yield  on 
ten-year Slovenian benchmark bond stood at 3.8 percent, below the reference value. 
Slovenia fulfils the criterion on long-term interest rate convergence. 

Source:  ECB, Eurostat, Commission services

Reference value

Slovenia

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7. 

ADDITIONAL FACTORS 

Slovenia’s financial system has substantially integrated into the broader EU financial 
system. Compliance with the acquis communautaire in the field of financial services 
was  already  broadly  achieved  on  accession  and  good  progress  has  been  made  in 
transposing  the  legislation  adopted  under  the  Financial  Services  Action  Plan.  The 
size of the financial system remains somewhat smaller than would be implied by the 
relatively  high  level  of  development  of  the  economy.  While  competition  via  cross-
border services provided by other EU financial institutions is increasing, Slovenia’s 
financial system is not fully privatised with a level of foreign ownership close to the 
one of euro area Member States but lower than in other new Member States. Strong 
economic  growth  and  convergence  in  interest  rates  have  stimulated  a  progressive 
pick-up  in  the  growth  rate  of  bank  lending  to  the  private  sector,  notably  to 
households. The share of foreign currency loans to household in particular has started 
to expand from negligible levels in 2003 to nearly 50 percent of new loans in 2005.  

The  Slovene  economy  is  highly  open  to  trade  but  it  is  relatively  little  receptive  to 
foreign  direct  investment  (FDI)  inflows.  Slovenia  has  also  adopted  a  relatively 
gradual approach to structural reforms particularly with respect to liberalisation and 
privatisation. At the same time, Slovenia has an industrial structure similar to that of 
the  euro  area.  The  relatively  low  level  of  inward  FDI  is  related  to  the  privatisation 
process, which has been less receptive to the participation of foreign investors. The 
low  intensity  of  FDI  may  limit  competitive  pressures  in  the  domestic  market.  Also 
further  progress  on  the  transposition  and  application  of  EU-wide  directives  is 
important for the smooth functioning of the Internal Market in Slovenia.  

Slovenia has a tradition of a broadly balanced current account, principally reflecting 
equilibrium between the deficit in trade in goods on one side and a surplus in trade in 
services together with a positive balance of current transfers on the other side. The 
Slovenian current account balance in 2005 recorded a deficit of 1.1 percent of GDP, 
down  from  2.1 percent  in  2004.  This  improvement  mainly  reflected  the  reversal  of 
the  trend  of  a  progressive  deterioration  of  the  balance  of  trade  in  goods  since  the 
second  quarter  of  2005  and  an  accelerated  improvement  of  the  balance  of  trade  in 
services. This suggests that the 2004 current account deterioration was most likely a 

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temporary  phenomenon  and  does  not  signal  competitiveness  problems  for  the 
Slovene  economy  or  potential  exchange  rate  pressures.  The  main  challenge  for 
Slovenia in the near future will be to safeguard a healthy competitiveness position, 
for  which  wage  moderation  will  be  essential.  At  the  same  time,  despite  a  high 
domestic saving rate, Slovenia may have scope for a more extensive use of foreign 
savings for increasing domestic investment and productivity.  

*** 

In  the  light  of  its  assessment  on  the  fulfilment  of  the  convergence  criteria,  the 
Commission  considers  that  Slovenia  has  achieved  a  high  degree  of  sustainable 
convergence.  

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