Council opinion of 4 March 2008 on the updated stability programme of Slovenia, 2007-2010
Date: 2008-03-04
Institutions: Council of the European Union
Subjects: Slovenia, budget estimate, economic forecasting, public finance, stability programme

20.3.2008

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Official Journal of the European Union

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COUNCIL OPINION

of 4 March 2008

on the updated stability programme of Slovenia, 2007-2010

(2008/C 74/02)

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty establishing the European Community,

Having regard to Council Regulation (EC) No 1466/97 of 7 July 1997 on the strengthening of the surveil-
lance of budgetary positions and the surveillance and coordination of economic policies (1), and in particular
Article 5(3) thereof,

Having regard to the recommendation of the Commission,

After consulting the Economic and Financial Committee,

HAS DELIVERED THIS OPINION:

(1)

(2)

(3)

On 4 March 2008, the Council examined the updated stability programme of Slovenia, which covers
the period 2007 to 2010.

Slovenia's generally strong GDP growth throughout the last decade peaked during the first year of
membership in the euro area. However, a marked pick-up in inflation, mainly due to commodity
price developments in conjunction with a lack of competition in some sectors, was also registered
in 2007, with spill-overs to wages being a risk for 2008.

Against the background of the strong economic growth during the run-up to EU and euro area entry,
good progress in consolidating public finances was made. For the future, enhancing labour produc-
tivity, keeping wages in line with productivity and continued fiscal efforts will be needed to foster
macroeconomic stability, including lower inflation. Addressing the recent acceleration of inflation in
Slovenia would help preserve the competitiveness of this export-oriented economy. Moreover, the
long-term sustainability of public finances remains a challenge in view of the significant expected
effects of ageing on the budget in the absence of further pension reform. To support the economy's
it will be important to continue with structural reforms, especially
ongoing catching-up process,
regarding labour and product markets. In the same context, further redirecting public expenditure
towards growth-enhancing categories, while tackling budget rigidity and improving the efficiency of
spending, will also be beneficial.

The macroeconomic scenario underlying the programme envisages that real GDP growth will slow
from 5,8 % in 2007 to 4,6 % in 2008 and 4,1 % in 2009 before picking up to reach 4,5 % by the
end of the programme period. Assessed against currently available information (2), this scenario
appears to be based on plausible growth assumptions, although risks for 2008 stemming from the
external environment have increased since the completion of the stability programme. After the unex-
pected increase in inflation in 2007, the programme's projections for inflation are significantly higher
than in last year's scenario. Nevertheless, they still appear to be on the low side for 2008 given recent
developments in food and energy prices. Second-round effects from the strong pick-up in inflation
in 2007 as well as public sector wage increases spilling over to the private sector could lead to a
larger inflation differential with the rest of the euro area. If persistent, this would entail less favourable
competitiveness developments than implied by the programme.

(1) OJ L 209, 2.8.1997, p. 1. Regulation as amended by Regulation (EC) No 1055/2005 (OJ L 174, 7.7.2005, p. 1). The

documents referred to in this text can be found at the following website:
http://ec.europa.eu/economy_finance/about/activities/sgp/main_en.htm

(2) The assessment takes into account notably the Commission services' autumn forecast and the Commission assessment of

the October 2007 implementation report of the national reform programme.

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(4)

(5)

(6)

(7)

For 2007, the general government deficit is estimated at 0,7 % of GDP in the Commission services'
autumn 2007 forecast, against a target of 1,5 % of GDP set in the 2006 programme. The difference
is mainly explained by a positive base effect from the 2006 outcome and by higher-than-projected
the
nominal GDP growth in 2007. At the same time, also according to the 2007 update of
programme, more positive-than-planned revenue developments were partly offset by higher expendi-
ture growth than planned in the 2006 programme. However, more recent information on a cash
basis points to a better 2007 outturn, possibly a slight surplus. Overall, budgetary implementation in
2007 was in line with the Council opinion of 27 February 2007 on the 2006 stability
programme (1), which invited Slovenia to speed up the achievement of the MTO taking advantage of
the good economic conditions, including the better-than-expected budgetary outcome in 2006. The
Council notes that the budgetary implementation in 2007 is also consistent with the April 2007
Eurogroup orientations for budgetary policies.

The main goal of the medium-term budgetary strategy in the update is to respect the medium-term
objective (MTO), which is a structural deficit (i.e. a cyclically-adjusted deficit net of one-off and other
temporary measures) of 1 % of GDP, by a growing margin over the programme period, although
some weakening is planned for 2008. This change vis-à-vis the previous programme's goal to reach
the MTO by 2009 follows from the above-mentioned better-than-expected 2006 outturn (mainly
reflecting higher nominal GDP growth), which implied that the MTO had already been broadly met
in 2006. Compared to the 2006 programme, the headline deficit planned in the 2007 update is
about 0,5 percentage point of GDP lower throughout the programme period, against the background
of a better starting position.

The deficit is planned to widen to 0,9 % of GDP in 2008 and then to gradually close, with the largest
adjustment planned in the final year. Following a similar path, the primary surplus is projected to
reach just above 1 % of GDP by 2010. The planned consolidation results from expenditure restraint
more than offsetting, except in 2008, the gradual decline in the revenue ratio. The projected decline
of primary expenditure over the programme period amounts to 2,25 percentage points of GDP.
While relatively broad-based, it reflects especially contained developments of social spending, repre-
senting 1/3 of the total consolidation. Largely influenced by the ongoing tax reform, the gradual
decline in the revenue ratio, by 1,75 percentage points, is mainly driven by indirect taxes, while a
slight increase in the direct tax burden is projected.

The risks to the budgetary projections in the programme appear broadly balanced in 2008, whereas
budgetary outcomes could be somewhat worse than targeted in the outer years. In 2008, the possibi-
lity of a positive base effect due to a potentially better-than-expected 2007 budgetary outturn counter-
balances the risks associated with the current deterioration of the external environment. Thereafter,
there are certain risks to the implementation of the budgetary strategy due, in particular, to the size-
able magnitude of
the back-loaded planned reduction in expenditure, with not all underlying
measures spelt out in sufficient detail. To some degree, these risks are mitigated by Slovenia's good
track record in the recent past, which suggests that outcomes might be better than expected.

In view of this risk assessment, the budgetary stance in the programme seems sufficient to maintain
the MTO throughout the programme period, but with a possibly smaller margin than planned for the
outer years. The slight deterioration of the structural balance envisaged for 2008 may turn out to be
pro-cyclical, although downside risks stemming from the external environment have increased. This
would not be in line with the Stability and Growth Pact. Furthermore, a tighter fiscal stance than
presently envisaged for 2008 appears to be warranted given the current strong inflationary pressures.
The Council notes that this would also be consistent with the April 2007 Eurogroup orientations for
budgetary policies, which called for carefully designing fiscal policy plans for 2008 to avoid feeding
macroeconomic imbalances. After 2008, the fiscal policy stance implied by the programme is in line
with the Pact.

(1) OJ C 71, 28.3.2007, p. 9.

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(8)

(9)

Slovenia appears to be at high risk with regard to the sustainability of public finances. The budgetary
position in 2007 as estimated in the programme remained roughly unchanged compared with 2006
and is just sufficient to stabilise the debt ratio over the long-term before the budgetary impact of an
ageing population is considered. However, the latter is well above the EU average, mainly reflecting a
stronger increase in pension expenditure. High primary surpluses over the medium term and, in par-
ticular, further measures aimed at curbing the substantial increase in age-related expenditures would
contribute to reducing risks to the sustainability of public finances.

The stability programme seems to be consistent with the October 2007 implementation report of the
national reform programme. In particular, both documents give account of the main reform measures
under implementation, such as the comprehensive tax reform, infrastructure investments as well as
changes to the system of social transfers. The programme does not include a detailed qualitative
assessment of the overall impact of the national reform programme within the medium-term fiscal
strategy. However, while this is not done in a systematic way, information on the direct budgetary
impact associated with major reforms envisaged is given and has been taken into account in
budgetary projections.

(10)

The budgetary strategy in the programme is partly consistent with the country-specific broad
economic policy guidelines included in the integrated guidelines and the guidelines for euro area
Member States in the area of budgetary policies issued in the context of the Lisbon strategy. In par-
ticular,
it does not include significant further measures to strengthen the reform of the pension
system with a view to ensuring long-term sustainability.

(11) As regards the data requirements specified in the code of conduct for stability and convergence

programmes, the programme has some gaps in the required and optional data (1).

The overall conclusion is that Slovenia met its MTO in 2007, two years ahead of previous plans, and that
the programme aims at respecting the MTO by a growing margin over the programme period. For 2007,
the most recent available information points to a better-than-planned budgetary outturn, possibly a slight
surplus. However, for 2008, a slight deterioration of the structural balance is envisaged despite the conti-
nuing strong growth prospects. The risks to the budgetary projections are broadly balanced in 2008. In the
outer years, budgetary outcomes might be slightly worse than targeted, mainly due to risks associated with
the envisaged reliance on expenditure restraint. The fiscal stance in 2008 may turn out to be pro-cyclical. A
tighter fiscal stance than presently envisaged for 2008 appears to be warranted also given the current strong
inflationary pressures. The high projected increase in public sector wage settlements is also a concern for
the inflation outlook. In spite of the current low debt level, Slovenia is assessed to be at high risk with
regard to the long-term sustainability of public finances due to the significant projected budgetary impact of
ageing.

In view of the above assessment Slovenia is invited to:

(i) building on a likely better-than-expected outturn in 2007, aim for stronger budgetary positions in 2008

and beyond than planned in the programme, thereby avoiding pro-cyclical policies;

(ii) stand ready to adopt further measures to tame inflationary pressures, complementing the recommended

fiscal stance with appropriate wage, labour market and competition policies;

(iii) in view of the projected increase in age-related expenditure, improve the long-term sustainability of

public finances, in particular by further reforming the pension system.

The Council also notes that such actions would be consistent with the April 2007 Eurogroup orientations
for fiscal policies.

(1) In particular, the data on some external assumptions (‘World excluding EU, GDP growth’,

‘World import volumes,
excluding EU’) and on some items regarding sectoral balances as well as the breakdown of the stock-flow adjustment of the
debt level are missing.

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Comparison of key macroeconomic and budgetary projections

2006

2007

2008

2009

2010

Real GDP
(% change)

HICP inflation
(%)

SP Nov 2007

COM Nov 2007

SP Dec 2006

SP Nov 2007

COM Nov 2007

SP Dec 2006

Output gap (1)
(% of potential GDP)

SP Nov 2007

COM Nov 2007 (2)

5,7

5,7

4,7

2,5

2,5

2,7

– 0,2

– 0,2

5,8

6,0

4,3

3,4

3,5

2,7

0,7

0,9

SP Dec 2006

– 0,5

– 0,2

4,6

4,6

4,2

3,5

3,7

2,5

0,5

0,8

0,0

4,1

4,0

4,1

2,8

2,9

2,2

0,1

0,3

0,3

4,5

n.a.

n.a.

2,6

n.a.

n.a.

0,2

n.a.

n.a.

Net lending/borrowing
vis-à-vis the rest of the
world
(% of GDP)

General government
balance
(% of GDP)

Primary balance
(% of GDP)

Cyclically-adjusted
balance (1)
(% of GDP)

SP Nov 2007

– 2,8

– 3,5

– 3,1

– 2,0

– 1,6

COM Nov 2007

– 2,6

– 3,3

– 2,6

– 1,9

SP Dec 2006

n.a.

n.a.

n.a.

n.a.

SP Nov 2007

– 1,2

– 0,6

– 0,9

– 0,6

COM Nov 2007

– 1,2

– 0,7

– 1,0

– 0,8

SP Dec 2006

– 1,6

– 1,5

– 1,6

– 1,0

SP Nov 2007

COM Nov 2007

SP Dec 2006

0,2

0,2

0,1

0,7

0,7

0,2

0,3

– 0,1

– 0,3

0,6

0,4

0,3

n.a.

n.a.

0,0

n.a.

n.a.

1,1

n.a.

n.a.

SP Nov 2007

– 1,1

– 0,9

– 1,1

– 0,7

– 0,1

COM Nov 2007

– 1,1

– 1,1

– 1,4

– 1,0

SP Dec 2006

– 1,4

– 1,4

– 1,6

– 1,1

n.a.

n.a.

Structural balance (3)
(% of GDP)

SP Nov 2007

– 1,1

– 0,8

– 1,0

– 0,7

– 0,1

COM Nov 2007

– 1,1

– 1,1

– 1,4

– 1,0

SP Dec 2006

– 1,4

– 1,4

– 1,6

– 1,1

n.a.

n.a.

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Government gross debt
(% of GDP)

SP Nov 2007

COM Nov 2007

SP Dec 2006

2006

27,1

27,1

28,5

2007

25,6

25,6

28,2

2008

24,7

24,5

28,3

2009

23,8

23,8

27,7

2010

22,5

n.a.

n.a.

Notes:
(1) Output gaps and cyclically-adjusted balances according to the programmes as recalculated by Commission services on the basis of the

information in the programmes.

(2) Based on estimated potential growth of 4,2 %, 4,9 %, 4,7 % and 4,5 % respectively in the period 2006-2009.
(3) Cyclically-adjusted balance excluding one-off and other temporary measures. One-off and other temporary measures are 0,1 % of GDP
in 2007 and 0,1 % in 2008, both deficit-increasing, according to the most recent programme. The Commission services do not
consider these to be one-off measures hence there are no one-off measures in the Commission services' forecast.

Sources:
Stability programme (SP); Commission services' autumn 2007 economic forecasts (COM); Commission services' calculations.