COMMISSION STAFF WORKING DOCUMENT Macroeconomic Imbalances – Slovenia 2014
Date: 2014-03-05
Institutions: European Commission
Subjects: Euro Group (euro area), Slovenia, competitiveness, economic growth, economic statistics, financial solvency, macroeconomics, private investment, public debt, stability pact, trade balance













EUR-Lex - 52014SC0088 - EN











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52014SC0088

COMMISSION STAFF WORKING DOCUMENT Macroeconomic Imbalances – Slovenia 2014 /* SWD/2014/088 final */









Results of in-depth reviews under
Regulation (EU) No 1176/2011 on the prevention and correction of macroeconomic
imbalances
Slovenia continues to experience excessive macroeconomic
imbalances which require specific monitoring and continuing strong policy
action. Imbalances have been unwinding over the last year, thanks to
macroeconomic adjustment and decisive policy action by Slovenia. Yet the
magnitude of the necessary correction means that substantial risks are still
present. The Commission will continue the specific monitoring of the policies
recommended by the Council to Slovenia in the context of the European Semester,
and will regularly report to the Council and the Euro Group.
More specifically,
the risk stemming from an economic structure characterized by weak corporate
governance, high level of state involvement in the economy, losses in cost
competitiveness, the corporate debt overhang, the increase in government debt
warrant very close attention. While considerable progress has been made in
repairing the banks' balance sheets, determined action with respect to the full
implementation of a comprehensive banking sector strategy, including
restructuring, privatisation and enhanced supervision is still required.
Slovenia continues to
struggle with the legacy of its previous boom, with corporates remaining
unsustainably over-indebted. The transfer of non-performing loans (NPLs) to the
Bank Asset Management Company (BAMC) has improved the banks' balance sheets but
NPLs remain elevated relative to pre-crisis levels and still need to be durably
restructured based on the recently amended insolvency framework. As domestic
demand, and especially investment, contracted significantly, the current
account has corrected sharply, turning into a large surplus, but cost
competitiveness losses have not been recouped and reforms so far have not fully
addressed the labour market flexibility and competitiveness challenge. Weak
corporate governance, particularly but not only in state-owned enterprises, reduces
the overall efficiency of the economy through possible inefficient allocation
of resources. Significant withdrawal of the state from the corporate and
financial sector, combined with a comprehensive strategy for the management of
core assets and divestment of non-core assets, could improve the adjustment
capacity of the economy. Finally, the substantial increase in government debt
in recent years, albeit from a relatively low level, creates new challenges.
While the headline fiscal deficit is expected to be above the targets due to
the significant expenditures related to bank recapitalisation in 2013 and 2014,
the deficit is also projected to exceed the target in 2015 under a
no-policy-change scenario. The structural adjustment likewise falls slightly
short of what would be needed. Taken together, these shortcomings and
challenges weigh on the near term macroeconomic performance. The recent fall in
sovereign bond yields relieves some pressure but the pace of implementation of
the programme of structural reform needs to accelerate.
Excerpt of country-specific findings on Slovenia, COM(2014) 150 final,
5.3.2014
Executive Summary and Conclusions 5
1.       Introduction  9
2.       Macroeconomic
Developments 11
3.       Imbalances
and Risks 21
3.1.     Financial
sector renewal 21
3.2.     Coming to
terms with higher sovereign debt 26
3.3.     Loss of external
competitiveness and export performance  29
4.       Specific
Topic - Corporate performance and restructuring  33
4.1.     Financial
performance and distress in the corporate sector() 33
4.1.1.  Main features
of corporate over indebtedness 33
4.1.2.  Confirmed weaknesses
in SOEs and SCEs 38
4.1.3.  Deteriorating
profitability and low investment capacity () 41
4.2.     Financial
restructuring and insolvency challenges 44
5.       Policy
Challenges 49
References 52
LIST OF Tables
2.1.     Key
economic, financial and social indicators - Slovenia   18
4.1.     Overview of
key ratios and financial indicators by sector (2012) 35
LIST OF Graphs
2.1.     Contributions
to potential growth  11
2.2.     Current
account balance by component 11
2.3.     Cumulative
change of exports and imports over 2008-2013  11
2.4.     Imports of
goods by demand components 12
2.5.     Market
share growth in goods 12
2.6.     Decomposition
of Rate of Change of NIIP  16
2.7.     Net Lending/Borrowing
by Sector 16
2.8.     Employment
and Social Indicators 16
3.1.     Sovereign
10-y yields, Slovenia & Italy  27
3.2.     World
export market shares, yoy growth rate  29
3.3.     Exports of
goods and services, constant prices 29
3.4.     Real
effective exchange rates vs EA-17, 2008=100  29
3.5.     Yearly real
effective exchange rates ULC vs EA-17  29
3.6.     Nominal
Unit Labour Costs, 2008=100  30
3.7.     Per
employee GDP and nominal compensation  30
3.8.     Real hourly
compensation of employees (00Q1 = 100) 31
3.9.     Geographical
and sectoral composition of nominal (USD) rate of change of goods exports 31
3.10.   Productivity
and labour cost (2000=100) 32
4.1.     Overview of
indebtedness of the Slovenian corporate sector in 2012  33
4.2.     Corporate
health indicators for companies classified by share of equity in total
liability (2012) 34
4.3.     Corporate
health indicators for companies classified by debt leverage ratio (2012) 34
4.4.     Distribution
of the debt overhang by company size in 2012  34
4.5.     Profitability
and the interest burden  41
4.6.     Net value
added contribution of the corporate sector (as % of GDP) 41
4.7.     Funding
cost of the Slovenian corporate sector 43
4.8.     Cash flow
capacity, net earnings and return on equity  43
4.9.     Cash-flow
capacity and capital expenditure (CAPEX) 44
LIST OF Boxes
2.1.     House price
outlook in Slovenia   14
3.1.     Banking
sector: assessment of the policy actions taken in 2013  22
3.2.     A scenario
for banking sector trends to 2015. 25
3.3.     Debt
Sustainability Analysis: primary surpluses needed   28
4.1.     The
distribution of corporate debt in Slovenia – a sectoral analysis and
cross-country comparison  37
4.2.     Overview of
Insurance Sector 39
4.3.     Increasing
Dependence on State Aid   40
4.4.     Reform of
Insolvency proceedings 45
4.5.     Enhancing
the business environment through improving the effectiveness of commercial and
civil justice  46
LIST OF Maps
No table of contents
entries found.
In April 2013, the Commission concluded
that Slovenia was experiencing excessive macroeconomic imbalances, in
particular with respect to developments related to the extent of state
involvement in the economy, corporate sector deleveraging, banking stability
and to some extent also external competitiveness. In the Alert Mechanism Report
(AMR) published on 13 November 2013, the Commission found it useful, also
taking into account the identification of a serious imbalance in April 2013, to
examine further the risks involved and progress in the unwinding of imbalances
in an in-depth analysis. To this end this In-Depth Review (IDR) provides an
economic analysis of the Slovenian economy in line with the scope of the
surveillance under the Macroeconomic Imbalance Procedure (MIP). The main
observations and findings from this analysis are:
·       The Slovenian economy was severely affected by the crisis and is
undergoing considerable adjustment.  In 2013 real
GDP was 10% below the peak levels experienced in 2008 but a fragile recovery,
driven by net exports, is expected to commence in the second half of 2014. As
domestic demand, and especially investment, contracted significantly, the
current account has corrected sharply from a deficit of 7% of GDP in 2008 to a
surplus of 3.1% of GDP in 2012, and a further increase of the surplus is
expected. The current account surplus reduces Slovenia's net foreign
liabilities, as the Net International Investment Position (NIIP) has seen a
marked improvement and now stands at a level below 40% of GDP.
·       Slovenia has taken decisive policy action in 2013 which has
stabilised the banking sector but further restructuring and consolidation is
required for the sector to return to long-term sustainability and profitability.  As a result of four consecutive years of balance sheet
contraction and asset transfers the Slovenian banking sector has shrunk by one
fifth. Policy action has included asset quality reviews, stress tests,
recapitalisation of the state owned banks and the transfer of Non-Performing
Loans (NPLs) to the Bank Asset Management Company (BAMC). Although the prompt
restructuring of banks' balance sheets is being facilitated by the transfer of
NPLs to the BAMC, the level of NPLs remains elevated relative to pre-crisis
levels and could pose a threat to future viability and privatisation of banks
if not swiftly resolved. Once the current phase of bank restructuring,
privatisation and impaired loan resolution is completed, the principal residual
risk to the sector will be the ability to return to sustainable profitability
and to maintain resilience to absorb potential future shocks. As there is
limited scope to widen net interest margins, profitability developments and the
strengthening of the sector will be largely determined by efficiency
improvements and related cost reductions over the medium term. 
·       The sharp increase in government debt in recent years, albeit from a
relatively low level, creates new challenges and risks which underscores the
need for sustainable policy actions. The
debt-to-GDP ratio rose from just 22% in 2008 to 54% in 2012. In 2013 the debt
is estimated to have risen by a further 18 pps to 72% of GDP. While the bank
recapitalisations and transfers to the BAMC in December 2013 account for a
significant part of this increase, a substantial proportion of it relates to
the accumulation of primary deficits. The debt is forecast to continue
increasing over 2014-15 and Slovenia appears to face sustainability risks in
the medium and long term due to the steep rise in ageing-related spending.
Higher debt and shortened maturities increase the importance of viable debt
management strategies, as illustrated by the substantial impact on interest
rate expenditure from debt issuances in late 2013 at elevated interest rates. 
·       A substantial loss of export market shares over the past five years
indicates Slovenia is not competing effectively in world markets. While export volumes are returning to the peak levels reached in
2008, they are not growing in line with the expansion in global trade. The
reversal of Slovenia's previous gains in export market shares is driven by
cost-competitiveness losses, which also inhibits investment and job creation.
These losses are particularly marked versus the catching-up economies of
central Europe which are a natural benchmark for Slovenia as a production
location, and versus the member states receiving financial assistance, which
are a benchmark as regards the pace of macroeconomic adjustment. Slovenia's divergent
unit labour cost developments from these benchmark economies provides clear
evidence of Slovenia's overall cost-competitiveness losses, driven by labour
cost growth which is out of line with productivity trends and labour market
inflexibilities. 
·       The postponement of financial restructuring of viable companies
delays the re-establishment of investment capacity and the recovery of the
Slovenian economy as a whole. The level of NPLs in
the Slovenian corporate sector has substantially increased in recent years. The
high level of indebtedness and financial distress limited the corporate sectors
capacity to invest and significantly contributed to the prolonged decline in
investment experienced in Slovenia. Furthermore, the fall in operational
profitability of companies indicates a decrease in efficiency and a loss of
competitiveness. This has wider implications for the economy with a sharp
deterioration in the corporate sector's contribution in terms of net added
value to GDP from pre-crisis levels. The restructuring of companies has been
severely constrained by a cumbersome legislative framework and weak corporate
governance, particularly but not only in state owned enterprises. A new
legislative framework for corporate restructuring was introduced in December
2013, the purpose of which is to improve the efficiency of insolvency
proceedings and provides for the preventive restructuring of viable businesses
with unsustainable debt overhangs before they become insolvent. The
introduction of the reform is welcome, though its impact is yet to be assessed
as it remains largely untested. 
·       The complex nexus of state ownership limits adjustment and distorts
resource allocation, especially as regards new investment. It also appears to deter foreign direct investment (FDI) which is
lower than in peer countries.. It also creates risks to public finances, either
directly or by way of contingent liabilities from guarantees provided.
Amendments to the legislation underpinning the Slovenia Sovereign Holding (SSH)
aimed at reconstituting it as a vehicle for consolidating the management of
direct and indirect ownership stakes of the State and the classification of
non-core assets for privatisation have been delayed. 
The IDR discusses the policy challenges
stemming from the imbalance and risks identified above and possible avenues for
the way forward in order for Slovenia to successfully pursue the full unwinding
of these imbalances. A number of considerations, outlined below, could guide
future policy response: 
·       Decisive action as regards operational restructuring, consolidation
and privatisation would improve profitability and enhance the long-term
viability and sustainability of the financial sector. Further determined action, particularly regarding operational
restructuring, would improve the profitability outlook of the financial sector.
Decisive and swift action as regards consolidation and privatisation would
enhance the long term sustainability of the sector. Furthermore, medium term
viability and the prevention of repeated build-up of risks will depend on the
quality of micro and macro supervision, risk management and governance. Prompt
asset divestments by the BAMC and implementation of the privatisation programme
could minimise potential future losses for the assets concerned as well as
generating proceeds for the reduction of debt.
·       Prudent and credible fiscal and economic policy-making will be
required to maintain market confidence and ensure debt sustainability in the
medium and long term. Given the substantial
increase in the level of public debt in Slovenia, albeit from a relatively low
level, decisive policy action is required. First and foremost, sustained
primary surpluses are needed to put debt onto a downward path. The right fiscal
institutions, including an effective fiscal council and fiscal rules can
provide important anchors for such a fiscal policy. The margin for revenue
increases has been largely exploited in the 2014 budget, so expenditure
consolidation options will need to be fully explored. A good alternative to
potentially damaging and inefficient linear expenditure cuts could be a more
targeted reorganisation of state activities. Credible expenditure reviews could
inform the budgetary measures required to meet the overall fiscal consolidation
objectives and also identify options to enhance efficiency, cost effectiveness
and exploit synergies to reduce duplication of services. In view of the steep
increase in ageing-related spending implied by Slovenia's demographics, the
pension and long term care systems will need to be reformed in the near term if
the overall expenditure envelope is to be stabilised over the medium and long
term. 
·       Restoration of cost competitiveness over the medium term could boost
export performance. Containment of labour cost
growth could help to regain cost competitiveness in the near term. Public
policy can influence labour costs via a number of channels, including the
reform of the minimum wage, labour taxation (including employers' social
security contributions) and public sector wages. Namely, the structure of the
minimum wage could be revised in order to differentiate between different
labour market groups, while indexation could take other economic trends into
account, including productivity. 
·       Policies to address the corporate debt overhang which focus on
supporting prompt debt restructuring could unlock new private investment. Financial and operational restructuring could prioritise the most
vulnerable companies, financial holdings and the state-owned entities where the
majority of the debt overhang is concentrated. Close monitoring and corrective
action is needed to ensure that the recently revised insolvency framework and
its implementation by the courts deliver the necessary improvements in the
restructuring of distressed companies. Early intervention by both debtors and
creditors via the new preventive restructuring procedure could allow for viable
businesses to be restructured before they become insolvent. If shortcomings
emerge the new legislation could be revised. In addition, policies supporting
enhanced reporting and corporate governance practices in key sectors of the
economy, and particularly in state-owned entities, will be necessary to improve
profitability and competitiveness.  
·       A significant withdrawal of the state from Slovenia’s corporate and
financial sector, combined with a comprehensive transparent strategy for the
management of core assets and the prompt divestment of non-core state assets,
could improve the adjustment capacity of the real economy and reduce the risk
to public finances. The state will remain an
important actor in many key restructuring cases, through the BAMC, the state
owned banks and state shareholdings. Private restructuring deals concluded
between privatised companies and privatised banks are likely to adhere more
closely to commercial principles and deliver more durable value than solutions
orchestrated by the state. Decisive progress with regard to the privatisation
of the 15 state owned entities identified for accelerated privatisation and the
adoption of a comprehensive strategy for core and non-core state assets could
provide a clear signal to the market regarding Slovenia's commitment to
implementing the necessary reforms. Continued transparent privatisation could
also help unlock productivity increases and provide the competitiveness boost
the Slovenian economy and enterprises urgently need. 
On 13 November 2013, the European
Commission presented its third Alert Mechanism Report (AMR), prepared in
accordance with Article 3 of Regulation (EU) No. 1176/2011 on the prevention
and correction of macroeconomic imbalances. The AMR serves as an initial
screening device helping to identify Member States that warrant further in
depth analysis to determine whether imbalances exist or risk emerging.
According to Article 5 of Regulation No. 1176/2011, these country-specific
“in-depth reviews” (IDR) should examine the nature, origin and severity of
macroeconomic developments in the Member State concerned, which constitute, or
could lead to, imbalances. On the basis of this analysis, the Commission will
establish whether it considers that an imbalance exists in the sense of the
legislation and what type of follow-up in terms it will recommend to the
Council.
This is the third IDR for Slovenia. The
previous IDR was published on 10 April 2013 on the basis of which the
Commission concluded that Slovenia was experiencing excessive macroeconomic
imbalances, in particular as regards developments related to corporate sector
deleveraging, banking stability and to some extent also external
competitiveness. Overall, in the AMR the Commission found it useful, also
taking into account the identification of a serious imbalance in April, to
examine further the risks involved and progress in the unwinding of imbalances
in an in-depth analysis. To this end this IDR takes a broad view of the
Slovenian economy in line with the scope of the surveillance under the
Macroeconomic Imbalance Procedure (MIP). 
Against this background, Section 2 gives an
overview of macroeconomic developments, Section 3 looks more in detail into the
main imbalances and risks, focussing in particular on the financial sector
renewal, debt sustainability and the loss of cost competitiveness and export
performance. Section 4 addresses specific topics related to corporate cash
flows and investment, like corporate performance and distress, deleveraging
pressure and quantifies the size and scale of the risk inherent in the
corporate sector. Section 5 discusses policy considerations. 
Growth and export performance
The crisis has had a profound and
prolonged impact on the Slovenian economy. Real GDP
in 2013([1]) was 10%
below the peak achieved in 2008 and the economy continues to contract, with
only a tepid recovery forecast from the second half of 2014 according to the
Commission services Winter 2014 forecast. The period has been marked throughout
by compression of domestic demand, particularly investment, which translated
into declining potential growth, where the majority of the decline is
attributable to factors other than labour input, i.e. capital and total factor
productivity (see Graph 2.1). The impact of reduced investment may be
overstated due to the prevalence of non-productive investment in the pre-crisis
years (see in-depth sections of 2012 and 2013 IDRs). 
The current account has corrected
sharply from a deficit of 7% of GDP in 2008 to a surplus of 3.1% of GDP in 2012. Additional widening of the surplus is expected in 2013-15. The
increase in the services trade surplus and the disappearance of the goods trade
deficit have contributed relatively equally to this correction (see Graph 2.2).
In nominal terms the exports of services increased by 9.5% in the period
2008-2013 and represent 15.5% of GDP in 2013. Exports of goods increased in
nominal terms by 7.6% in the same period and represented 63.2% of GDP,
signalising the importance of merchandise trade for the GDP. 
Compression of domestic demand has
translated into a decline of imports. Over the
period 2008-2013, import volumes declined by 13.6% while exports volumes
increased only by 2.5% in the same period. However, the cumulative price effect
has been positive both for imports and exports (see Graph 2.3), thus stemming
the impact of the decline in import volumes on the current account balance. 
The bulk of the change in imports of
goods since 2008 can be attributed to the decline in construction investment
and disposable income. Given the weakness of
domestic demand, the only import growth in recent years has occurred in intermediate
goods, which is driven by Slovenia's export industries (see Graph 2.4).
Export performance has been below the
average of peers. Slovenia has lost almost a fifth
of its market share in world exports over the last five years. Since 2009,
catching up Visegrád member states such as the Czech Republic, Poland and
Slovakia have participated more in the rebound in world trade in goods (see
Graph 2.5). The competitiveness developments underlying this underperformance
are examined in more detail in Section 3.3.
Financing conditions
Domestic bank credit has continued to
contract, particularly to the corporate segment.
Restricted access to finance for viable companies due to market fragmentation
could limit the growth potential of the economy which is primarily composed of
SMEs. Domestic deleveraging is, however, a key driver of the development of the
financial position of Slovenia. Section 3.1 further analyses banking sector
developments which are characterised by balance sheet cleaning and contraction.
Credit to households has also shrunk. This may reflect the expectation of further house price declines.
The Eurosystem Household Finance and Consumption Survey indeed finds that
Slovenian households, despite their strong balance sheets, were faced with the
second highest refusal rate for credits (28%) in the euro area. They also
refrained the most from applying for credit due to perceived credit constraints
over the past two years. Overall households' financial strength ([2]) would be suggestive of credit supply constraints, although
banks state that demand from viable households is lacking. If confirmed, any
such supply constraints could be a factor depressing consumption and the
housing market. Following a cumulative fall in house prices from their peak by
almost 20% (29% after inflation adjustment), the overvaluation gap that built
up during the boom has considerably narrowed. However, our analysis of the
housing market indicates that, although prices may start showing signs of a
stabilisation, the outlook for house prices continues to be negative as
economic fundamentals are likely to drag down the equilibrium house price
level, while the still fragile credit market conditions increase the risks of
an undershooting of the equilibrium house price level (see Box 2.1).
Asset market developments have been weak
but improved after banking sector assessment.
Nevertheless this development is too recent to have passed through to
economy-wide borrowing costs ([3]). House prices have continued to decline with transaction and
construction volumes remaining low (Box 2.1 assesses the scope for further
correction in the housing market). The stock market remains subdued with a
relatively low number of liquid listed blue-chip companies, some of which are
earmarked for disposal by banks and the state.
 (Continued on the next page) 
 Box (continued) 
The current account surplus reduces
Slovenia's net foreign liabilities. Between 2005
and the beginning of 2009, Slovenia quickly accumulated a substantial negative
Net International Investment Position (NIIP) of approximately 40% of GDP. The
primary driver was the foreign borrowing of Slovenian banks to fund investment,
particularly in booming construction and acquisition activities ([4]) (see net transaction effects in Graph 2.6). The secondary driver
was the emergence of negative net valuation changes in 2008, stemming
principally from sustained reductions in asset values within 'other
investments', part of which may reflect Slovenia's exposure to depressed
markets in the former Yugoslavia. The sudden halt in foreign bank financing in
2009 led to substantial net repayments of debt. The persistence of negative
trends in net valuations offset the positive impact of transactions on NIIP
until end of 2012. Since 2013, due to improving transaction effects and
declining negative valuation effects, the NIIP has seen a marked improvement
and now stands at a level below 40% of GDP.
The collapse in corporate borrowing has
driven the change in Slovenia's financial position.
Decomposing net lending and borrowing by sector (see Graph 2.7) shows the
extent to which non-financial corporations (NFC) have ceased borrowing, but
also reveals that modest deleveraging only commenced in 2012 (corporate
deleveraging is further analysed in Section 4). It also shows the impact of
government borrowing which is examined in greater detail in Section 3.2,
including a stock-taking of the impact of one-off capital support operations in
2013-14. 
Employment and social conditions
Unemployment increased from 4.4% in 2008 to 8.9% in 2012
and has continued to increase moderately throughout 2013; yet it remains below
the EU-28 average. There is substantial upward risk
to unemployment as there has only been a limited reallocation of the workforce
released by labour shedding in construction, real estate and, to some degree,
manufacturing ([5]). Real wages
are now edging downwards but remain above 2008 levels. Section 3.3 examines the
competitiveness implications of labour market developments.
Employment protection, strong household
balance sheets and broader social support have muted the social consequences of
the crisis to some extent. Youth unemployment
remain below the levels seen in other vulnerable EU economies, though the
annual increase in 2012 of 31% was the highest in the EU-28 and levels are
still rising. Although the key social indicators stay below the EU average, the
underlying trend is not reassuring. The NEET ([6]) rate increased from 6.5% in 2008 to 9.3% in
2012 (EU average in 2012 is
13.2%) and the share of long term unemployed is up from 1.8% in 2009 to 4.3% in 2012 (EU average in 2012 is 4.7%). As detailed in
the 2013 IDR, unemployment, much more than low pay, is a key determinant of
risk of poverty and social exclusion. Young people have been the most severely
affected by the crisis (see Graph 2.8) as has been the case across Europe. The
risk of labour market scarring increases as long as economic growth does not
resume. This would particularly hit younger unemployed people whose skills and
lifetime earnings potential can atrophy over time and older unemployed people
who are at a higher risk of transitioning into inactivity. Despite these
trends, Slovenia remains one of the most equal societies in the EU, with a Gini
coefficient below 0.24.
3.1.      Financial sector renewal
Balance sheet contraction, raising NPLs
and erosion of capital buffers have marked the last four years triggering
decisive policy action. At the end of 2013 the
total assets of the Slovenian banking sector, which comprised of 23 entities
(17 banks, including seven subsidiary banks, three branches of foreign banks
and three savings banks), stood at approximately EUR 41 billion (116% of GDP),
down from EUR 52 billion (146% of GDP) at the end of 2009. As detailed in
previous IDRs, the first phase of deleveraging was triggered by the
international financial crisis,  many Slovenia-specific elements, like the high
level of state influence in banks and corporates, were revealed and reinforced
by the crisis, in particular the spiking of non-performing loans (NPLs) in the
corporate sector, concentrated in large and state owned companies. These credit
quality trends, together with deteriorating collateral values, quickly eroded
capital bases.
Policy action taken in 2013 addressed
the immediate stability risks in the banking sector. Credit risk has been credibly quantified and provided for with
substantial capital injections into state owned banks. The prompt restructuring
of banks' balance sheets is being facilitated by the transfer of NPLs to the
Bank Asset Management Company (BAMC). However, NPLs in the remaining domestic
credit portfolios stands at approximately 12% ([7]) and remain elevated relative to pre-crisis levels. 
The policy actions in relation to the
financial sector announced by the Slovenian authorities on 12 December 2013 was
assessed in the Commission's enhanced monitoring report ([8]) to the Economic Policy Committee of the Council (see Box 3.1). The
asset quality review (AQR) highlighted several vulnerabilities of the banks
practices and procedures and in light of this Bank of Slovenia (BoS) requested
banks to prepare remedial actions plans to address the key issues identified.
The remainder of the section assesses the
medium term trends in the financial sector.
Corporate deleveraging is only now starting
in earnest and will be a key driver of bank deleveraging. The initial contraction in bank credit to companies in 2010-11 was
partially compensated by other sources of credit, including from abroad (see
Section 2). Forbearance by creditors has sheltered many large loss making
corporates to date. Companies' debt-equity ratios remain elevated due also to
lower equity values. The pace of deleveraging could pick up if wide scale
financial restructuring now gets underway (see Section 4). The residual NPLs
after transfers to the BAMC also represent a significant credit risk though it
has been conservatively assessed (for the period to 2015 but not beyond) in the
stress test and specifically provided for in the recapitalisations. This could
generate further losses, thus limiting growth potential in an economy primarily
composed of SMEs. 
Deleveraging pressures will also
continue on the liabilities side. Banks may
anticipate the repayment of significant volumes of ECB funding (LTROs) and
deposit volumes are expected to stagnate in line with economic activity ([9]). Given domestic banks have limited or no access to financial
markets they are likely to adjust their loan books accordingly. Foreign banks
which currently operate with elevated LTD ratios are likely to remain under
pressure by their parent institutions or the supervisor to reduce their intra
group financing which is likely to result in further deleveraging.
 (Continued on the next page) 
 Box (continued) 
The banking sector is currently
undergoing consolidation but further consoldation is likely in the coming
years. Further merger activities, in particular
between smaller domestic banks, could exploit cost synergies resulting in the
creation of a fourth large domestic bank. A full privatisation of such a bank
would have a beneficial impact on the quality of its governance and risk
management. Box 3.2 presents a potential scenario for the evolution of the
banking sector in 2014 -2015 and finds that despite the signficiant
consolidation experienced in recent years, a further reduction in the size of
banks' balance sheets is likely over the period.  
Banking sector income and profitability
are set to remain depressed over the medium term, limiting the scope for
internal capital generation. The deleveraging
trends on the asset and liability sides will reduce the basis for bank
incomes ([10]) and curb
margins. On the asset side, lending rates are already elevated, with firms
paying a substantial premium over euro area competitors. As described in
section 4, higher interest rates may not be affordable for firms. On the
liability side, the scope for one-off profit taking has been exhausted.
Furthermore, the repayment of the LTRO funding will have a negative impact on
the banks' average funding costs ([11]). As a consequence capital for viable firms could become more
costly.  
Scope for a further increase of the
profitability beyond 2015 seems to be limited to cost reductions. The weak real economy and already high effective interest level
strictly limit interest income and interest expense will be affected by the
potentially increasing average cost of funding. This leaves reduction of the
underlying cost base as the key strategic imperative for banks in the short
term if they are to improve profitability and their capacity to build a
sustainable capital base through retained earnings. This highlights the
importance of realising the full cost reduction potential of the on-going
restructuring of the major domestic banks in the near term. Further
consolidation in the sector would also help to eliminate inefficiencies and to
raise synergies.
 (Continued on the next page) 
 Box (continued) 
3.2.      Coming to terms with higher sovereign debt 
The more than tripling of the government
debt ratio in recent years creates new challenges and risks. Firstly, the higher and increasing debt level and shortened
maturities increase (re)financing needs and hence the importance of prudent
debt management. Secondly, the higher yields for recent stressed debt issuance
and the overall debt increase results in overall higher interest costs.
Finally, the general government is fully and explicitly exposed to the risks
associated with the assets transfer from the banks to the BAMC. These are
valued at around 4.4% of GDP but the proportion of this value that is
eventually realised will depend largely on policy trade-offs and on the BAMC's
work-out strategy, both of which are yet to be clearly defined. This section
quantifies developments to-date and describes baseline and alternative
scenarios for the debt-path over the time horizon 2015-30 (see Box 3.3).
The debt-to-GDP ratio rose rapidly in
recent years, from just 22% in 2008 to 54% in 2012.
Approximately half of this increase is due to the accumulation of primary
deficits; one quarter derives from the impact of slow growth and high interest
rates (the so-called snow-ball effect); and the remaining quarter is due to
stock-flow-adjustments in the form of capital support operations. 
In 2013 the debt is estimated to have
risen by a further 18 pps to nearly 72% of GDP. The
impact of the bank recapitalisations and the transfers to the BAMC decided in
December 2013 (see Box 3.1) is of the order of almost 13pps of GDP. This was
financed by the issuance of a new bond, tapping existing bonds and depleting
the government cash buffer. This also entails a one-off increase in the
headline deficit, of around 10 pps in 2013 and 0.7 pps in 2014, but without
consequences on the structural adjustment path in both years. Although
sizeable, this increase could be considered as the materialisation of
contingent liabilities that were anticipated by the market, thus not
significantly worsening the market perception of debt sustainability. 
Higher debt and shortened maturities
increase the importance of securing market confidence and debt management
strategies. Slovenia's public debt rollover needs
in 2009 were of the order of EUR 1.5 billion, resulting from an end-2008 debt
of just over EUR 8 billion. This could quadruple to an average of around EUR 6
billion per year in 2014, on the basis of an estimated outstanding debt at
end-2013 of EUR 25 billion and a reduction in average maturities by around
three years ([12]). Total
financing needs also comprise fiscal deficits of about EUR 2 billion. This
underscores the need to access markets at more affordable rates and to issue
longer dated maturities, alongside the achievement of primary surpluses. 
Recent issuance of debt at elevated
interest rates has a substantial impact on public expenditure. To illustrate, the impact on public expenditure of these issuances,
we quantify the difference in the interest rate burden if Slovenian bond yields
had followed those of Italy (see Graph 3.1) between mid-2012 and end-2013. The
rationale for using Italy as a benchmark ([13]) is due to the high correlation of the two countries 10 year
sovereign bonds at the start of the period([14]). Additional interest costs of 0.2% of GDP could have been saved
(EUR 30 million on T-bills and EUR 43 million on bonds). For 2014,
the impact of past stressed issuance is around 0.4% of GDP (EUR 30 million
on T-bills and EUR 104 million on bonds). This premium reflects market
concerns regarding the underlying health of the financial sector and the cost
of policy inaction from 2008 to 2013. This results in the transfer of
consolidation pressure to other revenue and expenditure items. Even if rates on
new issuances were to remain at current levels from now on, the impact of this
period of elevated yields on interest expenditure would take until 2023 to
fully fade out. If new stresses were to develop, the direct impact on public
finances would be significant, given the now higher financing needs. The
indirect impact on economy-wide borrowing costs would consume corporate cash
flows, posing a risk to the balance sheet repair progress (see Section 4).
The debt is forecast to continue
increasing over 2014-15 and may follow unsustainable trajectories under a
number of plausible scenarios. The main driver of
these trends is the steep increase in ageing-related spending implied by Slovenia's
demographics combined with its current social welfare system. For instance, to
keep the Pension Fund budget in balance, additional transfers from the central
government budget to the Pension Fund increased from 1.8% of GDP in 2008 to
around 3.4% of GDP in 2013. A comprehensive reform of long-term care remains at
the planning stage. A further pension reform to preserve sustainability of the
system beyond 2020 is currently being discussed by the government, with the
help of academic experts. To assess the sustainability of public debt under a
range of possible economic circumstances, some possible stochastic scenarios
for debt developments are presented in the Box 3.3. 
3.3.      Loss of external competitiveness and export performance
A substantial loss of export market
shares over the past five years indicates Slovenia is not competing effectively
in world markets. Although export volumes are returning
to the peak levels reached in 2008 ([15]) (see Graph 3.3), they are not growing in line with the expansion
in global trade (see Graph 3.2). Other advanced economies are also losing
market shares, but the higher level of losses by Slovenia, for both goods and
services, is a symptom of underlying problems connected with the loss of
competitiveness. 
Slovenia lost cost-competitiveness, in
particular when compared to relevant country groupings. As shown in Graph 3.5, the main real effective exchange rate (REER)
indicators against the euro area (EA-17) have appreciated substantially at the
wake of the crisis and until 2010. The REER calculated using unit labour costs
appreciated the most, as the measures taken at the time to stem the impact of
the collapse in economic activity on the labour market, in the form of subsidy
schemes for reduced working hours and for workers on forced leave, resulted in
labour hoarding and wage inertia. Recent developments vs EA-17 are less clear
cut, depending on which REER measure is assessed; the unit labour costs
(ULC)-based REER has depreciated the most.  
As a competing production and FDI location,
Slovenia's performance can be usefully compared to that in the Visegrád
countries (Hungary, Czech Republic, Poland and Slovakia). In terms of
adjustment to macroeconomic imbalances, it can also be compared to rapidly
adjusting member states benefiting from financial assistance (Cyprus, Greece,
Ireland, Portugal). Graph 3.6 shows that the REER depreciated sharply at the
beginning of the crisis in the two comparisons groups, while it was still
appreciating in Slovenia.
Unit labour costs in Slovenia have
increased more than in other benchmark countries.
Graph 3.7 shows the hike in nominal unit labour costs (NULC) that Slovenia
recorded in the first two years of the crisis. ULC have broadly stabilised
since 2010, in spite of some relaxation in employment protection legislation
and in the indexation of the minimum wage to inflation (see Box 2.1 in the IDR
2013). Member States benefiting from financial assistance and the Visegrád
countries have instead recorded a gradual decline or even a sharp correction of
their ULC. 
Labour costs in Slovenia are somewhat
out of line with productivity. The relative
importance of the productivity and labour cost trends underlying NULC
developments can be assessed by comparing Slovenia with the benchmark groups.
Graph 3.10a shows that in Slovenia the sharp increase in nominal compensation
per employee between 2008 and 2010 was accompanied by a decline in
productivity, as output dropped. The sustained dynamics of nominal compensation
in the Visegrád countries was compensated for by a continued productivity
increase during and after the crisis (see Graph 3.10b). The reduction of ULC in
Member States benefiting from financial assistance has been driven by a
decrease in nominal compensation and productivity gains, which occurred at the
expense of rising unemployment (see Graph 3.10c). In absolute levels, Slovenian
labour costs and productivity are between those of the Visegrád countries and
those of the other benchmark groups. Proportionally, Slovenia has made more
progress towards European average wage levels than it has made towards average
European productivity levels, as can be seen from its position above the line
in graph 3.8. 
In real terms, wages in public sector
have been declining since 2010. Growth in real
hourly wages in both the private and public sectors was quite dynamic before
the crisis, but slightly more so in the private sector (see Graph 3.9). Wages
in the public sector decoupled from those in the private sector in 2010, when
they started to decline under the constraint of fiscal consolidation. As policy
currently stands, there are in-built dynamics in wages that could reignite
adverse trends in the coming years. The minimum wage, which was discretionary
increased by 22.9% in March 2010 and adjusted by the inflation rate at the
beginning of 2011, 2012 and 2013 is among the highest in the EU as a percentage
of average wages. ([16]) The high
level of the minimum wage relative to the average wage in Slovenia could have a
significant negative impact on employment, deter FDI, prevent creation of lower
productivity jobs and as a consequence delay the employment recovery. Renewed
economic growth would also put pressure on wages just above the level of the
new minimum wage as employees seek to re-establish differentials that were
compressed in 2010.
Slovenia's export performance also
suffers from an unfavourable product specialisation and geographical orientation. Graph 3.4 decomposes the growth in nominal goods' export before and
during the crisis into two indicators showing the extent to which exports have
been geared towards dynamic geographic and product markets, and two performance
indicators capturing Slovenia's success in achieving above-market export growth
in intial geographic and product markets. The Graph 3.9 shows that before the
crisis Slovenia's exports were oriented towards still dynamic destination
countries – mainly Italy and the former Yugoslav republics, while it managed to
gain considerable market shares in new product markets. However, as the crisis
hit Slovenia's key trading partners, the geographical specialisation of
Slovenia's exports turned into a disadvantage, and the economy lacked sufficient
dynamism and/or competitive advantage to enter new markets. This accounts for
approximately half of the decline in goods exports since the crisis. The other
half of the decline has occurred through losses of market shares within
specific product markets, where Slovenia had an established foothold. Product
specialisation remains a drag on export performance, indicating slow adjustment
of industrial base.
4.1.      Financial performance and distress in the corporate
sector([17]) 
Slovenia's corporate sector has been
significantly impacted by the economic downturn.
The level of non-performing loans (NPLs) in the Slovenian corporate sector
substantially increased during 2013 (from 16% at end December 2012 to 28% at
end November 2013). In parallel, profit margins remain squeezed, burdened by
high interest costs. The fall in operational profitability of the companies
indicates a decrease in efficiency and a loss of competitiveness. This has
wider implications for the economy as the corporate sector's contribution in
terms of net added value to GDP has deteriorated from pre-crisis levels.
Furthermore, the high level of indebtedness has limited the corporate sector
capacity to invest and has notably contributed to the 50% decline in investment
experienced in Slovenia. 
The assessment ([18]) in this Section is based on data from the database of the Bank of
Slovenia, which comprises micro data of 2000 - 2012 annual reports for more
than 55,000 Slovenian companies. The data is analysed from a bottom-up
(company-by-company) and a top-down perspective (consolidated for the entire
corporate sector, by industry or by company size). The primary data source is
the Agency of the Republic of Slovenia for Public Legal Records and Related
Services (AJPES) ([19]). In
addition, a different set of publicly available data from Bureau Van Dijk
(Orbis database ([20])) was used
in order to allow sectorial and cross-country comparison (see Box 4.1). The
data excludes companies in insolvency proceedings and those with negative
equity value, thereby improving the quality of the sample base and somewhat
overstating the real situation.  
4.1.1.   Main features of corporate over indebtedness 
High debt leverage accumulated in the
years preceding the crisis has only been partly corrected. The debt level compared to total assets and to operating profit
increased significantly in the period 2007 to 2009 (see Graph 4.1). While
deleveraging commenced in 2010, progress to date has been limited and
companies' debt leverage ([21]) and debt to
assets ([22]) ratios remain
elevated.
The accumulation of debt in the past has
distorted liability structures. Continued
postponement of financial restructuring has considerably weakened companies'
balance sheets and reduced their loss absorbing buffers. In 2012, the equity
ratio ([23]) of 46% of
the Slovenian companies was below 50% (see Graph 4.2). While the number of
companies in this category has remained relatively stable since 2004 ([24]), their proportion of the cumulated net corporate loss has
increased significantly from 30% to 67% in 2012. Similarly, these firms display
particularly low profitability and hold 75% of gross debt. Without
restructuring the ability of some of these companies to continue to operate is
questionable. The reform of the insolvency legislation with the objective to
enable financial restructuring at an early stage and rapid resolution is key to
facilitating the reallocation of economic resources and recovering value for
creditors (see Section 4.2 and Box 4.4). In addition, fresh equity investment,
including FDI, will be an important facilitator to reforming capital structures
and restoring operational efficiency in the corporate sector.   
The debt overhang ([25]) is
concentrated in a small number of vulnerable large and medium sized companies.
Highly indebted companies ([26]) account for
65% of the total debt and more than half of the corporate assets in Slovenia
(see Graph 4.3), although they represent only 28% of the number of companies
(up from 15% in 2000). They contribute to more than half of the total net loss
of the corporate sector in 2012.
 
Only a dozen highly indebted companies ([27]) are liable for 90% of the debt overhang (see Graph 4.4). The
remaining 10% is dispersed among a limited number of small companies (2.4% of
small companies) and a much wider group of micro companies (18.4% of micro
companies). Corporate governance and misallocation of capital may be the
underlying reasons for this uneven debt concentration. Consequently, from the
economic efficiency perspective, the focus of the financial and operational
restructuring should be on the large companies.
Corporate debt imbalances affect several
sector of the Slovene economy. Unlike in other
vulnerable countries, where the economic distress was concentrated in the real
estate and construction sectors, in Slovenia the pattern is rather
cross-sectorial and likely linked to capital misallocation and inefficient
corporate governance. The transport and storage, services and leisure ([28]), as well as wholesale and retail trade sectors are also highly
indebted (see Table 4.1) ([29]). These
sectors have in recent years generated losses or low profits and their average
leverage ratios (2007-2012) are above five. Box 4.1 further examines the level
of indebtedness of Slovenian corporates on a sectorial and company-size basis
at the end of 2012, using different company-level data ([30]) to allow a comparison to regional peers (Czech Republic and
Slovakia).
Financial holdings ([31]) represent
a key vulnerability for both the corporate and the banking sector, given the high
levels of debt and financial distress concentrated in these entities.
Financial holdings participated in a number of debt-driven management buy-out
transactions (MBOs) during the period 2005-2007. Many of those transactions
were part of the second wave of privatisations in Slovenia, when powerful
internal stakeholders consolidated ownership in key industries supported by
state-owned banks and funds (see European Commission 2013 IDR and Country
Focus). Some of the largest financial holdings (i.e. Zvon) are insolvent while
others are currently going through debt restructuring processes (i.e. ACH).
 (Continued on the next page) 
 Box (continued) 
In 2012, the financial holdings were
liable for as much as EUR 6.7 billion or 20% of the total corporate debt,
despite the fact that there are relatively few of them and they are
insignificant in terms of employment (below 1%). On average financial holdings
reported significantly higher losses (-42% net profit margin) and debt levels
(leverage of 61x in 2012 and median for 2004-2012 of 78x) than the overall
average (see Table 4.1). The specific role of the financial holdings in Slovenia
as well as their ownership structure needs to be assessed in view of their very
limited contribution to the economy by way of employment and their low profit
generation capacity. Their viability is questionable, given the unsustainable
levels of debt they hold. 
4.1.2.   Confirmed weaknesses in SOEs and SCEs
State-Owned and State-Controlled
Enterprises (SOEs/ SCEs) in Slovenia continue to generate losses and pose
significant risks to the public finances. The 2013
IDR and 2013 Country focus presented key evidence on the nature and extent of
state involvement in the economy, focusing on ownership links, the fiscal
effects of capital injections and the impact on overall efficiency of the
economy through misallocation of resources. Most of the SOEs/ SCEs ([32]) included in last year's review continue to be highly indebted, and
as a result their performance has deteriorated further in 2012, with the
exception of the insurance sector, which is in good financial health (see Box
4.2 for more detailed assessment of the insurance sector). The number of
companies assessed as highly vulnerable has increased from 13 in 2011 to 17 in
2012([33]). Moreover,
when compared to other ownership structures, SOEs/ SCEs appear to hold the
largest proportion of the corporate capital in Slovenia (27% of total debt and
29% of total assets). SOEs/ SCEs are also responsible for a large share of
losses in the corporate sector, contributing almost a quarter of the total net
loss in 2012 (see Table 4.1). As discussed in a recent note by the Slovenian
Institute of Macroeconomic Analysis and Development (IMAD) ([34]), SOEs are significantly larger than average enterprises and in
some cases more capital intensive. Their profitability and productivity in 2012
was lower than the privately and foreign-owned companies in Slovenia,
particularly in the agriculture and mining, construction, manufacturing, and in
the services sectors (accommodation and food services; professional, scientific
and technical activities). Although SOEs appear to be present in most of the
sectors of the economy, they are more concentrated in the energy, transport and
storage, financial services (i.e. financial holdings), and professionals
services, which are also amongst the most highly indebted sectors in Slovenia
(see Table 4.1). 
The high level of state involvement in
the economy is one of the factors limiting equity investment and FDI which
would support the reform of capital structures. A
business environment open to private competition is one of the main
prerequisites for FDI. However, the most recent findings by the Slovenian
anti-corruption agency (KPK) point at systemic corruption risks, distortion of
the allocative function of the banking system, lack of robust risk management
and supervision practices. The study, which is based on case-by-case
investigations, draws attention to the privileged role of SOEs and SCEs in the
Slovenian economy, particularly when it comes to access to finance and
investment opportunities. Box 4.3 broadens the scope beyond ownership links to
show the extent of subsidies and state aid to companies, irrespective of
ownership, which further worsens the investment climate in Slovenia. Distortion
of market principles and rent-seeking practices in Slovenia threaten to block
the privatisation process which would help to boost productivity, deepen the
role of capital markets ([35]) and enhance
the potential for technological spill-overs from FDI. Indeed, at only 34% of
GDP in 2012, the level of inward FDI stock in Slovenia has remained the lowest
among new EU Member States since 2000, with the exception of Romania in
2002-2003 and Lithuania in 2008 when their inward FDI stock relative to GDP
edged just below the one of Slovenia. 
Implementation of targeted reforms to
reduce the level of state involvement in the economy has been delayed. As a first step in the privatisation process, the authorities
identified an initial 15 companies for accelerated privatisation in June 2013,
but progress to date has been mixed. One small company (Fotona) and one
medium-sized company (Helios) have since been privatised, though the state only
had a blocking minority in the latter. In the interim, the state ownership in
the banking sector has increased due to state recapitalisations and the state
may become owner of a further two domestic banks if private capital is not
raised (see Box 3.1). Two key privatisations are expected to be completed by
July 2014 and to attract substantial FDI flows, one in the banking and another
one in the telecommunication sector. Several of the other assets sales
processes appear to be stalled with limited progress, partially due to the
intention to firstly undertake debt restructuring, but also in some cases due
to difficulties in reaching shareholder agreements for the sale of the company.
Moreover, the amendments to the legislation underpinning the Slovenia Sovereign
Holding (SSH) and reconstituting it as a vehicle for consolidating the
management of direct and indirect ownership stakes of the Republic of Slovenia
and the classification of non-core assets for privatisation envisaged by end
September in the context of the 2013 CSRs have yet to be adopted.
4.1.3.   Deteriorating profitability and low investment capacity ([36])
The profitability of the corporate
sector has deteriorated considerably due to the loss of competitiveness and the
high interest burden. Profit margins have collapsed
since the beginning of the crisis and remain squeezed at below pre-crisis
level.  This has been evident both in terms of operational profitability
(EBITDA margin([37]), suggesting
decreasing efficiency and loss of competitiveness, as argued in section 3.3,
and in terms of net profit margins, revealing the impact of increased interest
burden on the debt accumulated during the boom (see Graph 4.5). 
The corporate sector contribution to the
economy in terms of net added value to GDP deteriorated significantly in 2009
and while it has recovered slightly it remains lower than the pre-crisis levels
(see Graph 4.6). 
The funding cost of the Slovenian
corporate sector has remained elevated compared to regional peers and to euro
area average since the beginning of the crisis. 
Slovenian companies benefited from lower short- and long-term interest rates
before the crisis, compared to regional peers (Slovakia and Czech Republic) and
to the euro area average. However, with the start of the crisis in 2008-2009,
the gap between corporate funding costs in Slovenia and peers (both regional
and the Euro area average) started widening, mirroring the deterioration in
their capacity to generate operating cash flows (see Graphs 4.7). 
The inefficient capital structures,
deteriorating profitability and elevated funding costs have considerably
reduced the companies' capacity to invest. While
debt levels might have been sustainable during the boom, the high interest
burden has wiped out net earnings and return on equity during the crisis (see
Graph 4.7). As a consequence, the investment capacity of many companies has
been significantly reduced and they have started to underinvest as of 2011([38]). Capital expenditure (CAPEX) ([39]) significantly decreased in 2010 and has not yet recovered to
pre-crisis levels. The stronger decline in investment compared to EBITDA
reflects the credit contraction and the companies' increased liquidity buffers
as a preventive mechanism (see Graph 4.9).         
High costs of capital, distress in the
banking sector and misallocation of resources have impacted viable companies,
limiting their sources of financing and damaging overall competitiveness. In addition, cross-ownership, weak corporate governance and vested
interests have been a further driver of the squeeze on profitability and the
excessive accumulation of debt, leading to delays in restructuring and an
increase in insolvencies. 
4.2.      Financial restructuring and insolvency challenges 
The absence of the necessary legislative
framework has delayed the necessary deleveraging process. The insolvency framework that was in place until the end of 2013
did not provide for sufficient incentives to stakeholders to promptly and
effectively respond to and address emerging solvency issues. Furthermore, it
did not allow for effective preventive actions which resulted in many
instances, as outlined above, in a further deterioration of the financial
situation and reduced prospects of a return to sustainability.  
The deficiencies in the insolvency
framework made it difficult for creditors to maximize recovery from companies
in distress. The authorities recently introduced
amendment in the insolvency framework (see Box 4.4) which, if properly
implemented should provide a more effective toolset for sustainable debt
restructuring and greater opportunity to rehabilitate viable companies with
large debt overhangs.
Given the concentration of debt in a
small number of large companies, the focus of financial restructuring should be
on financial holdings and SOEs/SCEs. Decisive
action by creditors in addressing the largest problematic cases first can also
assist in restoring insolvency as a credible threat for non-payment of loans,
essential for a functioning financial system. Impediments to corporate
restructuring arose not only from the out dated legal framework but also from
the significant delays experienced of courts processing cases. Recent trends
indicate a favourable improvement in the overall processing times (see Box
4.5). If appropriately extended to insolvency disputes, these trends coupled
with the new framework could also assist in addressing the debt overhang of
corporates in a durable manner.
 (Continued on the next page) 
 Box (continued) 
This IDR has analysed five main challenges
for the Slovenian economy – related to the need for a durable repair of the
banking sector, addressing the level of state ownership, bringing the public
finances onto a sustainable path, improving export performance and
competiveness and enhancing corporate profitability and viability. The
discussion of banking sector repair highlights further deleveraging that will
continue despite the recently completed asset transfers and recapitalisations. In
order to facilitate new lending, in particular to viable companies, a
restoration of banks' profitability is essential but this is only feasible
through cost rationalisation in the medium term. The analysis of public debt
developments quantifies the impact of the increased debt levels on the debt
servicing costs and identifies the risk of unsustainable debt trajectories. The
analysis of export performance highlights the extent to which labour market
rigidities undermine Slovenia's competitiveness. The complex nexus of state
ownership limits adjustment and distorts resource allocation, especially as
regards new investment. It also appears to deter FDI which is lower than in
peer countries. Finally, a focus on corporate debt overhang discusses the
factors preventing the appropriate debt restructuring or liquidations that
would take companies out of financial distress and unlock new investment. All
five challenges will need to be overcome for Slovenia to effectively correct
its imbalances and to fully realise its growth potential. Against this background, this section discusses different possible
policy avenues that could be explored in order to address the above challenges.
Financial Sector restructuring
Further restructuring and consolidation
in the financial sector beyond the progress made in 2013 is required to return
to long-term sustainability and profitability. The
next phase of the restructuring process will focus on the operational
restructuring of banks and could involve further consolidation in the sector.
Given declining lending volumes and rather compressed net interest margins, the
cost reductions achieved in this phase will be the main tool to improve
profitability prospects over the medium term and in turn secure viability and
maintain resilience to any potential future shocks. Financial stability in the
longer term will also depend on the quality of governance and risk management.
Here there is an important role for bank privatisation and rigorous micro and
macro supervisory oversight.
Debt sustainability
The sharp increase in government debt in
recent years, albeit from a relatively low level, creates new challenges and
risks which require durable policy actions to ensure debt sustainability in the
medium term.   This IDR has detailed how Slovenia
faces new challenges due to its substantially increased and still rising
general government debt ratio. In particular, the materialisation of a range of
risks could push debt onto unstable trajectories. The main risks are further
bank recapitalisations and additional funding needs of the BAMC, protracted low
nominal GDP growth, failure to curb expenditure dynamics and weak budgetary
execution. These risks are further compounded by the projected substantial long
term increase in expenditure deriving from demographic ageing. 
Minimisation of risks associated with a
higher debt level in a low growth environment requires competent and credible
policy-making. First and foremost, sustained primary surpluses are needed to
bring the debt on to a downward path and compensate for any materialisation of
risks. The right fiscal institutions, including an effective fiscal council and
fiscal rules can be important anchors for such a fiscal policy. The margin for
revenue increases has been largely exploited in the 2014 budget, so expenditure
consolidation options will need to be fully explored. A good alternative to
damaging linear expenditure cuts would be a more targeted reorganisation of
state and local government activities based on credible expenditure reviews.
The pension and long term care systems will also need to be reformed in the
near term if the overall expenditure envelope is to be stabilised over the
medium term. Materialisation of risks from the BAMC needs to be minimised.
Losses on some assets may be inevitable, but these should be minimised and the
riskiest strategy would be to hold assets for the full lifetime of the BAMC
based on expectations of market recovery. This would merely replicate the
recent failings of the banks but this time within the general government's
balance sheet. Restructuring or insolvency procedures with prompt recovery of
value are the key to minimising this risk. This imperative applies equally to
the government's divestment of companies, where swift execution would reduce
the fiscal and economic risks arising from further corporate governance
failures, while at the same time the proceeds would contribute to debt
reduction. Finally, the higher debt level brings greater rollover needs, which
increases the importance of skilful debt management and sound economic policies
consistent with affordable interest rates. 
Restoring competitiveness
Containment of labour costs is essential
for restoring cost competitiveness. This IDR
identifies labour cost dynamics as one of the key challenges for Slovenia.
Labour costs are a particular challenge in industries which are heavily reliant
on workers earning the minimum wage or slightly above, industries where
productivity growth is not sufficient to bring down unit labour costs and
industries which need to adjust their workforce to lower demand but face labour
rigidities. Over the medium term, the best way to contain unit labour costs is
to generate productivity growth. There are many determinants of productivity
growth at the microeconomic level, but it is investment, particularly high
quality FDI, where Slovenia appears to face the biggest challenges. 
There are ways in which policy makers can
address labour cost dynamics so as to ensure that wage developments and labour
market institutions support competitiveness and job creation.  The minimum wage
is set very high in Slovenia, is indexed for inflation, with no link to
(sectorial) productivity, and is set at a uniform rate. These parameters could
be reviewed and the possibility of introducing separate wage floors for certain
categories of workers (such as the young) could be explored.  
Corporate sector restructuring
Enhancing governance in the corporate
sector and providing the tools to effectively address the debt overhang will
help to unlock productivity. This IDR has detailed
the extent and nature of the corporate debt overhang in Slovenia. Balance sheet
repair is slowed by depressed activity but it is also hindered by frictions,
notably in financial and operational restructuring. The delay in decisively
addressing this debt overhang has resulted in a further deterioration in the
viability of the corporate sector and a large increase in the level of NPLs
held by banks.
There has been policy action since May 2013
to overcome barriers to financial restructuring of companies. The insolvency
code has been amended to improve the efficiency of procedures and institute new
debtor-initiated pre-insolvency procedures for larger companies. There has also
been continued improvement to court functioning to address the long case
backlog and to process cases faster, which will help preserve recovery values.
However, there has been no policy action regarding operational restructuring.
Financial and operational restructuring
could start with the most vulnerable companies, financial holdings and the
state-owned entities where the majority of the debt overhang is concentrated.
Close monitoring will be required to ensure the recently revised insolvency
framework and court processes deliver the necessary improvement in the restructuring
of distressed companies. Early intervention by both debtors and creditors via
the new preventive restructuring procedure could allow for viable businesses to
be restructured before they become insolvent. Reinforcement of legal and court
capacity may be necessary to fully implement the new legislation and to
facilitate the prompt work out of distressed companies.  
The state is an important actor in many key
restructuring cases, through the BAMC, the state owned banks and state
shareholdings. Further policy options which incentivise and provide for the
timely restructuring of corporate debt, prioritising the most indebted
companies and sectors could be explored and introduced in a manner that does
not hinder the ongoing privatisation process. Private restructuring deals
concluded between privatised companies and privatised banks are likely to
adhere more closely to commercial principles and deliver more durable value
than solutions orchestrated by the state. Private ownership, including foreign
ownership, would also deliver the productivity and competitiveness boost
Slovenian enterprises urgently need. In addition, attracting fresh private
capital, including FDI, will be an important prerequisite for reallocating
economic resources and reforming highly indebted capital structures of
companies.    
Privatisation and state ownership
Encouraging private ownership and  a
comprehensive strategy for the management of strategic/core assets could
improve the adjustment capacity of the real economy  The level of state ownership and influence prevalent in Slovenia
creates significant risks to the public finances directly and indirectly by way
of contingent liabilities from guarantees provided. Furthermore, the high level
of state ownership deters FDI and equity financing from playing a full role in
Slovenia’s recovery. Decisive progress with regard to the privatisation of the
15 state owned entities identified for accelerated privatisation and the
adoption of a comprehensive strategy for strategic, core and non-core state
assets would provide a clear signal to the market regarding Slovenia's
commitment to implementing the necessary reforms and openness to private
ownership. Continued divestment of state ownership beyond the initial 15
companies identified is important in order to improve governance and
efficiency. The success of the privatisation process would be further enhanced
by an improved business environment and the promotion of greater competition in
the relevant sectors. 
AJPES, JOLP, ‘Public Posting of Annual
Reports’, 2013 (http://www.ajpes.si/Registers/Annual_
Reports/JOLP-Public_posting?id=765). 
Bank of Slovenia, ‘Financial Stability
Reviews’, 2007, 2008, 2009, 2010, 2011, 2012, 2013 (http://www.bsi.si/en/publications.asp?MapaId=784).
Bank of Slovenia, ‘Stability of the
Slovenian Banking System’, 2009, 2010, 2011, 2012, 2013  (http://www.bsi.si/en/publications.asp?MapaId=1357).
Bank of Slovenia, ‘Monthly Bulletins’,
December 2011, March 2012, December 2012, December 2013 (http://www.bsi.si/iskalniki/publications-montly-bulletin.asp?MapaId=210).
Bank of Slovenia, ‘Poslovanje bank v
tekočem letu, gibanja na kapitalskem trgu in obrestne mere’ issues from
August 2009 – January 2014 (http://www.bsi.si/iskalniki/porocila.asp?MapaId=1329). 
European Central Bank, ‘The Eurosystem
Household Finance and Consumption Survey’, April 2013
(http://www.ecb.europa.eu/pub/pdf/other/ecbsp2en.pdf?53288960625588e88e973b611451d64b).
European Commission, ‘Alert Mechanism
Report 2014’ COM (2013) 790 final (http://ec.europa.eu/europe2020/pdf/2014/amr2014_en.pdf).
European Commission, ‘The EU Justice
Scorebooard’
(http://ec.europa.eu/justice/effective-justice/scoreboard/index_en.htm).
European Commission, ‘Macroeconomic
Imbalances Slovenia 2013’, In-depth review, Occasional Papers 142|April 2013 (http://ec.europa.eu/economy_finance/publications/occasional_paper/2013/pdf/ocp142_en.pdf).
European Commission, ‘Macroeconomic
Imbalances Slovenia 2012’, In-depth review, Occasional Papers 109|July 2012 (http://ec.europa.eu/economy_finance/publications/occasional_paper/2012/pdf/ocp109_en.pdf).
European Commission, ‘Slovenia - Review of
progress on policy measures relevant for the correction of Macroeconomic
Imbalances’, February 2014 http://ec.europa.eu/economy_
finance/economic_governance/documents/
20140224_si_imbalances_epc_report_en.pdf).
European Commission, Product Market Review
2013, European Economy 8| 2013
(http://ec.europa.eu/economy_finance/publications/european_economy/2013/pdf/ee8_en.pdf).
European Commission, ‘Review of progress on
policy measures relevant for the correction of Macroeconomic Imbalances’,
November 2013 (http://ec.europa.eu/economy_finance/economic_governance/documents/si_imbalances_epc_report_en.pdf).
European Commission, ‘European Economic
Forecast Automn 2013’, EUROPEAN ECONOMY 7|2013 (http://ec.europa.eu/economy_finance/publications/european_economy/2013/pdf/ee7_en.pdf).
European Commission, ‘State Aid Scoreboard
2013’, Non-crisis aid (http://ec.europa.eu/ competition/state_aid/scoreboard/non_crisis_en.html).
European Commission, press release ‘State
aid: Commission approves rescue or restructuring aid for five Slovenian banks’,
IP/13/1276   18/12/2013 (http://europa.eu/rapid/press-release_IP-13-1276_en.htm)
European Commission, ‘Winter forecast 2014’
(http://ec.europa.eu/economy_finance/eu/forecasts/2014_winter_forecast_en.htm).
European Commission, ‘Assessing the
dynamics of house prices in the euro area’, Quarterly report on the euro area,
4/2012
(http://ec.europa.eu/economy_finance/publications/qr_euro_area/2012/pdf/qrea4_en.pdf).
Cuerpo, C., I. Drumond, J. Lendvai, P.
Pontuch and R. Raciborski (2013), ‘Indebtedness, Deleveraging Dynamics and
Macroeconomic Adjustment’, European Economy, Economic Paper no. 477.
IMF, ‘Slovenia 2013 Article IV
Consultation—Concluding Statement of the Mission’ ( http://www.imf.org/external/np/ms/2013/102813.htm).
IMF, ‘Republic of Slovenia: 2013 Article IV
Consultation’ (Staff Report; Informational Annex; Debit Sustainability Analysis
(DSA); Press Release; and Statement by the Executive Director for the Republic
of Slovenia), January 2014. (http://www.imf.org/external/pubs/ft/scr/2014/cr1411.pdf).
IMF, ‘Euro Area Policies’, Country Report
No 13/231 (http://www.imf.org/external/pubs/ft/scr/
2013/ cr13 231. pdf).
Institute of Macroeconomic Analysis and
Development, Slovenian Economic Mirror (2011) No 5 Vol. XVII, (2012) No 3 Vol.
XVIII, (2013) Nos 10 and 11 Vol. XIX; (2014) No 12 Vol. XIX, IMAD publishing.
Insurance Supervision Agency, Annual
Report, 2012 (http://www.a-zn.si/Documents/Porocila/ annual_report-2012.pdf)
Republic of Slovenia, Slovenia Sovereign
Holding Act, 2012; and proposed amendments.
Slovenia, Ministry of Finance, ‘15th
State Aid Annual Report’, December 2013 
(http://www.mf.gov.si/fileadmin/mf.gov.si/pageuploads/dr%C5%BEavne_pomo%C4%8Di/15LPoDP_1.pdf).
([1])  Real GDP value (constant prices)
according to European Commission Winter forecast (February 2014).
([2])  Corroborated by relatively low
loan-to-value ratios reported by the Bank of Slovenia.
([3])  In Slovenia interest rates on corporate
loans have been elevated since early 2009 and there was no significant increase
since. In practice the link between sovereign interest rates and corporate
financing conditions does not seem to be very strong.
([4])  See 2012 IDR.
([5])  Pharmaceuticals, energy and insurance
are among the sectors that have weathered the crisis better.
([6])  A NEET is a young person who is ''Not
in Education, Employment or Training''. 
([7])  Applying the EBA harmonised definition
for NPLs the level might even be higher. 
([8])  Report available at: http://ec.europa.eu/economy_finance/economic_governance/documents/20140224_si_imbalances_epc_report_en.pdf
([9])  At end-2013, the deposit base was
reduced by EUR 2.1 billion via the conversion of state deposits into equity of
the three major domestic banks. A further less significant one-off reduction of
state deposits can be expected in 2014 in the context of the still outstanding
recapitalisation cases. 
([10]) However, Net Interest Income
(NII) will decrease less significantly than total assets due to the transfer of
EUR 4.8 billion of NPLs to the BAMC. 
([11]) The NII margin (basis total assets)
will at the same time be positively influenced in 2014 and 2015 by the transfer
of NPLs to the BAMC.
([12]) The actual rollover need in 2014 is
lower due to gaps in the maturity structure of the debt.
([13]) Italy itself was exposed to interest
rate pressure.
([14]) The correlation coefficient between the
two countries' representative 10-year sovereign bonds declined from 0.9 to 0.5
in this period.
([15]) According to the latest export data,
the exports surpassed the 2008 level in Q3 2013.
([16]) See ECFIN Country Focus on minimum
wages in Slovenia, June 2013: http://ec.europa.eu/economy_finance/publications/country_focus/2013/pdf/cf_vol10_issue4_en.pdf
([17]) While the 2013 IDR and 2013 Country
focus assessed the performance and economic implications of state-owned and
state controlled companies, this section looks at the performance of the
non-financial corporate sector in Slovenia more broadly.  
([18]) Commission services staff assessment
([19]) Bank of Slovenia database based on AJPES data: https://www.ajpes.si/?language=english.
The companies included in the dataset are limited and unlimited liability
companies (including listed companies), economic interest groupings and main
offices of foreign business entities. Excluded are companies in insolvency
proceedings, banks, insurance companies, stock exchange, investment funds and
certain other financial and investment companies which are not using corporate
accounting standards. The scope of companies reporting to AJPES is changing
every year, which may have an impact on time series analysis and conclusions on
long-term trends.     
([20]) Orbis is a publicly available database https://orbis.bvdinfo.com. It contains
information for both listed and non-listed companies.  
([21]) Debt leverage ratio is defined as total
gross debt (long-term and short-term financial liabilities) divided by earnings
before interest, tax, depreciation and amortization (EBITDA).
([22]) Debt to assets ratio is defined as
total gross debt (long-term and short-term financial liabilities) divided by
total assets.
([23]) Equity ratio is defined as the equity
(book value of equity) divided by the total liability (long term and short-term
financial liabilities and book value of equity).
([24]) Varying between 42% and 48% of
companies each year.
([25]) The debt overhang is defined as debt of
companies which have high credit risk characteristics with debt leverage ratio
above five.
([26]) Companies are considered to be highly
indebted if they have a debt leverage ratio above five.
([27]) Majority of them are reporting very
high levels of indebtedness with debt leverage ratio above seven.
([28]) Including the financial services sector.
The financial services sector excludes banks and insurance companies. It is
assumed that financial holdings are classified within the financial services
sector predominantly as micro or SMEs companies.   
([29]) This analysis is based on consolidated
data on sector level (and not micro company-by-company data). The retail and
the services sectors together comprise more than half of the Slovenian
companies in terms of numbers, but only about a quarter of the total debt and
approximately 30% of employment. Therefore, it could be concluded that these
are primarily small companies (micro or SMEs) such as retail stores and other
high street businesses. Given the uneven distribution of indebtedness among
large and small companies, it is possible that there are few outliers
distorting the analysis. 
([30]) The analysis is based on 2012 financial data for 3,070 Slovenian companies obtained from the Bureau Van Dijk
Orbis database, in order to allow cross-country comparison. Companies that are
known to be majority-controlled subsidiaries are excluded from the analysis to
avoid double-counting of their financial data, which are consolidated with the
parent companies. For benchmarking purposes a similar regional peer dataset is
constructed covering 5,607 Czech and Slovak companies. These two Visegrad
countries were chosen because of good data availability and the fact that their
NFC debt remained moderate over the 2000s.
([31]) According to data classification by
AJPES, financial holdings are classified within the financial services sector
(which does not include banks and insurance companies), predominantly as micro
or small companies. Financial holdings are therefore analysed based on
consolidated data for the financial services sector. They are not included in
the micro data analysis on the concentration of debt presented above (Graphs
4.2-4.4), as they are extreme outliers in terms of debt leverage ratios and
magnitude of the loss they generate. 
([32]) State-owned and state-controlled
enterprises (SOEs/ SCEs) are defined in the European Commission's 2013 in-depth
review and 2013 Country Focus as companies, where the Republic of Slovenia owns
directly or indirectly at least 25% plus one vote of the total capital, thus
having an effective blocking minority over most strategic corporate
transactions. 
([33]) According to the assessment in the 2013
IDR and Country focus, highly vulnerable companies are those which not only
have high leverage ratio of over 4 and report negative net profits, and in some
cases even negative operating profits (EBITDA). 
([34]) The note is based on various data
sources to describe trends in the Slovenian corporate sector depending on the
ownership structure and it reveals considerable differences among the three
ownership categories examined (state-owned, majority foreign-owned and majority
domestic-privately-owned), with SOEs/ SCEs being the worst performers based on
a number of operating and performance indicators.   
([35]) All 10 companies included in the
Ljubljana Stock Exchange’s benchmark SBI TOP index are to a greater or lesser
degree state-owned or state-controlled, with potentially negative impacts on
minority shareholders.
([36]) Please note that analysis in this
section is based on aggregate data (consolidated balance sheet and income
statement for the entire corporate sector). 
([37]) EBITDA margin is defined as EBITDA
divided by revenues
([38]) Product Market Review 2013, DG ECFIN,
European Commission.
([39]) CAPEX has been estimated from
consolidated balance sheet data for the entire corporate sector as the difference
between tangible assets and real estate assets from previous year plus
depreciation.