Slovenia can avoid an EU bailout

When Slov­e­nia joined the EU in 2004, it was the most developed among the coun­tries of Cent­ral East­ern Europe (CEE) and gen­er­ally con­sidered a suc­cess story of eco­nomic trans­ition towards mar­ket eco­nomy. Slovenia’s income level had already reached 80% of the EU’s average. Only six years later, Slov­e­nia has turned into a prob­lem case for the Euro zone and is named a strong can­did­ate for the next bail-out. The eco­nomy has re-entered into reces­sion in 2012, its bank­ing sec­tor is ail­ing and the gov­ern­ment per­sist­ently runs a primary defi­cit. What has gone wrong?

Slov­e­nia was hit by the fin­an­cial and eco­nomic crises in a way much sim­ilar to what other advanced eco­nom­ies exper­i­enced: an unsus­tain­able boom of the con­struc­tion and hous­ing sec­tor came to an abrupt end, the con­sec­ut­ive credit defaults forced domestic banks to delever­age, which in turn led to a tight­en­ing of credit that trans­mit­ted the crisis into the real eco­nomy. Slovenia’s bank­ing sec­tor was hit harder than other CEE’s because its biggest banks are still state-owned and had been badly man­aged prior to the crisis.

But it is not only the bank­ing sec­tor that is in bad shape: pen­sion sys­tem and labour mar­ket have long been need­ing struc­tural reforms, but these were delayed until 2011 – only to be vetoed in a ref­er­en­dum. Addi­tion­ally, the export-oriented Slov­e­nian eco­nomy suffered from the reces­sion in the rest of Europe and par­tic­u­larly in its biggest trad­ing part­ner Italy.

So all in all, Slovenia’s cur­rent situ­ation looks rather gloomy – and this pic­ture is not going to change overnight. Reces­sion will pre­vail for at least another year, the gov­ern­ment defi­cit is still much above the 3% Maastricht threshold and the bank­ing sec­tor is likely to need some more €1 bil­lion of fresh cap­ital.

But things are chan­ging in Slov­e­nia. Since 2012, a num­ber of reforms have been ini­ti­ated to tackle the most press­ing fin­an­cial and eco­nomic prob­lems. The newly foun­ded Bank Asset Man­age­ment Com­pany, a “bad bank” in fin­ance jar­gon, will take on bad assets and allow troubled banks to clean up their bal­ance sheets. A pen­sion reform adop­ted in Decem­ber 2012 increases the retire­ment age and will thus help to face the con­sequences of a rap­idly age­ing pop­u­la­tion. In the labour mar­ket, reforms have rendered work con­tracts more flex­ible and admin­is­trat­ive pro­cesses easier.

Slovenia’s reforms have been greeted by the EU and by other inter­na­tional organ­isa­tions as steps in the right dir­ec­tion. Though many of the meas­ures might turn out not to be suf­fi­cient, they could mark the begin­ning of a gradual pro­cess of restruc­tur­ing that will bring the country’s eco­nomy and fin­an­cial sys­tem back on track.

Slov­e­nia now has to pay the price for hav­ing delayed neces­sary reforms for too long. But even if Slov­e­nia man­aged to imple­ment its reform agenda as pro­jec­ted, it could still lose the race against time and end up ask­ing for a bail-out. This is where Cyprus enters the stage. The unco­ordin­ated and delayed res­cue plan for Cyprus has yet again squandered investors’ trust in the Euro area and made them look for the next vic­tim in the Euro dom­ino play.

The risk of con­ta­gion becomes vis­ible when look­ing at the long-term interest rates for Slov­e­nian gov­ern­ment bonds.  In March 2013, yields for 10-year bonds were still at 5.09%, but within little more than a month they rose to 6.33% and are now near­ing the psy­cho­lo­gic­ally import­ant mark of 7% above which a bail­out is said to be inev­it­able. Of course, Italy’s polit­ical crisis and draw­backs in the Por­tuguese reform agenda are not help­ing either.

The moment of truth for Slov­e­nia is likely to come at the begin­ning of June when the gov­ern­ment will have to issue new debt.

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