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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