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Impact of the financial crisis on the credit market in Slovenia

At the onset of the financial crisis, the situation on financial markets changed considerably. To repay their existing liabilities, given the very limited availability of new financing sources, financial institutions sharpened their lending terms and reduced their lending activity. Banks restricted access to loans even to those enterprises that were willing to accept less favourable borrowing terms. On the other hand, there was a significant shift in the demand for loans. Household demand decreased in all segments, while the structure of demand by enterprises and NFI changed considerably. The latter asked for more working capital loans, mainly as a consequence of lower incomes due to decreased demand and lack of payment discipline, whereas demand for investment loans and loans to finance increased production fell. Restricted accessibility of financing sources and the liquidity problems of enterprises had a negative impact on the stability of the financial system. The quality of bank assets began to gradually deteriorate, and the banking sector was forced to create additional impairments, which all negatively affected banking-sector results.

Along with the expansion of the financial crisis, lending activity began to slow down both in Slovenia and in other euro-area countries. This slowdown was more explicit among enterprises and NFIs that mainly net repaid their loans, while the slowdown in household borrowing was somewhat less pronounced and this type of borrowing even began to see slightly stronger growth at the end of last year.

In the past, the intense lending activity of the Slovenian banking system was mainly financed through borrowing abroad. Between 2005 and 2008, banks took up foreign loans in the net amount of approximately EUR 12 bn. With the worsening of conditions on international interbank markets, the accessibility of these sources shrank significantly, and banks recorded a net outflow of foreign loans and deposits of over EUR 3 bn in 2009 alone. Thus, they became more dependent on other sources of financing provided by central banks through non-standard measures, whereas in Slovenia a greater role was assumed by (mainly long-term) government deposits and state guarantees. Funds for government deposits were acquired through additional borrowing on international financial markets. In terms of the maturity structure of financial sources, greater importance was also attached to long-term household deposits, mainly as a result of their migration from short-term deposits, since net flows of household deposits into banks in the past year recorded a decrease, which, according to our estimates, was due to worsening conditions on the labour market and more favourable trends on certain capital markets.

Active interest rates in Slovenia are above the euro-area average. The largest disparities are observed in interest rates for corporate borrowing, where the level is among the highest in the EMU. It is estimated that the reasons for such disparities lie in both supply and demand. Differences in interest rates for household borrowing were considerably less evident, while passive interest rates in Slovenia exceeded the average EMU value. Major differences were recorded in long-term deposits, probably owing to the deteriorating situation on international financial markets and the consequent lower accessibility of foreign long-term financing sources.

Slovenian enterprises and NFIs are among the most indebted in the euro area, since other forms of financing are rather limited given the poorly developed Slovenian financial system. The share of loans thus nearly equals the share of equity capital. The structure of liabilities reveals a lower share of liabilities in the form of shares and other securities, and an above-average share of short-term loans. On the other hand, enterprises and NFIs record a relatively small share of financial assets relative to liabilities. Compared with other euro-area countries, enterprises and NFIs in Slovenia mainly lack more liquid sources, such as currency and bank deposits, as well as securities other than shares. At the same time, Slovenian enterprises and NFI record a share of other liabilities that is above the euro-area average, mainly on account of trade credits and advances. The current situation in the economy, i.e. the lack of payment discipline and extended payment terms, creates additional pressures on the liquidity of enterprises and NFIs, which increasingly depend on external financing sources.

The expansion of the financial crisis to other sectors of the economy also caused a worsening of the quality of bank investments. The amount of bad and non-performing loans thus began to increase at a relatively high pace and banks responded by creating additional impairments, which affected their business results. The main risk is corporate and NFI borrowing, mainly activities related to investments into real estate and those involved in takeover activities. Amid negative trends on the labour market, household borrowing also represents a risk, but this risk is slightly lower, by our estimate. In the period of intense lending activity households mainly borrowed in the form of housing loans, a large part of which were taken up in Swiss francs. Negative trends are also expected to continue in 2010 – based on data relating to the first quarter of the year, the volume of non-performing debts increased by approximately one tenth.

Considering the strong dependence of the Slovenian economy on bank financing, structural changes in the manner of financing should also be taken into account. A very important part of this is short-term sources, causing increased pressures on corporate liquidity. Therefore, a more stable financial structure calls for redirection toward securities (mainly for larger enterprises) and direct investments. In the short term, liquidity could be improved through better payment discipline and mutual offsetting of claims.

Fiscal development and policy

The slowdown in economic activity resulting from the global financial and economic crisis, and fiscal measures taken to combat the crisis, led to substantial deterioration of public finances in euro-area and EU countries in 2009; most EU Member States have been in excessive-deficit procedures since last year. Average general government debt in the euro area and the EU rose rapidly due to high general government deficits and large-scale financing of measures to prop up the financial sector through government borrowing. Portugal, Spain, Italy, Ireland and, in particular, Greece stand out as countries whose public finances are in a much worse state than the euro area average. In early 2010, Greece requested financial aid in the amount of EUR 110 bn amidst growing tension on the financial markets. To counter the risk of the crisis spreading from Greece to other euro-area countries, and given the fall in the value of the euro, measures were taken at EU level, including aid to Greece along with expansion of the existing European balance-of-payments facility from countries outside the euro area to euro-area members, and agreement on establishing a permanent mechanism in the EU to ensure the stability of the euro. The ECB contributed to tackling the crisis by deferring implementation of its exit strategy of gradual phase-out of liquidity measures, and by committing to directly purchase sovereign and private debt securities. Under the circumstances, these solutions were urgently required to avert destabilisation of the euro area, but they are not a long-term solution; this will require systemic adjustments and changes in the institutional framework of the EMU.

The severe worsening of the imbalance of public finances in Slovenia in 2009 was also largely a result of the fallout from the financial and economic crisis. At the end of 2008, and in particular in 2009, as the economic situation substantially deteriorated, the cyclical component of the deficit surged. General government revenue dropped as a result of the deterioration of macroeconomic trends and the effects of tax changes implemented in previous years. At the same time, current government spending remained high due to the effect of automatic stabilisers, wage reform and the impact of stimulus measures. Discretionary fiscal-policy measures that had a direct impact on deficit expansion were mainly targeted at the labour market and tax breaks, support of research and development, and financing of small and medium-sized enterprises. Conversely, deficit growth was held back with increases in excise duty. Discretionary measures were deployed on a small scale, mainly due to budgetary restrictions, but also because of the relatively limited efficiency of large-scale measures in an open economy.

Slovenia is still among the euro-area countries with relatively low debt levels, but the speed of last year’s debt increase, and the projected rise this year and next, lends urgency to consolidation if a deterioration of the perception of Slovenia on financial markets is to be prevented. Amidst the economic downturn, general government debt soared in 2009, mainly as a result of a high deficit and front-loaded borrowing by the treasury to finance the deficit in 2010. Measured by debt and interest as a share of GDP, Slovenia is still one of the least indebted EU countries, but its relative debt increase was among the highest in the EU last year. During the crisis, Slovenia managed to maintain its credit rating, while the yield to maturity of government bonds was significantly lower than in high-risk countries. To retain its sovereign rating and preclude a worsening of the perception of Slovenia on the financial markets, it is vital that fiscal policy ensures that borrowing conditions remain at the present level with consistent consolidation of public finances. Only in this way can Slovenia dam the growth of debt-servicing costs and the crowding-out effect on other government expenditure. This would also have a positive impact on the borrowing conditions of private-sector players on the financial market.

Public finances will not start to improve in 2010, making achievement of stability by 2013 an even more challenging task. The proposed supplementary budget for 2010 does not include expenditure-side cuts achieved with more systemic measures, it only matches expenditure with lower projected revenue; therefore this year the budget will not contribute to the consolidation of public finances. On the revenue side, the supplementary budget, much like the adopted budget for 2010, relies heavily on EU funds and higher excise revenue, neither of which can structurally plug the budget gap. These trends confront fiscal and economic policy-makers with the challenge of realising the Stability Programme objective of bringing the deficit down to 1.6% of GDP in 2013. Consolidation must therefore start as soon as possible, and be conducted in a manner that ensures sustainability of public finances. This is urgent because of the widening current deficit and the pressure on expenditure exerted by an ageing population, which will start to increase more rapidly in the coming years, as well as the relatively high scope of public guarantees, which are a potential liability, and represent a risk of a rapid increase in debt should they be called. Deficit-cutting measures must start as soon as possible, in particular structural measures that will reduce the general government deficit in a sustainable way, i.e. preserve a stable structural fiscal position on a more sustainable basis. Without these reforms, other macroeconomic balances could collapse: the risk of inflation would increase and borrowing conditions on the international financial markets would tighten.

On the revenue side, the scope to increase taxes is limited. Higher rates of taxes on labour and capital would have an adverse impact on economic activity and competitiveness, which, particularly in a period of slow and uncertain recovery, would have a dampening effect on the economy. In deciding on measures to increase revenue in these areas, it would be wise to consider solutions that would not put any additional burden on labour and capital. Tax-policy measures must focus on improving tax capacity by preserving tax rates and expanding the tax base with elimination of the current distortions (e.g. student work), simplifying tax procedures to reduce the scope of tax evasion and consequently of the grey economy, and improving the information system by introducing uniform records and ensuring better oversight. The introduction of a cap on the base for social-security contributions could also have a positive long-term impact on competitiveness and, by extension, revenue. In the short term, however, capping social-security contributions would reduce revenue, which would not be sustainable. The resulting revenue shortfall would have to be replaced with other sources, primarily an expansion of the tax base. There is still scope to ensure more stable revenue through taxation of consumption. It would make sense to undertake a transition towards raising indirect taxes, which are far less affected by the economic cycle, while keeping in mind the impact on the increase of general price levels. In excise duty, in particular excise on fuels for transportation, it is however necessary to take into account the potential drop in consumption. It is preferable to raise excise on products with relatively low elasticity of demand.

Despite last year’s improvement in the drawing of EU funds, additional efforts are needed to realise the Stability Programme objectives in this field. Following two years of modest drawing of EU funds, Slovenia was once again a net recipient last year, due to measures at EU and national level. The drawing of funds according to the financial perspectives may vary from year to year, but to increase absorption capacity, it is vital to ensure the quality of proposed projects as well as the preparation and implementation of tenders, and improvements will have to be made in this area in the coming years. This will be of particular importance given that the Stability Programme – Update 2009 makes EU funds an important element of the consolidation of public finances in the coming years. Failure to realise the set objectives would pose a significant risk to the success of the deficit reduction process; it could affect the dynamics of investment activity and hence the speed of economic recovery.

Liabilities for debt servicing are a fast-growing segment of expenditure and in the consolidation process they will limit and crowd out expenditure for other purposes; our estimates suggest that expenditure with higher development potential will decrease in this year. The structure of expenditure by function highlights a renewed increase in the share of expenditure for public administration due to higher debt-servicing liabilities, a trend that will continue in the coming years. Considering the urgency of curbing the growth of total expenditure in the process of consolidation, such projections mean that expenditure on public administration will limit and crowd out expenditure on other functions, including spending on social protection, health, education and economic activities, which in relative terms had been comparable to that in similarly developed countries in 2008. Analysis of expenditure by programming structure does show that measures to mitigate the consequences of the economic and financial crisis were the main driving forces of the ballooning expenditure on development policies. However, in the adopted budget for 2010 a reduction was already planned, and our estimate shows that it will be further cut in the supplementary budget for 2010 (December 2009). In last year’s budget for 2010, a step towards greater consideration of development priorities was undertaken with the adoption of a programme-based budget, which changes the underlying logic of budget planning by putting national development priorities foremost. However, the 2010 supplementary budget was not structured to match these programme priorities, which interrupted, at a very early stage, the process of qualitative change in budgeting that was supposed to form the basis of a restructuring of expenditure towards greater emphasis on development.

General government expenditure can be partially reduced through savings and streamlining, but there is insufficient scope here to achieve sustainable consolidation. Expenditure savings can be made through consistent implementation of measures to improve the efficiency of the public sector and with rationalisation, as stipulated in the Stability Programme and Slovenian Exit Strategy 2010–2013. Implementing the planned measures to curb employee remuneration is especially important here. Given that employment growth in the
general government sector was not halted this year, achieving the set bjectives will require additional efforts in the years ahead, restricting employment while considering actual needs and pursuing the goal of maximising efficiency, as well as efforts in wage policy. Considerable savings can also be made by improving the efficiency of the public-procurement system.

A broader and consistent solution to reducing total expenditure as a share of GDP lies in restructuring expenditure with structural reforms geared towards strengthening the role of development expenditure earmarked for promoting competitiveness, and maintaining the long-term sustainability of public finances. It is vital to consistently implement programme-based budgeting and to exclude inefficient programmes, sub-programmes and measures of public financing from individual functions and policies. Restructuring also makes it possible to reduce expenditure on otherwise efficient economic activities, by curbing and reforming spending on agriculture and scaling back state aid to troubled companies and old industries. In financial support of entrepreneurship, measures are needed for better promotion of small enterprises as the most dynamic part of the economy, which should support a change in the structure of the economy. Efficiency can also be improved in other areas of expenditure that contribute to competitiveness, especially spending on research and education. In financing public investments, which are crucial for economic activity, it is necessary to make a transition to the financing predominantly with EU funds envisaged by the Stability Programme and the Exit Strategy, and to consider strengthening public-private partnership. In social protection, savings can be made by improving the efficiency of social policy and better tying social transfers to social status, as is also envisaged in the Exit Strategy. In the provision of individual public services, in particular, it is advisable to shift part of the burden onto the private sector.

The long-term sustainability of the public finances will crucially depend on systemic adjustments of social-protection systems and on economic-policy measures that will raise potential economic growth rates. The key factor determining the state of the public finances over the medium and long term is the changing demographic structure of the population. It is therefore essential to undertake key systemic changes in the provision of social security, and to consistently implement economic-policy measures that will increase potential GDP growth rates. The planned adjustments of social-protection systems must be carried out before expenditure related to the ageing population begins to surge. Pension reform, initially a change of the valorisation mechanism, followed in the shortest possible time by a comprehensive modernisation of the pension system, will slow the growth in pension expenditure and postpone retirement. Additionally, pressure on expenditure growth will be alleviated by reform of health care and long-term care. These reforms are already planned in both of the government documents mentioned previously, and it is now crucial that they be adopted as soon as possible and implemented in a comprehensive fashion.

The introduction of the fiscal rule can buttress the consolidation process, but it is essential that it be well designed and consistently adhered to. It is sensible to introduce the fiscal rule as part of the consolidation of public finances, as shown by the examples of best practice offered by other countries. However, the key parameters of the fiscal rule should be adapted to the country’s specifics, in particular the starting position and pressures on the long-term sustainability of public finances. In the process of consolidation, an expenditure fiscal rule, which is also proposed by the Stability Programme, should be relatively restrictive, representing a framework within which expenditure is reoriented towards development and ensuring the long-term sustainability of public finances. What is important is that stable financing sources are provided in this period. In particular, however, the rule must be consistently applied in budgeting; even the best economic policy rule is efficient only if it is observed.

Sale of state shareholdings and better management of state-owned property can contribute to consolidation to a certain extent. Through ownership shares in companies, the state can support fiscal consolidation, in particular by improving management, allowing these companies to develop and raise capital and, by extension, boosting the annual income generated. For this to happen, it is necessary to open up the shareholder structure and allow these companies to raise capital. The scope for reducing public debt by selling off ownership stakes held by the state is limited in our view; for many of the companies directly owned by the Republic of Slovenia, it will be difficult to reach political consensus on what proportion of shares should be sold. There are also many companies that perform general public services and are therefore not expected to be privatised. Several of these are unlikely to attract investor interest and some are already in the process of liquidation. The Exit Strategy objective to reduce public debt by 2 p.p. by selling state-owned property is realistic, but in political and economic terms it is not necessarily one that can be easily achieved.

Labour market – consequences of the crisis and the government’s response to the crisis

The economic crisis affected the labour market in Slovenia and right across the EU. In the EU as a whole, the unemployment rate increased by 1.9 p.p. to 9% in 2009. The employment rate (age group 15–64) in the EU decreased by 1.3 p.p., most of all for young people and those with lower levels of educational attainment. The unemployment rate in Slovenia according to the labour force survey increased by 1.5 p.p. in 2009, while the employment rate declined by 1.1. p.p. The number of people employed in the private sector fell by 8% in Slovenia between October 2008 and March 2010, while the number of registered unemployed people increased by 65.9% from September 2008 (when it was lowest) to May 2010. Growth in registered unemployment eased in the last five months, but restoring employment growth and reducing unemployment nevertheless remain two of the most important challenges to economic policy, in our estimation.

Age segmentation on the labour market is still a problem in Slovenia. The prevalence of temporary employment otherwise declined in 2009, as, with the onset of the crisis, enterprises first reduced employment by not extending contracts for fixed-term employment, a type of employment which is particularly frequent among the young (15–24 years). Although the proportion of temporary jobs among young people declined in Slovenia in 2009, it is still much larger than in other age groups in Slovenia and among the largest in the EU.

Wage growth in the private sector has picked up in 2010, after declining in 2009, while wage growth in the public sector is easing, following a significant increase (due to the new wage system). Growth in the private-sector gross wage slowed significantly in 2009 with the impact of shrinking economic activity, particularly due to lower overtime payments. At the same time, it was also marked by significant changes in the structure of employment and unexpectedly high extraordinary year-end payments in certain sectors; in 2010, it is strengthening again. Public-sector wages increased significantly in 2008 and 2009 as a result of the first two phases of the elimination of wage disparities, but, in the second half of 2009, their growth started to slow as a result of government measures.

The implementation of wage reform in the public sector coincided with the economic crisis, which required intervention by the government. The completion of the wage reform programme remains a challenge. The Public Sector Salary System Act was adopted in 2002, but preparations for its implementation took place until mid-2008. As the implementation coincided with the beginning of the economic crisis, new agreements had to be reached between social partners on wage policy in the public sector, which delayed dealing with the problem of disparities between public- and private-sector wage growth to the following years. Wage reform in the public sector was intended to change internal wage ratios in the public sector. However, the first two wage adjustments towards the elimination of disparities also brought about a significant change in the ratio of public- to private-sector wages, which was not the purpose of the reform. In 2009, this ratio thus exceeded the ratio from 2000 (before the reform), and is also set to increase significantly in the coming years, according to our estimates. The ratio of the public- to private-sector gross wage in Slovenia had already been high in 2006, compared with other countries, according to Eurostat’s data. As another two quarters of the elimination of wage disparities in the public sector are foreseen, wage policy is faced with the challenge of how to carry out the reform without impairing relationships between the public and private sectors. Growth in public-sector wages and employment also widened the general government deficit in 2009. With the need for public services growing, due to demographic and other reasons, it will be necessary to provide systemic solutions to ensure creation of jobs in this area, which will not be funded from public sources alone.

Active employment policy will need to pay special attention to the number and share of long-term unemployed people and the unemployment rate of young people, all of which are rising again. After declining in the first half of 2009 due to the high inflow of newly unemployed people, the share of long-term unemployed people in the total number of the registered unemployed resumed growth towards the end of the year, which calls for attention and active employment policy measures. Given that long-term unemployment reduces an individual’s opportunities to find a new job, it is necessary to devise and expand programmes preventing transition into long-term unemployment and increase the participation of long-term unemployed persons in active employment-policy schemes. In 2009, the unemployment rate of young people (15–24 years) increased much more than the average unemployment rate. Special attention should therefore also be devoted to this group of the unemployed, within the scope of labour-market, as well as educational, policies.

The government responded to the deteriorating labour-market situation by passing, in 2009, two emergency acts to preserve jobs (the Partial Subsidising of Full-Time Work Act and the Partial Reimbursement of Payment Compensation Act). Funding allocated to the implementation of active employment-policy (AEP) schemes increased to 0.5% of GDP, after hovering between 0.21% and 0.39% of GDP for a number of years.

The volume of funds for the implementation of active employment-policy programmes increased during the economic crisis, but the programmes need evaluation. The number of people participating in AEP programmes rose significantly in 2009, though not for all groups of the unemployed. The participation rate (measured as the ratio of the number of participants in a certain group of unemployed people to the total number of unemployed people in the same group) grew most notably for women, while the increase in the participation of long-term unemployed people and those older than 50 was very modest, which heightens the risk of unemployment persisting in the years to come. Growth in the number of financial social-assistance beneficiaries participating in the schemes is relatively modest, which is unacceptable from the perspective of social inclusion. Along with the implementation of measures, it would be necessary to provide for continuous assessment, comprehensive monitoring and independent evaluation of their effects.

The time of crisis also calls for changes in the system providing income security to the unemployed, which in Slovenia have yet to be made. As Slovenia has not yet changed the unemployment-insurance system in the current crisis, the weaknesses of the system have become all the more visible. The share of unemployed young people (aged 15–29) receiving unemployment benefits increased only temporarily in 2009 and is still relatively low, as a result of the relatively short period of entitlement to unemployment benefits and strict eligibility criteria for the young. It would be necessary to improve the legislation governing unemployment benefits so as to provide income security for the unemployed during the current crisis and thus to support the concept of flexicurity. This will be partly addressed by changes brought about by the new draft Labour-Market Regulation Act, but we estimate that these changes will nevertheless come too late to provide income security for the unemployed in the present crisis.

It was mainly enterprises from the manufacturing sector that availed themselves of job-preservation schemes. Enterprises have shown great interest in both emergency acts aimed at preserving jobs ever since their adoption; however, towards the end of 2009, their interest began to fade due to the gradual recovery of economic activity in manufacturing, where these schemes were most extensively used. According to ESS data on payments, around 4,800 wage compensations, on average, were reimbursed per month (0.6% of employed people), and around 32,000 subsidies for full-time work paid (4.2% of employed people). In the manufacturing sector, the manufacture of metals and the manufacture of electrical appliances recorded the largest shares of employees participating in the two schemes. As the Partial Subsidising of Full-Time Work Act does not tie the allocation of subsidies to difficulties related to the crisis, subsidies were also granted to a number of enterprises from sectors where difficulties may not have been entirely due to the crisis. A particularly large share of enterprises taking part in the schemes has also been observed in transport and storage activities, due to the participation of employees of Slovenske železnice, which also received various subsidies in previous years, and where difficulties worsened further in 2009.

The economic crisis has not been sufficiently used for developing the skills of workers on temporary layoff. The Partial Reimbursement of Payment Compensation Act obliges employers to provide education and training for workers on temporary layoff that is subsidised by the government. The extent to which “non-working” time was used for training and education was nevertheless modest. Furthermore, the contents of training programmes are questionable and may not contribute to an individual’s employability, given that enterprises mainly offered internal training carried out only by in-house mentors. As already pointed out in Economic Issues 2009, leaving the responsibility for education and training of employees entirely to the employer (without appropriate support by expert institutions) may not be the best solution in terms of using the crisis as an opportunity to develop new skills relevant for the labour market.