Mission Concluding Statement 

Slovenia: Staff Concluding Statement of the 2018 Article IV Mission

December 11, 2018

As the post-crisis recovery continues, growth remains well above the euro area average, helped by sound policies. Going forward the authorities should take advantage of the positive economic cycle to deepen fiscal and structural reforms, to rebuild fiscal buffers and to increase productivity growth. We see the following reform priorities:

• Continue fiscal consolidation toward the Medium-Term Budgetary Objective (MTO) of structural balance through the pension, health and long-term care, public wage policy and tax reforms;

• Complete the repair of bank and corporate balance sheets, including by accelerating the resolution of small and medium enterprises’ nonperforming loans (SME NPL);

• Deepen labor market reforms and reduce the administrative and regulatory burden;

• Accelerate the privatization program.

Outlook and Risks

1. The post-crisis recovery continues . Real GDP growth is expected to decelerate to 4.5 percent this year and 3.4 percent in 2019, still above potential. Domestic demand, particularly public investment, has recently picked up, gradually complementing exports as the key driver of growth. Labor market conditions are increasingly tight with emerging skills shortages despite inflows of foreign workers. The unemployment rate has declined to 5 percent, the lowest in a decade. The strong economic growth pushed headline fiscal balance into a surplus for the first time in a decade. On the external side, the current account remains in surplus in 2018, helping to adjust past imbalances. It is expected to moderate as consumption and investment fully recover from the crisis.

2. The medium-term outlook is less favorable with risks tilted to the downside . Economic growth is expected to decline gradually, with output remaining above its potential level. The potential growth rate is going to be constrained by adverse demographic trends. In addition, external risks are prominent: a rise in protectionism would hit Slovenia hard given its reliance on exports and integration in global value chains. Intensified policy uncertainty in Europe or weaker-than-expected global demand could slow investment and hiring.

Fiscal Policy: Rebuild Fiscal Buffers and Ensure Sustainability

3. Slovenia has achieved substantial fiscal consolidation since the 2013 banking crisis. The structural fiscal balance improved by 2.3 percentage points of GDP between 2013 and 2017. Consolidation was achieved by a mix of structural measures (e.g., pension reform, VAT rate increases, and debt reprofiling) and crisis-motivated temporary measures (e.g., a one-off freeze on wages and social transfers indexation, and a cut in non-EU-financed public investment).

4. Fiscal consolidation should continue taking advantage of the current expansion until the authorities’ MTO of structural balance by 2020 is achieved. This objective is an appropriate fiscal anchor, and it will help bring down the high public debt gradually towards 60 percent of GDP. Achieving the MTO will require a cumulative structural adjustment of about 1 percent of GDP by 2020. The effort could be evenly spread over 2019 and 2020 and should be underpinned by substantial spending reforms and well-targeted tax policy and administration reforms that generate permanent savings while modernizing government operations.

5. Spending reforms should focus on pension, health, education, and the wage bill .

• Pension system . Despite the 2012 pension reform, further actions are needed to ensure the adequacy and the long-term sustainability of the pension system. We support the White Paper proposals to raise the statutory retirement age to 67 and automatically adjust it to demographic trends, as well as to provide incentive for extended working life. We recommend additional reforms, including (i) indexing pensions to inflation only and (ii) abolishing the pension bonus. To increase the effective retirement age, we recommend the gradual elimination of the long-service early retirement provision (40 years rule) and the discontinuation of the arrangement whereby up to 5 years of service time can be purchased prior to retirement.

• Health, long-term care and education reforms . Potential reforms include (i) expanding centralized procurement to benefit from more supplier competition and economies of scale, (ii) better means-testing of financial support for tertiary students, and (iii) linking university funding to students’ labor market outcomes.

• Wage bill . A functional and institutional review of the public wage system should be undertaken to prepare a reform. The reformed system should link public wage dynamic and economic conditions and motivate employees by rewarding good performance rather than providing automatic, seniority-based wage hikes. To contain the wage bill, we recommend a multi-annual remuneration framework, with separate limits for the number of employees and for the wage increases by sector.

6. New emphasis should be put on growth-enhancing tax reform. Slovenia has the 8th highest tax wedge among 35 OECD countries. Social security contributions could be reduced by rebalancing taxation towards a broad-based VAT and PIT, market value-based property taxes, and environmental taxes; or by rationalizing tax expenditures in the immovable property tax and capital gains tax.

Financial Policy: Address Legacy Problems and Emerging Risks

7. Since the 2013 banking crisis, financial stability has improved thanks to the decisive restructuring of ailing banks and prudent macroeconomic policies . Banks are well capitalized and liquid, and overall asset quality has improved. Profitability also increased but largely because of the one-off release of impairment provisions. However, SME NPLs remain elevated in the low double digits. BoS’s NPL guideline and supervisory dialogue, as well as the measures introduced by the European Central Bank for the three directly supervised institutions, helped banks make progress in resolving NPLs. Large banks have adopted a proactive management of their NPLs, and supervisory authorities should continue to encourage and support these efforts. The deleveraging process of the corporate sector is well advanced.

8. Emerging financial vulnerabilities need enhanced vigilance. Credit risks could emerge due to the elevated share of high variable-interest loans to both households and non-financial corporations. In addition, risks in the housing market need to be closely watched. At 10 percent in 2017, Slovenia’s housing price growth rate was the third highest in the euro area, but the relatively low price-income ratio does not point to any overheating yet. We welcome the BoS’ decision to extend the scope of macroprudential tools to all household lending and to recommend a maturity cap of 10 years for all non-mortgage household lending.

Structural reforms to support productivity growth.

9. Higher productivity will be required to mitigate the impact of aging. Since the population is aging rapidly, long-term economic growth will increasingly depend on productivity growth. To address these challenges, the government has undertaken a series of reforms of the labor market, State-Owned Enterprises (SOEs), and product and service markets. We recommend accelerating and deepening these reforms.

Labor markets and skill development

10. The recently enacted reforms of vocational training and apprenticeship are welcome . If well-implemented, they will promote inclusion, as low-performing and disadvantaged students are highly concentrated in vocational programs. Moreover, they will help address the increasing skills shortages. Further developing training in entrepreneurship and new technologies should help workers adapt to and succeed in the digital economy and fast-changing technological world.

11. There is scope to increase labor market flexibility and reform the tax-benefit system to make work pay. The protection of open-ended contracts is still high relative to peer countries. In addition, low after-tax earnings and relatively generous unemployment benefits reduce the incentive to work. For instance, the replacement rate of unemployment benefits is above 80 percent in the first months of unemployment for low-wage earners, higher than the EU average. Reforms in this area would help reduce structural unemployment.

SOE reforms

12. We recommend accelerating the privatization program. With the investment to GDP ratio still well below the pre-crisis level, accelerating the privatization program could boost private and foreign investment. In this regard, we recommend reducing the list of companies classified as “strategic” and “important.” We welcome the authorities’ efforts that have advanced privatization of the largest bank, Nova Ljubljanska Banka (NLB). The third largest bank, Abanka, is expected to be privatized in 2019.

Product and service- market reforms

13. The administrative and regulatory burden should be reduced further to support investment and firm growth. We welcome the authorities’ SME test in assessing the impact of the administrative burden on SMEs. Rapid progress in the new spatial planning and construction regulation that entered into force in mid-2018 will help simplify building permits acquisition procedures, reduce administrative burden and risks for SMEs, and relieve the current supply bottlenecks on the housing market. In addition, we recommend reducing the number of regulated professions to enhance competition and increase productivity.

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We thank the authorities for their exceptional assistance to the mission’s work, the warm hospitality, and the candid and informative discussions.