Slovenië: de volgende dominosteen?

7/30/2019 Sloveni: de volgende dominosteen?

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KBCECONOMIC RESEARCH (GCE)

ECONOMIC UPDATES

SIEGFRIED TOP (02/429.59.91)

18APRIL 2013

Slovenia: the next domino?

Executive summary

Slovenia has tumbled into a double-dip recession, with GDP now at 10% below its 2008 peak,and domestic demand being weak as a result of the deflating of the construction bubble. The

countrys recent export performance is weak and it has attracted limited FDI. The recent

contraction in domestic demand has nevertheless brought the current account to a modest 2%

surplus.

The three largest, state-owned banks are challenged by non-performing loans on the corporatesector of up to 30% of total loans, mostly located in the construction sector and state-owned

companies. Banks are undercapitalized, and the government earmarked a further 1 bn (2.9% of

GDP) for a new recapitalization round, although this may increase to 2 bn. A government

guaranteed bad bank will be put in place and cover up to 4 bn (11.4% of GDP) in nonperforming

loans.

Slovenia is however not comparable to Cyprus, as total bank assets are only 146% of GDP,compared to 698% in Cyprus. The government will probably resort to less drastic measures than

was necessary in Cyprus. A bail-in of junior bondholders (often also government-related holders)

is likely in our view, but we do not see a bail-in of senior bondholders happen, as we do not

expect one of the three largest bank to be put into resolution. A bail-in of large depositors would

be counter-effective for the Slovenian government, as most deposits are domestic, and most

large deposits belong to the state-owned companies, for which the government is also (partially)

liable.

Public finances are sustainable in the longer term, as long as fiscal consolidation, pensionreforms and the privatization process are pursued. Government debt is likely to peak just below

70% of GDP in 2015. Under an adverse economic scenario, debt could rise to 80% of GDP in

2015, which would still be below the average euro area level. In the short term, Slovenia may

face a liquidity problem, as the country did not place longer term bonds in EUR over the last two

years and bond yields on the 10-year benchmark rose above 6%. A relatively successful 18-

month T-bill auction did provide some temporary relief. We believe nonetheless that an EU

financial assistance package similar to that of Spain is in the best interest of Slovenia, in order to

help severe the link between government finances and the banking sector restructuring and

recapitalization process, and to keep the implicit interest rate low. An ESM credit line of 1 to 2

years may also be applied, and has the benefit of being OMT-eligible.


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1. Economic background and outlookSlovenia has tumbled into a double-dip recession, with real GDP now almost 10% below the peak

reached in 2008 (see graph 1). The pre-crisis boom was driven by easy access to external funding and

excessive risk taken by banks and businesses. As a result, banks and firms balance sheets have now

been severely impaired and the continuing deleveraging is expected to further depress growth.

According to the Commission, IMF and OECD, the risks of a prolonged downturn through this protracted

balance sheet repair are substantial.

Looking at components of aggregate demand, we find that domestic demand has continuously

contracted since 2008, with a recent acceleration of the decline following the euro crisis. Slovenia has

had a construction boom, pushing up residential prices and fueling an investment bubble. Now,

construction activity collapsed by more than 60% since its peak in 2008 and activity is not expected to

be bottoming out soon. Domestic demand is expected to remain weak the next two years, partly due to

the still increasing level of unemployment (graph 2).

Graph 1. Real GDP growth Graph 2. Unemployment rate further rising

(Q1 2008 = 100) (in % of total labour force) */ **

Source: Eurostat * CEE: Poland, Hungary, Slovakia, Czech Republic, Romania, Bulgaria

** GIIPS: Greece, Ireland, Italy, Portugal Spain

Slovenia is a small exporting economy, with exports amounting to over 75% of GDP. Exports have

quickly regained most of the losses of the 2009 recession, but have been stagnant since mid-2011.

External demand weakened, especially for low and medium-low technology products (which is about

40% of Slovenias export), with particular weakness coming from Slovenias largest trading partner, Italy.

Export volumes fell further in Q4 2012. As imports fall more, there will thus be a positive growth

contribution from net external demand. This has also turned the current account into a surplus of 2%ofGDP (see graph 3). Because of export weakness, gross fixed investment is expected to further fall, as a

result ofsignificant excess capacity (thus negatively impacting domestic demand). Recent trends (see

graph 4 below) suggest some bottoming out of economic sentiment, industrial production and retail

sales, albeit at low levels.

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Graph 3. Current account balance Graph 4. Recent improvement in business trends

(in % of GDP) (year-on-year change)

Source: EC, Macroeconomic imbalances procedure (MIP) Source: Bloomberg

Nevertheless, export is not expected to help Slovenia avoid a prolonged recession, as market shares have

been lost, and export performance is substantially weaker than in peer countries (see graph 5). Cost-

competiveness losses since 2010, when the minimum wage was increased by 23% (from 597 to 734 per

month), have not completely been reversed. The minimum wage was even indexed by 6.7% (to 784 in

2013). The number of workers receiving this minimum wage also more than doubled. This has made

Slovenia one of the countries with most expensive minimum wage workers compared to the average

wage workers. Wage moderation to achieve a further depreciation in the unit labour costs (ULC)-based

measure of the real effective exchange rate (REER) will make Slovenia more competitive vis--vis

countries like Austria or Germany (see graph 6). To do so, public sector wages were cut by around 3% in

2012, and the wage bill would be further cut by 5% in 2013. This however only indirectly affects the

tradable sector, although in Slovenia, unit labour costs for the manufacturing (tradable) sectors seem to

be closely tracking those of the total economy.

Graph 5. Export performance weaker than peers Graph 6. Competitiveness slightly improving

(Export market shares, 1999=100) (Real effective exchange rate, ULC total economy)

Source: EC, MIP, own calculations Source: OECD, 2013

Problems of competitiveness not only lie in costs. The Slovenian labour market is very rigid, as

employment protection legislation reduces the adjustment capacity of the economy and causes labour

market segmentation (in- or outsproblem). The recent labour market reform (March 2013) urges firms

to use permanent contracts as a rule, dismissal procedures were streamlined, and reduced dismissal

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Average CEE

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Economic sentiment

indicator

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CEE Germany

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costs for workers with longer tenures. The reform also introduced the possibility of mini-jobs for retired

persons. Nevertheless, the EU and IMF judge the reforms as not yet deep enough to have a sufficient

impact. The problem of the extensively used and under-regulated student work status has e.g. not been

addressed. Entry barriers for regulated professions (over 300, compared to EU average of 200) are also

still too high.

The lack of competitiveness deters FDIs, which are relatively low in comparison with peer countries

(31% FDI stock in 2009, compared to 78% in Hungary and 58% in Slovakia). FDI inflow is also deterred by

high public ownership in Slovenia and weak protection of minority shareholders. This partially explains

the (vis--vis other CEE and GIIPS countries) relavitely small negative level of the net international

investment position (NIIP), which is around 35% of GDP (see graph 7). All NIIP can be explained by

portfolio and other investments, which makes Slovenia more vulnerable to abrupt changes in investor

confidence than headline indicators would suggest.

Graph 7. Net international investment position Graph 8. Size of banking sector *

(2011, in % of GDP) (total assets in % of national GDP, Q3 2012 data)

Source: EC, MIP Source: ECB, * Luxembourg stands at 1765% of GDP

2. A problematic, mainly state-owned banking sectorMost recent studies have highlighted Slovenias weak banking sector as the main cause for its

government to be shut out of the bond market, especially after the Cyprus crisis. Still, the size of the

Slovenian banking sector is relatively small (total bank assets are 146% of GDP) and less than half of

the euro area average, and thus not comparable to the Cypriot banking sector (see graph 8 above).

Nevertheless, major domestic banks (which are mostly state-owned and represent the bulk of the

Slovenian banking sector) face continued deterioration of their credit portfolios, which puts sustained

pressure on capital buffers via write-downs.

At the core of the weakness of Slovenian banks lies the boom-bust credit cycle since 2002, which has led

to a doubling level of debt of the corporate sector. Although the current level of private debt to GDP is

not excessively high (128 % of GDP, see graph 9), and is much lower than average EMU or GIPS

countries, its composition made it less sustainable. Construction and real estate sectors are most

indebted, with debt-to-equity ratios at 315%. Household indebtedness is low however, as relatively

prudent lending in general has protected households from a major deterioration of their balance sheet.

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Graph 9. Private sector debt Graph 10. Debt to equity ratio non-financial corporates

(non-consolidated, in % of GDP, 2011) (debt as % of shares and other equity)

Source: EC, MIP Source: OECD, 2013

The weakness is concentrated in the countries two largest banks, NLB (Nova Ljubljanska Banka) and

NKBM (Nova Kreditna Banka Maribor), as 40% of banking loans are issued by these state-owned banks.Both banks are heavily exposed to major construction companies, state-owned enterprises and financial

holdings. They have e.g. lend respectively 20% and 15% of their capital to Zvon Ena, a financial holding

company, which went bankrupt. As of Q3 2012, NPLs in the non-financial corporate sector rose to 24%

of total loans, with the NPLs of state owned banks now at 30% of their loans (see graph 12).

The deflating of the housing bubble made house prices already fall by about 24% in inflation adjusted

prices, which is still moderate compared to e.g. Hungary and Poland (-31%) and Romania (-64%).

However, according to the European Commission, house price valuation methods signal a substantial

additional correction potential. A further drop of 10% from 2011 prices is foreseen by the Commission,

which again has potential implications for loan collateral values and banks soundness.

Graph 11. NPLs in European perspective (OECD) Graph 12. NPLs in Slovenian banks

(in % of total gross loans, 2012) (In % of private firms portfolio)

Source: OECD, 2013 Source: OECD, 2013

The liquidity position of the Slovenian banksis still precarious. The shift away from foreign wholesale

funding has continued, but new sources of replacement funding remain absent. The ECBs LTROs now

amount to 8.5% of sector balance sheet. Banks under foreign ownership or those which were previously

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reliant upon funding from their parent institutions, have intensified the competition for retail deposits.

This results in squeezing of interest margins. Domestic deposits also declined by 4.8% in the first nine

months of 2012. Funding pressures thus remain high.

Graph 13. OECD 2012 capital adequacy comparison

According to a 2013 OECD study, Slovenian banks are (Total capital as % of risk-weighted assets)

poorly capitalized in international comparison, even

after several capital injections (see graph 13).

Throughout 2010-12, several capital injections were

made already. NLB was e.g. recapitalized in 2012 by

the government via a contingent convertible bond

(CoCo) worth 320 mn, and a further 500 mn was

acquired via direct cash injections and restructuring

of existing subordinated instruments. The states

share increased to 64%, and to 86% end 2012 after

KBC Group sold its remaining 22% shares to the

Slovenian state.

End 2012, new capital needs were estimated by the government at 1 bn (2.9% of GDP), but may be

significantly higher according to the OECD, EC and rating agency Fitch. The 2011 stress tests indicated

that under a double-dip adverse scenario, recapitalization of around 5% of GDP would be necessary.

Results of more recent 2012 stress-tests were not made public, but are also most likely outdated.

According to Fitch (April 5) in its recent downgrade of the Slovenian banking system, capital requirement

for the three largest banks may be about 2 bn, or 5,8% of GDP.

We believe that the size of the Slovenian banking problem is however not comparable to Cyprus, as

total bank assets are only at 146% of GDP, compared to 698% in Cyprus. As bail-in may increase fundingcosts for banks, a careful designed strategy is nevertheless necessary. The government will therefore in

our view resort to less drastic measures than was necessary in Cyprus. A bail-in of junior bondholders

(often also government-related) is likely. Banks can e.g. be recapitalized using hybrid capital instruments

and subordinated debt (which stands at 3% of total banking assets, according to the OECD). For NLB,

Tier-1 further fell to below 7% in February, which triggered the CoCo of 2012. NKBM will according to the

Commission convert a hybrid loan from the government. We believe none of the large banks will we

forced into resolution. Should, however, one of the banks be put into resolution, senior debt could also

be imposed losses on. According to Fitch, this is currently not on the agenda of the Slovenian authorities.

A bail-in of depositors is in a case of bank resolution is likely to be counter-effective for the Slovenian

government in our view, as most deposits are domestic, and a lot of large deposits belong to the stateowned companies, for which the government is also (partially) liable.

It is unlikely that new foreign investors will be willing to invest in new capital and bonds (as was the case

in the Irish banking sector last year), as the government has announced to reduce the public share of

NLB and NKBM after cleaning up their balance sheets and recapitalizations, but still wants to retain a

blocking minority shareholding. Most of the recapitalization bill will thus have to be carried by the

Slovenian government.

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The December 2012 Banking Stability Act also made available up to 4 bn (11.5% of GDP) of state

guarantees for asset transfer to abank asset management company (BAMC), which is not yet active.

This bad bank would take over non-performing assets in return for government-guaranteed bonds of up

to 4 bn. The current BAMC-structure has almost no equity, so it would have a low immediate impact on

the budget deficit. Nevertheless, according to a recent Eurostat decision, the bonds would likely be debt

increasing. If the BAMC makes losses, these will also generate future deficits.

3. Public debt in se not problematic, but Spain scenario loomingPolitical context: new government stable enough?

Slovenia has a ratherunstable political constellation, as the political landscape is very divided since the

2011 parliamentary elections. There are two similarly large parties, Positive Slovenia (liberal left) and the

Democratic Party (conservative), without a clear majority (see graph 14). After failed coalition talks of

Positive Slovenias president and mayor of Ljubljana, Zoran Jankovic, the conservatives could form a four

party coalition under PM Janez Jansa. This government was never stable and fell early 2013, after which

Positive Slovenia was again in a position to form a government. However, its frontman Jankovic had by

then stepped down after corruption allegations, and he was succeeded by Alenka Bratusek. She now has

the difficult task to lead a broad, centre-left coalition of four parties: Bratusek liberal left Positive

Slovenia party, the Social Democrats of president Borut Pahor, and two smaller parties that were already

in the Jansa centre-right government (the Pensioners Party and the Civic List).

Bratusek thus controls 49 votes in the 90-seat parliament, which may not be sufficient to introduce

large reforms. As in the former government, the Pensioners party may prevent any necessary reforms to

the pension system, while the now more left-oriented coalition is also less likely to follow the European

Commissions advise on certain labour market and liberalization reforms. Under the Slovenian

constitution, large reforms also often require a public referendum before adoption. The recent failure to

introduce a debt brake (legal limit on government debt) indicated again the difficulty of the Slovenian

political process.

Graph 14. Divided political landscape Slovenia

Positive Slovenia

Slovenia Democratic

Party

Democrats

Gregor Virant's Civic List

Pensioners Party

Slovenian People Party

New Slovenian

Christians

Hungarian and Italian

minorities


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Public finances: a long term sustainable debt path, but continued liquidity issues

Slovenias public finances were very healthy at the start of the crisis, and have only come under

pressure more recently (see table 1 below). To cope with derailing finances and looming risk of being

locked out of the sovereign bond market, the government has engaged in an ambitious fiscal

adjustment to cut the deficit from a 6.4% peak in 2011 to an initially targeted 2.5% in 2014. In 2012, aheadline deficit of 4.3% was reached.

Further consolidation in 2012 consisted of a package of measures including a nominal wage cut in public

sector and reinforced restraint in social transfers. The 2013 deficit is projected at 5.1% (EC), with an

increase of 0.9% because of the conversion of hybrid debt-equity instruments of banks into equity.

Under our base scenario, the 2013 headline deficit may reach up to 6.9% including the larger

recapitalization costs. With unchanged policy, the 2014 headline deficit will stand at 4.9%. Nevertheless,

there has been a significant improvement of the structural budget balance in 2013 (at -2.3% of GDP)

and the Slovenian structural primary balance is close to balance (see graph 16). A slippage in the budget

could be offset by the conditional increase in the standard VAT rate.

Graph 15. Headline budget balance Graph 16. Structural primary balance

(in % of GDP, including one-offs) (cyclically adjusted, in % of GDP)

Source: EC, Winter forecast 2013, own calculations Source: EC, Winter forecast 2013

Still, government finances face significant headwinds. Public expenditure stands at 50% of GDP, which is

very high relative to peers, mostly because ofsocial spending. The formerly communist country has one

of the largest redistributions in the OECD, and income inequality is low even before redistributive

policies (low GINI coefficient, see graph 18). From the income side, the Slovenian government is lowering

the corporate income tax gradually from 20% in 2011 to 15% in 2015. Next to this, generous R&D and

investment tax allowances have been adopted to restart economic activity, but cause a decline ingovernment income.

Slovenia is also one of the OECD countries with the highest costs of ageing. Despite a 2012 pension

reform, expenditure on pensions is still expected to increase by 5-6% of GDP between 2010 and 2060.

Further structural reforms will probably be difficult to implement, as e.g. the initial more rigorous labour

market changes and pension system reform were rejected in a 2011 referendum.

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Graph 17. Expected increase in ageing costs Graph 18. Low GINI coefficient

(in % of GDP, 2010-2060) (Lower coefficient = more equality)

Source: OECD, 2013 Source: OECD, 2013

Although general government debt is still clearly below the euro area average, debt is expected to

approach the 60% of GDP threshold in the course of 2013, even without including additionalrecapitalizations. Public debt could thus be lifted on short notice if banks recapitalizations exceed official

estimates, or some contingent liabilities are recognized. Contingent liabilities (mainly to state-owned

enterprises) stand at 24.7% of GDP. Many state-owned companies and banks are not profitable, and

require regular bailouts. This may be the case for the debt of national highway company (DARS), which

could according to the OECD even increase public debt by 8.1% of GDP (DARS is highly indebted and

100% state guaranteed). The new bad bank (BAMC) will also raise contingent liabilities with another

11%.

Under these assumptions, the Slovenian debt ratio will increase further from 53.9% of GDP in 2012, to

62.5% of GDP this year, and peak slightly below 70% of GDP in 2015 in our base scenario (see table 1).

This takes into account a banking sector recapitalization further burdening government debt by 5% of

GDP over 2013 and 2014, and further commitment of the government to curb the headline deficit, reach

a (structural) primary surplus this year and continue both the pension reforms and privatizations of

public companies. Under the adverse scenario of the IMF (deeper contraction of GDP, larger

recapitalization costs, no privatizations), debt could reach a peak of80% of GDP by 2015, which is still

below the euro area average (see graph 19).

Table 1. KBC Forecasts

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12Education and unemployment benefits

Long-term care

Health care

Pensions

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0.5 Market (primary) income

Disposable (secundary) income

2012 2013 2014 2015

GDP growth (in %) -2.3 -2.5 -0.5 1.0Deficit (in % of GDP) -4.3 -6.9 -4.9 -3.3

Gross debt (in % of GDP) 53.9 62.2 66.8 69.1


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Graph 19. Gross government debt Graph 20. Long term interest rates

(In % of GDP) (10y bond yields, monthly average in %)

Source: EC, Winter forecast 2013 Source: Bloomberg

While the Slovenian debt path looks sustainable in the longer term, the country may face short-termliquidity problems. Since mid-2011, the country did not refinance itself in longer-term bonds in EUR. In

October last year, a sizeable USD issue was made, but the country still faces significant financing needs

for the next 3 years (approximately 12 bn estimated in the latest IMF fiscal monitor).

Slovenia has maintained an investment grade rating (Moodys Baa2, S&P A-, Fitch A-), and bond yields

were until recently strongly correlated with Italy and Spain. Debt refinancing has become more

challenging with the recent yield increase after the Cyprus crisis. An issue of 18month bills on April 17

was successful with demand doubling the offered amount (1.1 bn was sold, while initially 0.5 bn was

offered). Furthermore, another 0.5 bn (or half) of the T-Bill redemption of June was rolled-over.

However, with an average T-bill yield of 4.15% and doubts about the ability of domestic banks to engage

in more government bond buying, it remains questionable whether Slovenia can sustainably refinance

itself. With total borrowing needs (deficit, redemptions and bank recapitalization costs) for the period

between 2013 and 2015 estimated by the IMF at 12 bn (35.1% of GDP), the chances of Slovenia

requesting official EU and/or IMF assistance have thus significantly increased.

Graph 21. Redemption profile Slovenian government (all entities)

(In mn EUR)

Source: Bloomberg

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Towards an ESM solution?

Although Slovenias sovereign debt trajectory seems sustainable in the medium and longer-term (debt of

about 70% of GDP in 2015 under our base scenario, and 80% of GDP under the IMF adverse scenario),

the country may need some breathing space in order to solve both its banking crisis and implement

economic reforms (pension reform, privatizations). As the largest banks are state-owned, most of the

recapitalization burden will be borne by the Slovenian government, thus short-term liquidity pressures

are Slovenias main problem.

We believe that a package similar to that of Spain may be in the best interest of Slovenia. Spain

received a 100 bn (10% of Spanish GDP) credit line mid-2012, which is exclusively to be used for

recapitalizing the banking sector. Under the conditionality of reforming the banking sector and

addressing some of the macroeconomic imbalances, Slovenias funding problems would significantly

decrease, and the links between the sovereign and the banking sector in that way severed, as was

demonstrated in the Spanish situation.

Another option for ESM support are the two not yet used light programmes, the Precautionary

Conditioned Credit Line (PCCL), and the Enhanced Conditions Credit Line (ECCL), see box 1. Both would

in our view also fit the Slovenian situation, as they would temporarily (1 -2 years) help the country to

refinance itself in a sustainable way, thus having more time to complete banking sector and economic

reform. Both programmes are also eligible for the ECBs OMT, which may be used to further alleviate the

Slovenian financial situation.

We believe that the Slovenian problem does not have the scale to let the euro crisis re-escalate or have a

significant impact on peripheral sovereign spreads. It may nonetheless become an interesting precedent

of solid EMU crisis management, in case Slovenia effectively requests a light programme or would be

supported by the ECBs OMT, and communication would be better than in the Cypriot case.

Box 1. Overview of ESM (European Stability Mechanism) programmes

Macro-economic adjustment

programme

Precautionary Conditioned

credit line (PCCL)

Enhanced conditions credit

line (ECCL)

Financial assistance programme

for bank recapitalization

When can it be

applied?

A country with significant

financing needs but lost to large

extent access to market financing

For state with sound

economic and financial

situation, as monitored by

the Commission

General economic and

financial situaton sound, but

not complying for some

criteria of PCCL.

Country is unable to meet capital

shortfalls of its banking sector

Offered help? ESM-loans in conditional

tranches (cf. GIP-countries)

ESM offers loans to member

states, who recapitalize banks

What reforms

required?

Banking sector reforms, fiscal

adjustment and growth reforms(e.g. labour market, internal

market)

Continue to respect the

eligible criteria as set out inthe Macro-economic

imbalances procedure (MIP)

Obliged to adopt corrective

measures, adressing thespecific weaknesses that are

problematic for market access

Focus only on banking sector

reforms, supervision, governanceand domestic bank laws

Control? Quarterly Troika missions,

requiring all information

deemed necessary

Compliance with i nstitution-

specific conditionality by

Commission and ECB.

OMT involved? No, not until return to bond

markets

Yes Yes No

Currently applied to? Greece, Portugal, Ireland, Cyprus Spain

Loan or primary market purchase,

for 1 year (renewable to max. 2 year)

Enhanced surveillance by Commission and ECB (if needed,

IMF), financial sector control, comprehensive independent

audit of accounts of government, regular missions on

quarterly basis


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Disclaimer

This publication is prepared by KBC Group NV, or related KBC-group companies such as KBC Bank NV,KBC Asset Management NV, KBC Securities NV (hereafter together KBC).

The non-exhaustive information contained herein is based on short and long-term forecasts forexpected developments on the financial markets and the economy. KBC cannot guarantee that these

forecasts will materialize and cannot be held liable in any way for direct or consequential loss arisingfrom any use of, or reliance on, this document or its content.

This publication is provided for informational purposes only and is not intended to be an offer, or thesolicitation of any offer, to buy or sell the securities or other financial products/instruments referred toherein. The document is not intended as personalized investment advice and does not constitute arecommendation to buy, sell or hold investments described herein.

This publication contains KBC proprietary information. No part of this publication may be reproduced inany manner without the prior written consent of KBC.

The information, opinions, forecasts, and estimates herein have been obtained from, and are basedupon, sources believed reliable, but KBC does not guarantee that it is accurate or complete, and itshould not be relied upon as such. All opinions and estimates constitute a KBC judgment as of the dateof the report and are subject to change without notice.

This publication is provided solely for the information and use of professionals (such as journalists,economists, and professional investors) who are expected to make their own investment decisionswithout undue reliance on this publication. Professional investors must make their own determinationof the appropriateness of an investment based on the merits and risks involved, their own investmentstrategy and their legal, fiscal and financial position.

Slovenië: de volgende dominosteen?

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