Public Information Notice No. 01/50

Public Information Notice: IMF Concludes Article IV Consultation with the Republic of Slovenia

May 21, 2001

On May 11, 2001, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Slovenia.¹

Background

The economy enjoyed fast and stable growth in 2000 thanks to a favorable competitiveness position and strong investment. Real GDP growth reached 4.8 percent in 2000, and unemployment fell to 7 percent-a record low. Continued real wage moderation in the private sector and the depreciation of the tolar during the year led to a historically strong competitiveness position. Export volumes grew by over 10 percent and, despite deteriorating terms of trade, the current account deficit declined to 3.3 percent of GDP in 2000. The current account deficit was mainly financed by medium- and long-term borrowing abroad, and reserve coverage in terms of imports and short-term debt remained broadly unchanged. However, inflation accelerated and remains high, partly as a result of successive exogenous price shocks and partly reflecting accommodating policies in the first part of 2000. Twelve-month inflation jumped from 4.3 percent in June 1999 to an average of 8.9 percent in 2000, and the 12-month inflation rate in April 2001 was still 9 percent.

Progress in structural reforms was relatively limited in 2000 due to the pre-election period and the state continues to have a significant presence in the economy. Steps were taken toward the resolution of the outstanding legal issues concerning the ownership of insurance companies; an energy regulatory agency was created; and a new law on railway traffic was passed, but there was little progress in the macroeconomically more relevant areas of bank privatization, labor market deregulation, or tax reform, and the indexation of financial contracts is still widespread.

Executive Board Assessment

Directors regarded the near-term economic outlook as favorable, even if external demand slackens. However, they noted the worrisome persistence of inflation. Directors recognized that this partly reflected the one-time impact of introducing a VAT as well as higher world oil prices last year, but they also considered that backward-looking wage indexation and accommodating financial policies had been important contributory factors.

Directors stressed that a rapid reduction in inflation should be a central aim of economic policy. Lower inflation would provide a favorable environment for the envisaged de-indexation of the economy; it would underpin the prospective continuing moderation in real wages; it would help safeguard competitiveness; and it would secure a convergence of inflation rates with EU countries. Against this background, Directors welcomed the tightening of policies in late 2000, as well as the moderately contractionary fiscal policy envisaged in the budget for 200l. Directors stressed, however, that monetary policy should be the main tool for lowering inflation, and should be guided principally by that objective. Directors considered that, in setting monetary policy, the authorities should give less emphasis than hitherto to preserving external competitiveness, which should preferably be achieved through appropriate structural and incomes policies. Directors welcomed the recent increase in interest rates, and urged the authorities to take further action if domestic liquidity remains excessive or the rate of exchange rate depreciation jeopardizes the goal of disinflation.

Directors regarded the envisaged de-indexation of the economy as another critical part of the authorities' strategy to lower inflation and dampen price shocks. They welcomed the agreement in principle between the government and the social partners to move to forward-looking wage indexation and to link wages and productivity in the private sector as of 2002, as well as the ongoing efforts by the Ministry of Finance and the Bank of Slovenia to promote de-indexed financial instruments.

Directors supported the authorities' medium-term objectives of competitiveness, sustainable growth, and social peace. They saw these objectives as within reach, provided that structural reform is boldly pursued, notably with regard to deregulation, privatization, corporate governance, and accelerating private sector development. Directors noted that, until now, the pace of structural reforms had deliberately been gradual. However, they considered that the outstanding reform agenda should now be addressed decisively in order to boost the economy's potential growth rate, increase its resilience to external shocks, increase its attractiveness to foreign investors, and prepare it for EU membership.

Directors endorsed the authorities' quantitative medium-term fiscal goal of moving to budget balance as well as the preparation of the two-year budget for 2002/03, which they saw as critical to their overall medium-term strategy. They welcomed the emphasis on containing expenditure, noting that, without restraining measures, several factors would combine to cause excessive expenditure growth. These factors include: unsustainable growth in public sector wages; the large share of entitlements; and the net costs of EU harmonization. Directors underlined the need to reform public administration, including wage-setting arrangements, and to restructure entitlement programs. Regarding the revenue side of the budget, Directors called for a reform of direct taxes that should expand the tax base, lower the tax burden, and eliminate distortions. They welcomed the government's intention to include all forms of income in the income tax base.

Directors observed that a fiscal policy emphasizing expenditure restraint would complement and facilitate a reduction in the economic role of the state. They considered such a reduction appropriate in the interests of efficiency and promoting an entrepreneurial private sector, and in view of Slovenia's prospective accession to the EU. They noted that the state's economic role remains disproportionately large compared to other advanced transition economies. Directors welcomed the authorities' intention to begin privatizing state-owned enterprises and utilities and to discontinue the operations of the Slovene Development Corporation. Directors urged the authorities to proceed decisively in making the labor market more flexible and to liberalize employment protection legislation, which continues to be very restrictive.

Directors welcomed the findings of the Financial Sector Assessment Program, noting the resilience of the Slovene financial system to a range of likely macroeconomic shocks. However, in light of the liberalization of the capital account, they encouraged the authorities to enhance competition and provide incentives for consolidation and greater efficiency in the financial sector and strengthen further its supervision. The privatization of the two state-owned banks is a key step in this direction, and the authorities' intention to proceed rapidly in this area is welcome. Equalizing the tax treatment of all financial savings instruments and de-indexing financial assets would also provide strong incentives for efficiency gains and help capital market development. Directors commended the comprehensive Action Plan prepared by the authorities to strengthen prudential standards, improve liquidity management, and deepen the money market. In this context, Directors welcomed the recent introduction of consolidated supervision.