ECONOMIC ENVIRONMENT

prof. dr. Franjo Štiblar,
Chief Economist NLB

The Slovenian economy performed better than most in 2002 as GDP grew 3.2 per cent, the current account recorded a surplus of 0.3 per cent of GDP, and inflation fell to 7.5 per cent, while there was no increase in the budget deficit.

Table 17: Main macroeconomic indicators for Slovenia, 1997- 2002

(Area: 20.000 square km; population: 2 million; GDP: 20 billion USD)

Economic environment in Slovenia

In 2002, the Slovenian economy was less affected by recession than most countries mainly due to a 12 per cent increase in exports to South-East Europe, CEFTA and countries of
ex-Soviet Union. This together with an increase in government expenditure was behind GDP growth of 3.2 per cent, with signs that the dip in growth has already passed in mid-2002. The relatively weaker economic growth by Slovene standards meant that employment growth slowed to below 1 per cent and the unemployment rate stayed at the relatively low level of 6.5 per cent by ILO standards.

Analysis of GDP growth shows manufacturing increased by 3 per cent, construction by 2 per cent and services by 3.4 per cent. Both consumer and producer sentiment indicate improvement in the economic climate towards the end of 2002.

Inflation of 7.5 per cent (annual average) remains the main economic issue as it is still off targeted EU Maastricht criteria that Slovenia wants to comply with by 2004. Both oil prices and domestic cost-push factors contribute to inflation as labour costs grow faster than productivity. Producer's prices increased by 5.7 per cent on average while wages grew by 2 per cent in real terms.

The current account surplus was over 60 million dollars mainly due exports exceeding imports and there was a surplus in the capital account caused by strong net inflows of foreign direct investments (FDI). The size of inflows at 10 per cent of GDP is almost equal to the cumulative amount for the previous 10 years. The gap narrowed between foreign exchange reserves and external debt reaching close to 8.2 and 8.8 billion dollars respectively. Reserves cover 7 months of import of goods and services and there is a low external indebtedness where the debt service ratio remains below 10 per cent.

The public sector deficit increased to 3 per cent of GDP due to a once off change in accounting period for revenues from 11 to 12 months. However, public sector revenues exceeded forecasts and the share of public sector expenditures in GDP increased again reaching over 43 per cent.

Monetary aggregates jumped twice during 2002 due to excess inflows of foreign currency. At the beginning of the year the inflow was created by the to introduction of euro and at the end of 2002 inflow was caused by sale of Lek to the Swiss pharmaceutical company Novartis. Annual monetary aggregate growth rates were 4.2 per cent for M0, 13.8 per cent for M1, 26.1 per cent for M2 and 22.6 per cent for M3. Financial savings grew faster than nominal consumption with the central bank monetary target of up to 20 per cent growth in M3 being surpassed. Financial deepening continues with total bank assets to GDP ratio reaching 90 per cent, which is still less than half of the ratio in developed economies.

The financial sector continues to be in good shape with only one small foreign bank recording losses in 2002. Banking assets increased by 14 per cent, ROE before tax was 13.5 per cent, ROA before tax 1.1 per cent while cost/income efficiency improved with a cost to assets ratio of 3.76 per cent. The insurance sector in Slovenia saw total premiums growing around 20 per cent, while the Slovenian stock exchange index reached an all time high in November 2002.

Slovenia continued with the policy of floating exchange rate with nominal depreciation of 3 to 4 per cent despite net inflow of foreign exchange. With average inflation at 7.5 per cent real appreciation is around 3 per cent. Nominal interest rates are falling with prime rate now around 10 per cent, however they are expected to further decline.

For Slovenia, the external environment is less favourable than a year ago with higher oil prices and recession in the EU, however this has been offset by the expansion of Slovenian companies to Southeast Europe.

Forecast for Slovenia

At the beginning of 2003 economic climate is improving, inflation is decreasing towards 6 per cent, nominal depreciation of tolar is slowing towards 2.5 per cent, and interest rates are declining with NLB prime rate already below 10 per cent in nominal terms. Current account remains positive, but budget deficit could grow so that re-balancing could be necessary.

At the end of 2002, Slovenia was formally invited to join the EU in May 2004. GDP growth is expected to accelerate to 3.7 per cent in 2003 and 4.3 per cent in 2004, while inflation is predicted to decline to 5.5 per cent in 2003 and to 4.3 per cent in 2004. This is important as the exchange rate will be fixed during the two-year preparation period for membership in ERM-2 as precondition for joining EMU, and will start around 2005.

On the domestic front, consensus among social partners should keep wage growth under control, while increased competition in the environment should help keep inflation in check, however external inflationary pressures will be more difficult to control. The current account is expected to remain positive with financial inflow still a feature but less so than in 2002.

Policy issues and uncertainties

Firstly, a balanced budget seems to be more and more difficult to achieve, as EU membership approaches more institutions will be established and more public servants will be needed causing additional costs to a small two million inhabitants country. In addition it appears that Slovenia could be net contributor upon entering EU, which will mean up to 1 per cent of GDP outflow to Brussels.

Secondly, external conditions could worsen if political and military intervention in Iraq increases the price of oil but this risk is for all economies. Revival of activity in developed economies would change the external impact in a positive direction.

Thirdly, inflation is currently at the highest among new EU candidate countries and could be jeopardised by external events.

Finally, on the positive side, as EU entry approaches and with continued expansion to the markets of central, south and east Europe, domestic activity could accelerate.

Economies of the region

Economic activity decelerated in central and eastern Europe in 2002 but GDP growth remains more than double the rate in the EU. Domestic demand including public expenditure and private consumption replaced declining exports as the driver of growth.

Prudent monetary policy and favourable external conditions contributed to a decline in inflation, and this coupled with competition resulted in a lower interest rate environment. Lower inflation and higher inflows of foreign currency led to stronger real appreciation of domestic currencies that in turn resulted in current account deficit remaining high despite declining imports. The budget deficit increased due to an increase in public spending and lower tax collection with the reduced economic activity.

Forecast for the Region

Economic activity in the region is expected to accelerate from 2.7 per cent average GDP growth rate in 2002 to 3.8 per cent in 2003 conditional on the revival of growth in developed economies and demand for exports from the region. In 2002 and beyond an additional boost is expected to come from membership in the EU and NATO adding up to 1-2 percentage points to the growth rate. Unemployment rates will slowly decline and inflation will decline further as members of EU prepare to enter ERM-2, while monetary, fiscal and income policies will be more in line with the EU standards.

A major policy dilemma for countries in the region is whether to prioritise growth or stability as the primary goal. With further integration into EU economy, cyclical dynamics will strengthen leaving a lower degree of freedom in economic policies with Central and East European countries.

The most significant uncertainty is the pace of economic development in developed economies as dependence on exports will increase in the future.

In the Balkan transition economies the situation is continually improving with GDP growth exceeded 4 per cent, declining inflation, no increase in unemployment, while both external and internal balances improve. Further growth is expected as favourable external conditions prevail including lower interest rates and growth in the EU and Russia. Also it will be helped by further improvement in the political climate and continuation of established economic reforms should help growth in the region.

With economic stability the region becomes a potential destination for investors in the near future as profits and margins in developed markets continue to decline. Regional country risk is rapidly improving, however a selective and careful approach is still required.

Optimism for the region stems from several factors including the signing of the Stability Pact for the region (1999), democratic evolution Yugoslavia (2000), the Framework Agreement in Macedonia (2001), elections in Kosovo (2001), transformation of Yugoslavia into Serbia and Montenegro (2002) and accelerated GDP growth in Croatia.

Table 18: Forecast for Slovenia, 2000-2004