Macroeconomic environment

Slovenia

The global economic picture improved dramatically last year. This turnaround can be attributed primarily to emerging countries. Rapid growth was mainly recorded in Asia, where China and its increasing global importance are worthy of note. Countries in the developed world also succeeded in reviving their economies, largely on account of specific measures taken by governments and central banks. Central banks played a key role by maintaining low interest rates and implementing additional measures to increase the liquidity of banking systems. Europe achieved moderate overall economic growth primarily due to aggressive growth in Germany. Last year was marred by the debt crisis, which brought Greece and Ireland to the edge of collapse, before euro area countries jumped to their assistance with financial aid.

The economic situation in Slovenia remained difficult in 2010, despite a tangible improvement compared with the previous year. GDP began to strengthen, but primarily on account of an increase in foreign demand. The strong export orientation of the economy contributed to positive growth, which stood at 1.2%. Despite year-onyear growth in exports of 10%, there continued to be no growth in household spending or investment, which are important indicators of the overall health of the economy. A revival in commercial trade also contributed to a slight increase in the trade deficit, while the current account deficit narrowed slightly.

The global and domestic economic recovery also left its mark on inflation. Inflation averaged 0.9% in 2009, but rose to 2.1% last year owing to higher energy prices and higher prices of certain municipal services.

The situation on the labor market deteriorated significantly in 2010 compared with 2009, particularly in the second half of the year, when the Employment Service of Slovenia once again recorded an increase in the number of registrations of people who lost their jobs due to corporate bankruptcies. New pension legislation also contributed to the aforementioned increase. The rise in unemployment was expected, as unemployment typically continues to rise for some time following renewed economic growth.

In 2010, the Slovenian government continued to strive to mitigate the effects of lower domestic economic activity. To that end, it increased budget expenditure aimed at financing social security programs. On the other side, budget revenues were down, primarily from personal and corporate income tax. Budget revenues were nevertheless higher than the previous year, while the budget deficit was also down 0.2 percentage points to stand at 5.6% of GDP. The deficit also resulted in a rise in public debt, which stood at nearly 38% of GDP at the end of the year.

Banking sector

The year 2010 was exceptionally difficult for the Slovenian banking sector, as corporate operating conditions deteriorated further in the majority of sectors. The entire banking sector was witness to an increase in impaired loans compared with a year earlier. Financial holdings and construction companies contributed most to the increase in impairments, construction companies in particular. Impairment costs were the main cause that banking sector achieved loss before tax in amount of EUR 48 million at the end of the year. The total assets of the Slovenian banking system were at the end of December 2010 in comparison with year 2009 2.6% lower. Total loans to non-banking sector were up slightly, but growth in the most important part of the credit portfolio (i.e. loans to corporates) was negative. More encouraging was growth in loans to households, which were up by nearly 10%, and the associated consumer optimism and capacity for increased spending. Deposits of the non-banking sector remained practically unchanged: household deposits, which account for slightly more than half of all deposits by the non-banking sector, achieved growth of just over 3%.

The government continued to stimulate the economy and financial system via SID banka (which received a capital injection in 2009 for that purpose) through more favorable loans. It also attempted to ease the credit crunch through other measures, including the government guarantee. The amended Banking Act, which set a deposit guarantee of up to EUR 100 thousand to bring the guarantee amount in line with European standards, entered into force on January 1, 2011. The temporary government measure, which provided for an unlimited guarantee on bank deposits during the crisis, similar to the majority of European countries, expired on the same day.

Southeastern Europe

Following a sharp drop in economic activity on the strategic markets of Southeastern Europe in 2009 due to the financial and economic crisis, the situation began to improve gradually in 2010. The trend of negative economic growth seen in 2009 in all of the countries in which the Group operates, except Kosovo, reversed gradually last year, so that positive economic growth had been achieved by the end of 2010. The only exception was Croatia, where the economy fell by 1.4% of GDP last year. Despite the improving macroeconomic situation, economic growth remains weak, primarily owing to lower domestic demand and a decline in foreign investment. The real sector continues to be exceptionally vulnerable, while the construction sector continues to decline and the banking sector is burdened by numerous impaired loans. Kosovo achieved the highest growth of 4.7%, while economic growth ranged from 0.2% to 1.8% in other countries.

Following a sharp drop in industrial output in 2009, when the construction sector recorded the sharpest decline, the volume of industrial output in the countries where the Group operates strengthened slightly in 2010. The largest increase was recorded in Montenegro (by more than 50 percentage points compared with the previous year), in Bulgaria (by around 18 percentage points) and in Serbia (by 10 percentage points).

Having declined in the second half of 2009, consumer prices followed a similar trend last year on the strategic markets of SE Europe. Low inflation rates continued to prevail in Croatia, Montenegro, Macedonia and Bosnia and Herzegovina, while a rise in prices was seen in the second half of the year in Kosovo, where deflation was recorded in 2009. Of all the Group’s strategic markets, only Serbia faced the problem of high and rising inflation, which stood at 10.3% at the end of 2010.

The situation on the labor market failed to improve in 2010, owing to declining economic activity and the exceptional weakness of the real sector. The unemployment rate was up in all countries in which the Group operates in 2010 compared with 2009. Unemployment rate remains by far highest in Kosovo at 45%, followed by Macedonia with a registered unemployment rate of more than 30%, while the unemployment rate in Croatia has risen to nearly 20%. The unemployment rate ranges from 10% to 20% in other countries in the region. Wage growth was down sharply in 2010, except in Serbia and Bulgaria, where growth was slightly higher, while Croatia actually recorded negative wage growth.

Having declined sharply decline in 2009, foreign trade strengthened again on all of the Group’s strategic markets in 2010. Exports rose faster than imports in certain countries, resulting in the narrowing of their current account deficits. External trade was up more than 10% in Serbia in 2010 compared with 2009, while the trade deficit narrowed by nearly 10%.

Banking sector

The banking system of SE Europe recovered slightly in 2010 following the recession of 2009. Nevertheless, the road to the pre-crisis situation remains long. Stress tests of the Serbian banking system for the first quarter of 2010 indicated a sufficient level of capital adequacy and liquidity. The stability of the banking system is also evidenced by year-on-year growth in lending activity, a high level of and moderate growth in capital adequacy, and a halt in the decline and a slight improvement in the profitability of the entire sector. The aforementioned stress tests indicate that the Serbian banking system is resistant to external and internal shocks. The central bank, whose restrictive monetary policy also affected banking operations, raised its key interest rate several times last year in an attempt to ease inflationary pressures. The situation in the banking sector in Bosnia and Herzegovina was satisfactory, despite the crisis. The banking system’s liquidity was sufficient, while the greatest threat was posed by bad loans. The banks thus became more prudent in their lending activities. Banking operations have changed somewhat during the crisis, and are more focused on attracting new deposits than on approving new loans. The liquidity of the Macedonian banking system was also stable, with the banks maintaining a high level of stable solvency. The capital adequacy ratio of Macedonian banks was two times higher than the legally prescribed minimum at the end of 2010. The stress test carried out by the Macedonian central bank at the end of September indicated that the banking system is sufficiently resistant to possible external shocks. The situation in the Montenegrin banking system deteriorated slightly last year, owing to a decline in total deposits and an increase in bad loans.