Europe’s slasher stalks Slovenia

Published in Business Spectator (Melbourne), 16 May 2013

If I were a cynic, I would now be predicting the next European bailout recipient. And the winner is… Slovenia! But how would I know?

I would know, primarily, because on Monday, Europe’s finance ministers and the Slovenian government categorically ruled out just that. Anyone vaguely familiar with the euro crisis patterns to date would take this as a clear indication that it can only be a matter of days or weeks until the troika of the European Central Bank, European Union and International Monetary Fund marches into the Slovenian capital of Ljubljana.

With a degree of predictability similar to the sequence of night and day, every single European bailout has been preceded by strong denials of the possibility. It was like this for Greece more than three years ago. It happened again in the cases of Ireland, Portugal, Spain and Cyprus.

When eurozone leaders declare their full support of and confidence in a country and its government, you should reach for the salt. Such declarations are expressions of wishful thinking.

German finance minister Wolfgang Schäuble’s latest remarks fall into this category: “The Slovenian government has told us that they will be making it without the help of the European Stability Mechanism”, he told reporters in Brussels, “and I believe that their assessment is right.”

To add a bit of drama, he then went on that this would, of course, still require austerity measures from the Slovenians but that a bailout, on the other hand, would not be a walk in the park either. In other words, though we still pretend to have trust in you, reform or else!

So what’s happened in Slovenia? Weren’t we told until just a few years ago that Slovenia was a great success story? That it had managed the transformation from socialism well? And in any case, for all non-European observers, where and what in the world is Slovenia?

For a start, Slovenia is a small country. Not quite as small as Cyprus, but still way smaller than Greece. Its population of about 2 million lives in the northern part of former Yugoslavia, bordering Italy, Austria, Hungary and Croatia. So obviously, it is “systemic” for the survival of the euro.

After the dissolution of Yugoslavia, Slovenia embarked on a process of export-led growth and modernisation that lifted its per capita income and also enabled it to join the European Union in 2004, the eurozone in 2007 and the OECD in 2010. Prior to the euro crisis, Slovenia appeared to be one of Europe’s more successful economies.

Yet despite its earlier growth and export successes, in hindsight Slovenia’s boom was lacking crucial elements to make it robust and sustainable. Privatisation never really took off and many of the country’s biggest companies are still in state ownership. Corruption also remained a constant problem, with Slovenia scoring mediocre results on Transparency International’s Corruption Perception Index.

What now really threatens to break the country’s back is the fact the Slovenia’s largest and state-owned banks are sitting on a pile of non-performing loans. As the OECD summarised the situation last month:

“Slovenia is facing a severe banking crisis, driven by excessive risk taking, weak corporate governance of state-owned banks and insufficiently effective supervision tools. Major state-owned banks have been recapitalised several times. Additional capital needs are expected but their amount remains uncertain as the main results of earlier stress tests and due-diligence analysis have not been disclosed and their assumptions are most likely outdated.”

In short, Slovenia’s financial sector is a complete mess – thanks not least to the development of crony capitalism in the post-Yugoslav years. According to the IMF, only Hungarian, Irish and Greek banks have a higher percentage of bad loans on their books.

Last week, the Slovenian government announced it would establish a bad bank to take on €3.3 billion of bad loans from the country’s three largest banks. State-owned banks NLB and NKBM would seek to raise additional capital of €767 million.

The need to deal with the ailing financial sector is putting additional pressure on Slovenia’s fiscal situation. It is difficult enough anyway. Welfare reforms, privatisation of state-owned assets and labour market deregulation have all been recommended by the OECD to help fill the holes in Slovenia’s budget. This year, the deficit is expected to reach 7.8 per cent of GDP – more than double the figure allowed under the European Stability and Growth Pact.

The ongoing recession will not make it any easier. According to a new forecast from the European Bank for Reconstruction and Development, the Slovenian economy will shrink by 2.5 per cent this year and another 0.9 per cent in 2014. Since pegging its former currency to the euro, Slovenia also gradually lost its competitiveness – the familiar story of the euro periphery.

To respond to the crisis, and in order to avoid a European bailout, Slovenian Prime Minister Alenka Bratušek last week announced a bundle of emergency measures, including a tax hike on Value Added Tax, a new property tax, the sale of 15 state-owned companies and budget cuts. It is undoubtedly a tough cocktail of measures.

However, whether all of these reforms will actually be implemented is another matter. In the past, Slovenia’s political system has often enough prevented change. For example, attempts to increase the retirement age and labour market reforms were blocked in referenda in 2010 and 2011.

This time, of course, is different. The Slovenian government will manage to break down all political resistance, get its budget to surplus, end the recession, reduce unemployment, fight corruption, privatise its assets, close down underperforming banks, reform the labour market and cut back the welfare state. And in doing so, it will restore market confidence in this small eurozone country and avoid any need for help from its European neighbours.

After all, the Slovenian government and European finance ministers have just promised us that no bailout is needed. Only a cynic would doubt this scenario.

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