Time to start reading up on Slovenia?
Is Slovenia the next Euro-domino to fall? That is a continuously repeated forecast. But what is the outlook and what are the financial facts?
Recently I spoke to a banker familiar with Slovenian banks. He was reasonably optimistic. The new Government seemed to be taking imminent problems quite seriously – but corruption remains a problem, he said.
According to a Eurobarometer 2012 study of perceived corruption in the 27 EU countries Slovenia topped the list of perceived increased corruption: 74% of Slovenian respondents thought the corruption was increasing, with 73% in Cyprus right behind. This bodes ill for Slovenia since a corrupt country might be less likely to taka the necessary but painful initiatives. However, the new Government has already shown some understanding of what is needed. Recent development in Cyprus might also have concentrated its mind.
On February 28 Prime Minister Janez Jansa, a conservative, lost a vote of confidence due to allegations of corruption amid economic gloom. The new PM is the leader of the opposition Alenka Bratusek, a liberal former civil servant. So far, the most serious allegation of corruption brought against Bratusek is that she had plagiarised one page in her PhD thesis – recently a common vice among German politicians. There are many intellectuals in the new Government, i.a. the minister of culture, Jernej Pikalo who since 2006 has been a visiting professor at the University of Bifroest, Iceland, lecturing on globalisation. Consequently, he should be familiar with what has and has not been done in Iceland post-collapse.
Fitch and the IMF on Slovenia
In a note 22 March 2013 from Fitch Ratings the assumption “remains that Slovenia will be able to avoid requesting international financial assistance. Maintaining investor confidence and therefore the ability to borrow in the market on reasonable terms will require the incoming government to finalise and implement legislation on a bad bank solution and state asset management company. Failure to tackle these issues in a timely manner would increase pressure on the ‘A-‘ sovereign rating.” (Emphasis mine in all quotes).
In the Concluding Statement March 18 2013 of the IMF staff visit to Slovenia the summary reads:
A negative loop between financial distress, fiscal consolidation, and weak corporate balance sheets is prolonging the recession. Prompt policy actions are necessary to break this loop and restart the economy. Repairing the financial sector and improving corporate balance sheets is of the essence. The Bank Asset Management Company is an effective way to clean bank balance sheets. Banks should be quickly recapitalized. A clear and coherent plan is key to access international capital markets quickly. Fiscal consolidation should continue to reduce the structural deficit, while letting the automatic stabilizers work. Recent labor market and pension reforms are steps in the right direction.
What needs to be done?
As can be seen above the IMF statement points out that a “negative loop between financial distress, fiscal consolidation, and weak corporate balance sheets is prolonging the recession.”
The numbers do not look promising. “Real GDP declined by 2.3 percent in 2012 as domestic demand shrank severely.” Here, Slovenia is in league with the worst performing countries such as Greece and the forecast for this year is a further contraction by 2%. However, growth is in sight for next year, depending on implementation of promised reforms, continued market access and – most elusive of all – growth in the Eurozone.
Quite promising, Slovenia has already set up the Bank Asset Management Company (BAMC) and a sovereign state holding company. This is the necessary framework to tackle much needed bank restructuring, debt overhang of corporate debt, improved governance and cutting back on state involvement in the economy. If all of this would be pushed in the right direction much could be achieved. Again, this “if” might prove elusive.
Fiscal consolidation, downsized public sector, labour market reform and more friendly attitude towards foreign investors (Slovenians seem even more hostile than Icelanders to foreign ownership in their economy) are all areas that are being worked on and need more.
The sick part of the economy: banks
No surprise here – the banks are under severe distress. That is of course ominous since we have seen banks causing severe problems in a country after country in the Eurozone (and of course beyond, Iceland being a case in point).
The rapid rise in non-performing loans is a sign of danger and distress in the Slovenian banking sector:
The share of nonperforming claims in total classified claims increased from 11.2 percent at the end of 2011 to 14.4 percent in 2012. The three largest banks saw their ratio increase from 15.6 percent to 20.5 percent in the same period with about ⅓ of their corporate loans non-performing. Meanwhile these banks have repaid the bulk of their debt with foreign private creditors, while increasing reliance on the ECB.
With BAMC the first steps towards a spring-cleaning of balance sheet have been taken but now the brooms and detergents have to be put to a ruthless use. To its relief, the IMF mission notes that international experts have been appointed as non-exec members on the BAMC board.
But the corporate sector – intertwined with banks – is not too healthy either
If the Slovenian corruption is similar to what is coming to light in Cyprus, the danger is that some of these non-performing loans have been given more on grounds of cosy relationships than business rationale, which might then indicate that the collaterals are not water-tight. Again, of course this can be handled professionally if the political powers stay away and the experts are allowed to deal expertly with the problems.
Cross ownership between large corporations, financial holding companies and banks is reminiscent of Iceland pre-collapse. It is a very bad sign indeed. “The debt to equity ratio is among the highest in Europe.” Primitive bankruptcy law make bankruptcy procedures lengthy and are a serious obstacle in dealing with debt. – Hopefully, the new Government gives priority to new bankruptcy legislation since this a mundane but often overlooked problem.
And then there is this:
Viable publicly-owned undercapitalized companies should be recapitalized by the state or attract private capital. However, the mission cautions the authorities against taking actions on debt restructuring or recapitalization that can lead to ineffective use of public funds. Finally, Slovenia has to address corporate governance weaknesses. A Report of Standards and Codes on Corporate Governance by the World Bank and the OECD could help in this respect.
To me this looks like a loud and clear corruption warning without the C-word mentioned.
Funds needed
But even experts cannot be expected to make something out of nothing. The IMF mission points out that transferring bad assets to BAMC is no substitute for real money needed to recapitalise the banks. The three largest ones need around €1bn this year – and if economic conditions deteriorate more might be needed.
Financing requirements are particularly pronounced in summer, with bank recapitalization needed soon and a large 18-month T-bill coming due in June. In all, financing needs for the remainder of the year (excluding the bonds to be issued by the BAMC) could reach some € 3 billion, and possibly more depending on bank recapitalization needs. A large part of this financing need should be met via external borrowing, given banks’ inability to absorb large amounts of government paper, but also to improve the maturity structure of government debt and reduce rollover risk. This highlights the importance of safeguarding market access in the near term.
To give context to the figures above the Slovenian GDP in nominal terms amounted to €35,466m in 2012. The uplifting figure is that debt to GDP was, in 2012, 52.5%.
Over at least 18 months Cyprus had plenty of warnings, its banks were in ECB intensive care for months and yet nothing was done until the patient was almost thrown out of the intensive care, also called “Emergency Liquidity Assistance.”
The key issue is that Slovenia is ok as long as it manages to remain on good terms with the markets – or as long as the markets are keen and willing to be on good terms with Slovenia. And if not… Well, we all know – it ends with an all-night meeting in Brussels, a bail-out at sunrise – or more recently a bail-in – and since that is never enough, it is followed later on by easing of terms and an uncertain future.
But perhaps Slovenia will show that this time it can be different.
*Here is a link from Global Finance to key figures of the Slovenian economy such as GDP, debt, unemployment and all these things that make a nerdy heart beat faster. Here is a link on the economy from the Slovenian Statistical Office.
*Update May 2: here is a Bloomberg article from yesterday when Moody’s cut Slovenia’s rating to junk.
Follow me on Twitter for running updates.