Slovenia Rises To The Challenge, Europe Sighs In Relief

by: Joan Feldbaum-Vidra

Looks like Europe may be able to sigh in relief. The era of bailing out the periphery might just be coming to a close, thanks to indications that Slovenia won't need to tap the EU for bailout funds. The results of Slovenia's recent banking sector stress tests reveal that the recapitalization needs are just Eur 4.8 billion $6.56 million U.S.), even using very conservative assumptions, a sum that Slovenian policymakers believe is manageable without outside assistance. Let's hope so.

Indeed this particular country risk analyst leans toward being constructive on Slovenia, in spite its shortfalls. Slovenia has a history of fiscal rectitude and responsible economic management. Government deficits were low by EU standards entering the crisis period, well below the magical EU threshold of 3% of GDP, and government debt stood at 27% of GDP in the earlier part of the decade.

Over-exuberance in its lending markets - an affliction shared by many others too, caused Slovenia's present problems. Still, Slovenia enjoyed steady growth that did not overburden the external accounts. Indeed, the current account deficit hovered between -1% and -2.6% of GDP in the pre-crisis years. Higher value added segments of the economy were especially productive.

There are engines of growth in both manufacturing and services in this economy which will be assisted by the boost in competitiveness that has occurred since the advent of the crisis with the real effective exchange rate declines. The labor market reform will help improve competitiveness too. The government's privatization agenda, once realized, will unleash further competitiveness and is also an important vehicle for government financing.

The economic program put forth by the government of Prime Minister Alenka Bratusek will help correct some of the problems in the Slovenian economy - namely, too much government influence - that show up in Slovenia's relatively low government effectiveness standing compared to many of its Euro Area peers. Restructuring of the banking sector will boost the future health of the economy, and in particular, reduce the linkages between banks and corporates which have been behind much of the troubles.

Credibility, of course is the key to success, and it appears that the situation is manageable from a solvency standpoint. The stress tests conducted were based on very conservative assumptions for both overall growth and domestic demand, as well as forecasts for deterioration in asset quality of the banks. The capital hole of Eur 4.8 billion to be filled in bank balance sheets is considered to be conservatively calculated by many experts, and the direct cost to taxpayers of just another Eur 3 billion (the infusion comprises Eur 2 billion in cash, and Eur 1 billion in government bonds) seems financeable. The remaining financing is coming from bailing in subordinated bond holders (Eur 441 million).

One main risk is that the banks will not be able to raise the Eur 1.1 billion of capital that the plan calls for, by end of June, and that is an even a greater burden that falls on the shoulders of the government.

The second main risk relates to liquidity. On top of the bank recapitalization, falling due in 2014 are Eur 3.3 billion in amortizations plus the government needs to finance a Eur 1 billion budget shortfall expected next year. Potentially, the government could need to hit the markets for Eur 5 billion - that's a lot.

While Slovenia's access to market finance has been circumscribed, it has been able to find funds, but not a ton. It privately placed Eur 1.5 billion with an unknown investor last month. Financing will be expensive.

Credibility as evaluated by the markets also rests on economic conditions and political stability - i.e., being able to follow through with the prescription. The government of Prime Minister Bratusek has been strengthened thanks to her ability to crisis manage. Her government started off strong in constructing a coherent plan of action back in May that met the approval of the EU. The ability of the government to push ahead with promises will be watched closely by the markets and the EU institutions, which want to avert another bailout.

Generating growth will be a very important piece of the puzzle for Slovenia. Slovenia won't be returning to growth in 2014, but growth may be around the corner. Conditions in its main trading partners are improving. Growth in the Euro Area, Slovenia's main trading partners, is expected to register 1.1% GDP growth next year, according to the most recent European Comission forecast. This should help stimulate demand for the Alpine country's exports, thereby assisting overall growth. Nominal GDP growth is buoyed by inflation of 1.3% y/y, same as in Germany, and quite good considering the low point in Slovenia's the economic cycle.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.