Washington, D.C., 19 January 2023
The Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation1 with the Republic of Slovenia on Wednesday, January 11, 2023, and endorsed the staff appraisal without a meeting.
Slovenia recovered quickly from the pandemic, with GDP increasing by more than 8 percent in 2021, largely driven by exports and private consumption. Strong economic performance has continued into 2022, but growth slowed significantly in the third quarter as spillovers from the war in Ukraine and rising prices weighed on economic activity. The labor market is tight, with unemployment at an historic low, but wage growth remains lower than inflation.
Growth is expected to slow further to 1.8 percent in 2023 from 5.4 percent in 2022, reflecting weaker external demand and subdued private consumption and investment, partly offset by an expected accommodative fiscal policy stance. Inflation is expected to decline but will likely remain elevated for some time before returning to target. The economic outlook is highly uncertain, and risks, mainly from war-related spillovers, are mostly on the downside. Over the medium term, growth is projected to rebound to its potential of around 3 percent, underpinned by investments and reforms, including those supported by EU funds.
Executive Board Assessment2
After an impressive post-pandemic recovery, Slovenia has continued to achieve strong economic growth, but the outlook has become more challenging. Real GDP increased by more than 8 percent in 2021, thus surpassing its pre-pandemic level, and economic activity remained strong in 2022. Staff’s preliminary assessment suggests that the external position in 2022 is moderately stronger than the level implied by fundamentals and desirable policies. Russia’s invasion of Ukraine poses considerable challenges, however, mainly through weaker external demand and high commodity prices, which are weighing on the economy. Growth is expected to slow in 2023 with downside risks stemming mainly from war-related spillovers. Inflation is expected to fall, but remain elevated, possibly triggering higher wage demands and higher inflation expectations.
A tighter fiscal stance is warranted in 2023 and energy price mitigation measures should be more targeted. Tight fiscal policy should support monetary policy in the effort to reduce inflation. With a positive output gap, tight labor market, and rising core inflation, it would be prudent to save part of the large contingency fund and to reduce the fiscal deficit in cyclically adjusted terms relative to 2022. Public debt remains sustainable but is vulnerable to shocks. Temporary and targeted support should be deployed to protect the vulnerable against high energy prices and less targeted measures should be phased out. Should downside risks materialize, automatic stabilizers should be allowed to operate fully and in case of a large adverse demand shock consideration could be given to deploying discretionary fiscal stimulus.
A growth-friendly consolidation would help rebuild fiscal buffers. Improving the tax policy mix to reduce reliance on labor taxes, while increasing property taxes and broadening the tax base, could generate additional revenue and induce a positive labor supply response. Reforming the pensions, health, and long-term care systems is a priority. On pensions, which account for the bulk of age-related fiscal costs over the long term, options include gradual adjustments to the retirement age and to indexation rules. Modernizing the public sector wage system by better linking remuneration to performance would align incentives and allow for better wage bill management. Further strengthening public investment management is also critical given the envisaged scaling up of public investment.
Slovenia’s macroprudential stance is appropriate but risks have increased. Given systemic risks, the recent increase in the countercyclical capital buffer from zero to 0.5 percent is welcome. Macroprudential policies should remain flexible to ensure the right balance between financial stability and credit supply to the economy. Continued close monitoring of asset quality and appropriate loan-loss provisioning remain important. Legacy Swiss franc loans should be handled on an individual basis and stability of contracts should be ensured.
Efforts should continue to be made to further strengthen the Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) and restructuring frameworks. The focus should be on enhancing supervision to ensure that accurate and up-to-date beneficial ownership information of legal persons is available to competent authorities and reinforcing money laundering investigations and convictions. The transposition of the relevant EU legislation and its implementation is important for restructuring.
Measures to increase energy security should be compatible with Slovenia’s green transition. The authorities should continue their efforts to ensure alternative gas supplies, encourage energy savings, and prepare contingency plans. While temporary reliance on more polluting energy sources may be needed in the short term, it is important to continue to keep a focus on long-term climate goals, including by further developing renewables to reduce dependence on fossil fuels. Carbon prices high enough to provide the right incentive for currently exempt polluting sectors should be put in place over time as the energy crisis abates.
Securing sustained and inclusive growth calls for further labor market reforms and digitalization to boost productivity. Policies to address disincentives to labor market participation should include reducing the relatively high labor tax wedge, reforming unemployment and pension policies to limit early exit from the labor market and tackling skill mismatches and inflexible work arrangements. Active labor market policies need to be well aligned with market needs, with education and training programs adapted to meet new demands from the green and digital transitions, and provided on a life-long basis. Closing remaining gaps in digital skills and the integration of digital technologies in businesses and public services would positively contribute to future productivity and growth.
It is recommended that the next Article IV consultation with Slovenia be held on the standard 12-month cycle.
1 Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.
2 Management has determined that this Article IV Consultation meets the established criteria as set out in Board Decision No. 15207 (12/74); (i) there are no acute or significant risks, or general policy issues requiring a Board discussion; (ii) policies or circumstances are unlikely to have significant regional or global impact in the near term; and (iii) the use of Fund resources is not under discussion or anticipated.
Source – IMF