Slovenia faces insurmountable debt crisis

Slovenia faces insurmountable debt crisis

There certainly are bad apples in the Slovenian basket; the question is whether the rot will spread to the entire economy and force a bailout of the country.

When Cyprus filled the headlines with talk of bailout and haircuts in March, it unsurprisingly triggered uncertainty and skyrocketing yields elsewhere in the Eurozone, more specifically Slovenia. It also sparked the question of whether Slovenia will be the next nation to walk the bailout trail; a topic discussed on Bloomberg TV, where it was suggested that Slovenia’s situation is more stable than Cyprus’. This conclusion is based on the fact that banking sector assets of Slovenia merely amount to 140% of GDP, against a whopping 700% in Cyprus. However, these mostly state-owned banks have around €7 bn of bad loans on their books, equal to about 20% of GDP – a factor which the Slovenian government may have underestimated, and which could prove critical.

Slovenia’s government has a sizable amount of bonds to sell if it is to finance future expenditure. According to estimates from the IMF, Slovenia will need to raise approximately €3 bn in 2013 in order to repay maturing debt, aid domestic banks and finance the public budget. Slovenian GDP stands at €34.86bn (2012 estimate based on the official exchange rate), making it the fourth smallest country in the Euro area. Debt-to-GDP stood at 54.1% by December 2012, a historical high, which in unison with the Cyprian bailout contributes to investor insecurity, pushing up the bond rate.

In fact, as Cyprus was unfolding, Slovenia experienced yields on its two-year bonds hitting almost 7%, overtaking longer-dated bonds and inverting the yield curve – usually interpreted as a sign that investors are pricing in a high risk of default. Same sentiment is evident in the cost of credit default swaps, which reflected that protection against a Slovenian default (405 basis points) was higher than similar protection against a default by Italy (314 bps), or Spain (309 bps). Seven percent is a notable rate, because it places Slovenia firmly in the club of Euro countries, which already have received bailouts: Greece, Portugal and Ireland. For these Euro members the 7% level was the first indicator eventually leading them to seeking aid from the Troika due to high costs associated with issuing fresh debt, and they too witnessed an inverted yield curve.

The moment of truth will reveal itself come June, when Slovenia faces €907 million worth of 18-month treasury bills reaching maturity. For now, the bond rate appears to have stabilized, and Slovenia faces the challenge of recapitalizing its banking sector. According to the OECD, Slovenia must sell viable state-owned banks and let the bad banks default, imposing some losses on debtholders. Slovenia’s government, headed by PM Alenka Bratusek, remains adamant that a bailout is not in the cards: “We will solve our problems on our own,” she said after a meeting with Barroso, the European Commission President.

Unfortunately, talk is cheap, and seeing as markets have grown rather accustomed to hearing reassurances on behalf of the ailing Eurozone, Bratusek may well be forced to do a U-turn. She plans to deal with the banking sector problems by setting up a ‘bad bank’ as vessel for problem assets, and thus free other financial institutions of bad debt.

In addition, privatization is seen as a method of salvation, with Bratusek stating that “We will start the privatization process of one or two bigger companies immediately […] My wish is that we privatize one of the banks as well.” Bratusek’s determination is evident, but the Slovenian economy is rapidly deteriorating around her, with an expected rate of contraction of 2.1% this year, and unemployment soaring – see chart.

“Against this difficult background and with a possible further deterioration in the international environment, Slovenia faces risks of a prolonged downturn and constrained access to financial markets,” (OECD).

Whether Slovenia can reign in its bad debt and get the banking sector back on track is made even more difficult by the race against time before the banks will need fresh capital in June. This makes the hurdles of non-transparent governance and generally poor administration even worse, since the government lacks credibility and is perceived to have “no programme, no strategy, no policy…” (Andrej Šircelj, president of the board of BAMC, the bad bank, and an opposition SDS parliamentarian). The fate of Slovenia may turn out to be disproportionately important to Europe despite the size of the economy, because nations such as Croatia are in the line-up for membership of the EU. It remains to be seen what will happen to Slovenia this summer and how neighboring nations will react.

Categories: Europe, Finance

About Author

Mikala Sorenson

Mikala Sorensen is an Economist with regional expertise in Europe. She holds a first class honours degree in Philosophy, Politics and Economics from the University of York and a Masters in Economics from the University of Copenhagen. Having interned at the Danish OECD-delegation in Paris and currently working at the Danish Ministry of Finance, she specialises in politics and macroeconomics. Analysis for GRI is an expression of her own views.