Now is a good time to raise international awareness of the development of Slovenia's local securities market," claims Stanislava Zadravec, state undersecretary for public debt management.
She has good reason to be optimistic. Slovenia, rated Aa3/AA/AA for local currency, is one of the richest per capita frontrunner applicants for the EU, and has one of the healthiest debt positions, with a government debt to GDP ratio little more than 25%.
Furthermore, in July 2001 Slovenia's central bank lifted restrictions on portfolio investments on securities with maturities exceeding six months. Previously, investors were restricted by a capital constraints regime similar to those in Hungary or Poland.
International participation in the Slovenian capital market must still take place through a licensed bank or broker on the Ljubljana Stock Exchange (LJSE). According to Darko Torkar, director of trading and surveillance at the LJSE, foreigners have always preferred equities. "Foreign ownership of domestic bonds is zero," he says. "But before the capital restrictions were imposed in 1997, up to one-third of equity turnover involved foreign accounts, and even afterwards it was still up to 5% until the Russia crisis."
The finance ministry tried to inform international investors about its domestic market during the roadshow of its latest Eurobond. "Most investors at that time expressed concern about the size and liquidity of bonds, and would not look seriously at the market because of the remaining capital inflow restrictions," says Zadravec.
With a population of only 2m, Slovenia is always going to stuggle to issue liquid sized bonds. Most Slovenian government bonds are in the range of St5bn-St10bn (Eu25m-Eu50m).
Since 2000 the government has issued only taps into the three, five and 10 year benchmarks at auctions every other month. But the Slovenian government's virtue of keeping its budget deficit within 2% of GDP has meant that even this policy has not produced noticeably larger benchmarks.
The supply of domestic government bonds has been further limited by Slovenia's preference for Eurobond issuance. The government's small total debt stock is split about 50-50 between internal and external debt.
"It is relatively difficult for the Slovenian government to rely on the domestic market to finance its borrowings," says Zadravec at the ministry of finance. "Firstly, our economy is small, and the market is just too small and underdeveloped to absorb our debt."
She adds that the newly liberalised financial environment in Slovenia should provide investment opportunities to foreigners. "This is expected to have a positive influence in the depth and liquidity of the local government securities market," she says.
Reappraising the domestic market
The experience of hyperinflation in the former Yugoslavia, of which Slovenia was a part until 1991, led to the practice of linking domestic debt issuance to TOM, the Slovenian 12 month rolling average CPI.
"Not just interest payments, but also the principal of T-bonds issued between 1993 and 2000 were TOM-linked," Zadravec points out. "Of the increase in our debt during those years, 14% was due to the exchange rate raising the value of external debt, but 27% was due to the indexing of domestic debt."
The result was that as long as the exchange rate continued to appreciate, it was cheaper to borrow internationally than at home. With the shift away from the TOM-linked debt principle, the focus of government debt strategy has moved back to the domestic market, with no Eurobond planned at least until 2003.
Marko Jernejcic, an analyst at Nova Ljubljanska banka, warns that the TOM is not going to be easy to dispense with. "The banks will still need a reference rate for their loans and deposits," he says. "But volumes in the government securities market and interbank money market are too low to provide a benchmark."
The total stock of government bonds, at $1.5bn-$2bn, is not likely to grow much larger (except for inflation indexing), as the government has set itself the target of balancing the budget from 2004 onwards, from an already frugal 1.4% of GDP deficit last year.
A recent government ploy to extend the yield curve has been to issue domestic euro denominated bonds, a cheaper form of inflation-proof security also adopted in another ex-Yugoslav country, Croatia. In 2000 Slovenia created a Eu50m 10 year bond over three auctions, and in 2001 it created two new 2011 bonds of a similar size.
Slovenia, like Croatia, has some history of hard currency issues, and the government still has DM374m of Deutschmark bonds outstanding, including a DM268m 2022 line, which is the most traded government security on the stock exchange.
Other issuers also use this option - Banka Celje issued a Eu10m five year bond in February 2001, while retailer BTC plans a Eu40m issue later this year.
"With the 10 year domestic euro denominated issues, we wanted to capture demand from outside the banking sector, especially from the insurance funds," says Zadravec. "Before 2000 there was no substantial investment from the insurance funds, but in 2001-2004 they are expected to grow by about 1% of GDP per year."
Besides insurers, the fastest growing part of the domestic investor base is pension funds. Slovenia introduced a three pillar system in 2000, and pension assets are expected to grow to around Eu200m by 2006. Growth will depend on the extent to which companies enter the third pillar, which could be substantial in a country which has the highest GDP per capita at purchasing power parity in central and eastern Europe.
"Because the banks own most of the bonds, achieving liquidity is a problem for the secondary market," says Torkar at the LJSE. "The banks know each other well, and prefer to trade on the OTC market, which is less transparent for other investors."
Banks have benefited from their market dominance. "When the bond market began in 1997, the banks were able to resell bonds to insurance funds at a 200bp-300bp premium over the primary auction price," says Jernejcic of NLB. "But now the fund managers also have access to the auctions."
According to one bank trader, making transactions is not such an easy matter. "Every day we try to offer other banks terms, but bid-offer spreads are so wide - up to 100bp - that it is hard to agree a price," she says. "The insurance funds do not add much liquidity as most choose to buy and hold."
OTC trading volumes are about twice those on the exchange. Although members of the LJSE are obliged to use its trading platform for transactions, half of Slovenia's 22 banks are not members, including the second largest, Nova Kreditna Maribor (NKM).
The banking market itself is concentrated, with the biggest bank, the state owned NLB, accounting for one-third of total banking assets, other banks in its group a further 10%. NLB is also the number one trader of fixed income and holds about 40% of government bonds. The top three banks, including NKM, which is being sold to a strategic investor, and SKB, which is owned by SG, own two-thirds of assets.
The banks also have close relations with their corporate clients, and this has tended to impede corporate bond issuance. The biggest 18 bonds out of the nearly 60 listed on the LJSE are all government issues. Most so-called corporate deals are issued by the banks, to finance their lending.
"For a long time after independence, a lot of the smaller banks were owned by companies," says the LJSE's Torkar. "They treated the banks like the Hausbanks in Germany, getting loans on favourable terms."
Torkar adds that the continued existence of an "old boy network" among banks and corporates, as well as the greater familiarity of corporates with loans, will pose an obstacle to the supply of bonds.
Zoran Bizjak, head of corporate origination and syndication at NLB, says that such club deals are common simply to avoid paperwork. "It is quicker for a client to raise funds via a private placement," he says. "There are usually only around 50 buyers of a corporate bond anyway, and deals are often listed some time after launch."
Torkar adds that companies have been put off bonds because they do not like having their liabilities indexed to the TOM. "In the past, they have been able to take out fixed rate loans, which have been eroded over time by inflation."
NLB's Bizjak says there has been a recent move among corporates to consider new forms of finance, such as bonds. "There has been a lot of investment and M&A to finance recently," he says. "They can get euro denominated bonds in fixed rate with a longer maturity, which they prefer to TOM linked loans."
Another option, pursued by supermarket chain Mercator, is to approach the Euromarkets. Mercator set up a Eu100m CP programme with RZB in July. However, RZB said at the time that Mercator - one of Slovenia's strongest corporate credits - was too small and unknown to come straight out with a Eurobond issue.
Bizjak of NLB says that other corporates are unlikely to follow Mercator's example. "Mercator was full up to its credit limits with the Slovenian banks," he says. "We had just done a Eu52m loan for them with WestLB. No other corporate is so full on banks' balance sheets." LK