SLOVENIA: Too small to fail
It sprung into the spotlight when it was likened to Cyprus; but the small Alpine state is likely to pull through
Just when Slovenia was thinking it was on the way to placing a successful and much-needed bond issue in the US, calamity struck: on April 30, Moodys downgraded the sovereign rating two whole notches to junk status.
The issue was initially pulled only to be put back on again when the Slovenes saw the markets had shrugged off the downgrade and interest was still strong.
On May 2 Slovenia raised $3.5 billion from a dual tranche of 5-year bonds at a yield of 4.95%, and 10-year at 6%, with bids amounting to some $1516 billion. Initial pricing on the five- and 10-year papers was around 5% and 6.12%, according to Bloomberg.
Despite the downgrade, Slovenia was still able to get its debt out the door at lower-than-anticipated yields. Luckily, the market wasnt half as bearish as Moodys: if anything, its been taking a more sanguine view of Slovenia of late, Nicholas Spiro, of London-based Spiro Sovereign Strategy, told Emerging Markets.
Indeed, from late March through April the yield on Slovene 10-year dollar bonds declined from around 6% to 5.6%, although this was more a reflection of general market trends in the eurozone peripheral markets than growing confidence specific to Slovenia, says Andraz Grahek, a Ljubljana-based financial consultant.
We need to read the market response carefully. The implied cost of financing for Slovenia remains the highest among eurozone countries, close behind the Portuguese rates, Grahek told Emerging Markets. The finances of the Alpine country of just 2 million people have been on a rollercoaster in the past nine months.
But just how has Slovenia which entered the European Union in 2004 as the richest of the former communist European states entered a double-dip recession and come under the spotlight as the next potential Cyprus? It is a question Slovenes proud of escaping Yugoslavia in 1991 with minimal violence, and of the nations subsequent rise as a manufacturer of high-quality exports ponder as much as foreign economists.
Slovenia proudly adopted the euro in 2007, the first of the new Eastern European EU members to do so; things were seemingly humming until the summer of 2008, when the global crisis hit, and as one Maribor-based manufacturer put it, orders dried up, overnight.
The slump in earnings exposed a real-estate bubble, and in 2009, with the construction industry seizing up, economic output plummeted by 7.8%. Although there was a modicum of recovery in the next two years, in 2012 the economy contracted by 2.3%, with another 2% shrinkage expected this year.
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Successive Slovene governments have struggled to tackle much-needed reforms, such as in education and pensions. They have also been reluctant to privatize, especially to foreigners, with anything from banks to ski makers, and much in between, still under state control. The result has been political cronyism, bad governance, outright corruption and spiralling debt.
The first, obvious problem is the banking sector: non-performing loans [NPLs] have surpassed 20% in three of the largest banks NLB, NKBM and Abanka where almost a third of corporate loans are NPL. The banks desperately need recapitalization, which could cost in the region of 4 billion euros, Saso Stanovik, head of research at Alta Group, a Ljubljana-based financial consultancy, told Emerging Markets.
The second problem is an over-leveraged corporate sector, particularly in construction, with a debt to GDP ratio of 98% that will have to be brought down in the next couple of years. There has been some progress in this area since 2012, but there are difficulties with refinancing this debt due to the banking sector problems, Stanovik says.
The fear is that sorting out this mess may well push public debt up from the current 54% to above the 60% threshold.
The four-party coalition headed by Alenka Bratusek and forged only in March, has promised to continue reforms started by the outgoing Jansa administration, including the establishment of the Bank Asset Management Company (BAMC, or Bad Bank) and the Slovene Sovereign Holding Fund (SSH) as a unitary institution to control state assets. The government unveiled a detailed reform plan on May 9, which includes privatizations and the sale of one bank.
But Bratusek is a natural left-winger having to enforce right-wing economic policies via a coalition with diverse interests.
There are some positive signs. As one western diplomat put it: It is reassuring that Bratusek, Finance Minister Cufer and newly-appointed central bank governor Jazbec are all on the same page regarding the Bad Bank and Sovereign Holding Fund.
And despite its problems, Slovene banking sector assets amount to only 130% of GDP nothing like the bloated situation in Cyprus, where the figure was 700%.
For now, the benign global sentiment and associated successful bond auction have given Slovenia breathing space but only that. Slovenia will be judged on the execution of the reforms and performance of its economy. The government will be on thin ice if they dont deliver on their promises by the end of the year, Grahek warns.
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