Euro star Slovenia becomes another trouble spot

LJUBLJANA Tue Oct 2, 2012 8:49am EDT

LJUBLJANA (Reuters) - When Slovenia joined the euro in 2007 it had the fastest growth in the currency area and its 2 million inhabitants had some of the highest living standards in eastern Europe.

The southern Alpine country is now in recession, shut out of the bond market and is trying to avoid following much larger euro zone members in asking for an international bailout to stop it going bankrupt next year.

The global financial and regional debt crises have exposed weaknesses in an economy dependent on exports of cars and car parts, drugs and household appliances and highlighted the sluggish pace of reform and political squabbling.

And while Europe's former communist states have so far avoided the worst of the debt crisis, there are signs they are also buckling under the strain of austerity. Slovenia could become the first to ask for a bailout.

"Slovenia was the best performer and a frontrunner among the new EU members. But many failures from the past became obvious due to the crisis," said Hermina Vidovic, an analyst at the Vienna Institute for International Economic Studies.

The government says a bailout will not be needed but the economic indicators paint a gloomy picture.

Local banks, mostly state owned, are struggling with bad loans, equivalent to almost 18 percent of gross domestic product. Some of the debts are owed by construction companies that ran into trouble when a property bubble burst in 2009 other by investment firms struggling with a tough financial market.

The budget deficit this year is expected to reach some 4.2 percent of gross domestic product, well above the earlier forecast of 3.5 percent.

That would be down from 6.4 percent in 2011 and is still lower than many other indebted euro zone states but any bank rescue where the state takes on a lender's losses could send the deficit soaring. That would be a similar situation to the one faced by Ireland which is in an international rescue program.

Analysts say the crunch would come at the end of this year or early next year if Slovenia fails to win back investors' confidence and market access ahead of a mid-year debt repayment hump of 2 billion euros.

"The longer bailout speculations continue the more likely the actual bailout. The government is now moving to assure the markets of its decisiveness in tackling the fiscal consolidation as well as structural reforms," said Otilia Simkova of a research and consulting company Eurasia group.

"The question remains whether this is enough to convince the skeptical markets and jumpstart the much needed ability of Slovenia to borrow within crucial period of next couple of months."

Slovenia's 10-year bond yield has risen from 5.2 percent in March to 6.29 percent on October 2 after peaking at 7.6 percent in August.

In April the government postponed a benchmark bond issue of 1.5 billion euros because the yield demanded exceeded 5 percent. It is now hoping to issue its first bond this year in October or November on the US market to raise $1.5 billion.

POLITICAL DIVISIONS

If Slovenia does need a bailout it would probably ask for help from Europe's rescue fund, as other countries have done. European officials have said they are worried.

"The situation in Slovenia is serious and Slovenia has no time to lose," head of the Eurogroup Jean-Claude Juncker said last month.

He said the country should be able to avoid a bailout by enforcing reforms but this may be a challenge given the disputes between the government, the opposition and trade unions.

Slovenia's fast economic expansion in 2007 and 2008 was fueled by cheap loans which dried up during the global financial crisis leaving a painful recession.

The country's problems worsened in 2011 when voters rejected crucial pension and labor market reforms in referendums which were demanded by trade and students' unions.

This led to the fall of the previous center-left government and several downgrades of country ratings by all the major credit rating agencies. Yields on sovereign paper jumped, and the country has not issued any bonds since.

Prime Minister Janez Jansa's center-right coalition has a tiny majority in parliament and faces strong opposition from trade unions and the center-left opposition so it is difficult for it to get reforms passed.

"The crisis in Slovenia is as much political as it is economic as political divisions are a big problem for the country," said Mojmir Mrak, a professor at the Ljubljana University's Faculty of Economy.

The government has failed to tackle generous worker perks such as payments for the cost of travel to work and a retirement age of 58, lower than in most other EU states.

By the end of the year Jansa wants to raise the retirement age, despite opposing a similar reform by the previous center-left government last year, speed up privatization and make it easier to hire and fire.

The government also plans to establish a new company that will take over bad debts of state-owned banks which are at the heart of Slovenia's financial problems and are still piling up as the country struggles with recession.

However, there is growing public awareness of Slovenia's problems and this could help Jansa get the reforms passed.

"It is now more likely that the government will manage to pass reforms than over the past two years as Slovenia's financial difficulties are deeper and everyone is more aware of the problems," said Borut Hocevar of daily Finance.

Parliament last week passed legislation to form a company that will manage all state capital assets but the opposition Social Democrats and trade unions are threatening to enforce a referendum against it, saying it would only allow a hasty sell-off of national assets.

The ruling coalition is also trying to change the constitution to prevent referendums on budget, human rights and defense matters in the future but has not yet gained the support necessary for the change.

(Editing by Anna Willard)

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