* Snap election casts doubt on pace of privatisation
* Some investors confident Slovenia will pursue selloff
* Bond sell-off seen luring back buyers
By Emelia Sithole-Matarise and Marius Zaharia
LONDON, July 11 (Reuters) - Uncertainty over whether Slovenia will pursue its privatisation plan at full speed after Sunday's snap election has cooled demand for its bonds among investors keen to see the small state shore up its finances.
The market sell-off since the end of June is proof that domestic affairs still matter to investors in euro zone bonds, at a time when many say European Central Bank largesse is blunting the market's function of pushing governments to reform.
But some investors see the rise in Slovenia's 10-year borrowing costs to five-week highs as an opportunity to buy the bonds. They are betting that a new government - likely to be led by political newcomer Miro Cerar - will pursue plans to reduce the state's 50-percent stake in the economy and cut the budget deficit.
"There's quite a lot of political risks at the moment given the upcoming elections, given the privatisation which has been going slower than anticipated," said Bob Maes, senior fixed fund manager at KBC Asset Management that holds Slovenian bonds.
"So we are still a bit concerned and monitoring the situation closely but overall we do think that Slovenia will be able to get out of the crisis without needing a bailout and so we have a positive outlook on the bonds."
Cerar's party, formed just last month, has shot to the top of opinion polls after decades of politically-connected lending and mismanagement that forced the outgoing government to bail out Slovenia's major banks last year.
Cerar supports liberalising the economy and labour market rules, cutting red tape and selling off smaller state firms. But he has come out against the major slated sales of Slovenia's telecoms operator and international airport.
KBC Asset Management has been trimming its exposure to Slovenian bonds in its European rates portfolio but remains overweight in the country's dollar bonds, classed in the emerging markets portfolio.
Yields on Slovenia's 10-year bonds have risen around 40 basis points over the past two weeks to 3.39 percent , the highest since early June and clawing off record lows of just below 3 percent.
The market is nervous over the fate of measures the outgoing government of Alenka Bratusek agreed with its European Union partners.
Bratusek stopped all privatisations last week, sparking criticism from her finance minister and analysts who said the country needs the revenue urgently after finding 3.3 billion euros ($4.5 billion) for its banks to avert an international bailout.
QUE CERAR CERAR
Some investors are willing to give Cerar the benefit of the doubt, saying his opposition to major privatisations could just be a pre-election tactic.
Besides, the fact that the country's budget has already been approved and that it is funded for next year gives investors comfort that they will get their money back in the near term.
"We still have an overweight to Slovenia and used the weakness ... to buy on the dips and especially because we think Slovenia is improving if you look at the export side, it's a healthy economy, wealthy country, people are skilled," said Gerard Moeman, head of rates at Aegon Asset Management.
Moeman said he was more cautious about buying 10- to 15-year bonds, preferring shorter-dated maturities but seeing scope for further outpeformance by Slovenian bonds over core euro zone debt such as German Bunds.
"If the elections are OK, then of course there are some buyers and if privatisations make more progress that's a positive sign," he said.
"As long as these positive indicators keep coming through, then spreads will continue tightening and on a 12-month horizon if we see the good news continuing then they could tighten another 50 to 100 basis points."
Slovenian 10-year bonds offer investors starved of higher returns a 220 basis point pick-up over benchmark German Bunds, and some 50-60 bps over Spanish and Italian bonds.
Besides, its government debt at 72 percent of gross domestic product is below the 93 percent average for the 18 euro zone states. Countries such as Italy, Ireland, Portugal, Belgium or Greece have debt higher than their annual economic output.
"Although the elections have halted the privatisation process, the majority of the policies enacted by the previous government to avert a debt crisis remain intact," said Martin Harvey, fixed income fund manager at Threadneedle.
"Slovenia's comparatively low level of debt versus the rest of the region continues to underpin our positive strategic view." ($1 = 0.7331 Euros) (Reporting by Emelia Sithole-Matarise; Editing by Ruth Pitchford)