yffiMAD CO o (N wo CU i/> u E o c o u a "O "5 u ro M uic M 73 UL £ • (G Summary In 2011 deficits in EU countries narrowed significantly for the first time since2009, and the consolidation process continued in 2012, albeit at a slower pace. As the economic crisis continues, the majority of EU countries are still subject to excessive deficit procedures; eight have so far been granted extensions for the correction of the deficit, while it was recommended this year that the procedure be terminated for the four countries that have managed to reduce their deficits below 3% of GDP. Five euro area countries whose situation deteriorated sharply and that were shut out of financial markets have so far requested financial assistance. Average growth in general government debt in the EU and the euro area has slowed in recent years following a significant acceleration in 2009, with the widening of the debt-to-GDP ratio increasingly driven by interest expenditure, expenditure not associated with the coverage of the primary deficit, and changes in nominal GDP. On top of the measures that directly increased debt, in the past few years many EU countries issued extensive guarantees under existing state aid rules, which has increased the contingent liabilities that will be realised if the guarantees are called. The yields on the government bonds of the most vulnerable euro area countries spiked in the aftermath of the Cyprus crisis in March this year, and they remain relatively high. The spreads over the German benchmark bond vary significantly, having already widened in mid-2012 amidst speculation that the euro area might break up or split into two tiers. In the last two years crucial steps were taken to strengthen economic governance and fiscal policy surveillance and coordination in the EU. Following the implementation of five regulations and one directive that are binding on the entire EU, and the Treaty on Stability, Coordination and Governance in the Economic and Monetary Union (the fiscal compact), which is binding on euro area countries and introduced a balanced-budget rule, two additional regulations were adopted in March 2013 (the two-pack), which set out in detail the implementation of the fiscal provisions of previous regulations. Slovenia's general government deficit narrowed significantly last year (4% of GDP) as a result of fiscal consolidation measures, to its lowest level since the outbreak of the crisis in 2008. Last years fiscal consolidation was largely underpinned by expenditure cuts; in contrast to previous years, a significant fiscal effort was made as expenditure was down in nominal terms for the first time, and declined as a share of GDP. For the first time since 2009 revenue also declined in nominal terms. The revenue dynamics were driven largely by the weakening of the economy, and partly by tax changes. In terms of quality, it is estimated that changes towards a more sustainable restructuring of expenditure were achieved in 2012. In contrast to previous years, fiscal consolidation measures were based to a greater extent on structural changes underpinned by legislative changes. This was reflected in a significantly lower structural component of the deficit, which fell for the first time since 2005. The structural deficit needs to be interpreted cautiously given its high volatility; nevertheless all recent estimates suggest that the structural position of Slovenia's public finances deteriorated significantly in 2008 and improved visibly in 2012. A slightly higher deficit in 2012 relative to the projections in the 2012 update to the Stability Programme (SP2012) was primarily the result of unbudgeted specific transactions in the amount of 0.4% of GDP, as well as expenditure structure, which was also different than planned.. Compensation of employees and intermediate government consumption were significantly above the levels projected in the SP2012, while expenditure on social benefits, interest, subsidies and investments was lower than forecast. Slovenia had one of the most pronounced reductions in the general government deficit in the EU in 2012, but it was still below the average in the EU and the euro area in terms of cuts relative to 2009. This is particularly problematic given that Slovenia faces declining revenue against the backdrop of one of the deepest economic downturns in the EU, and it is one of the countries facing the greatest pressure on public finances due to an ageing population. Slovenia's general government debt has been growing faster than in the majority of EU countries, and as in previous years, last year's increase was used to finance the deficit and roll over debt. General government debt was estimated at 54.1% of GDP at the end of 2012, up 32.1 percentage points on 2008. Although Slovenia is still in the lower half of the EU in terms of the debt-to-GDP ratio, the increase in the last four years was the seventh largest in the EU. Throughout the entire period debt growth was driven by deficit financing and borrowing to roll over debt. In 2009 and 2012, the debt-to-GDP ratio was also significantly affected by a nominal contraction in gross domestic product. As overall debt continued to rise and the macroeconomic conditions deteriorated, borrowing costs rose significantly last year. Bond yields were affected by domestic factors as well as the general tightening of conditions on the Eurobond market mid-year. In September ECB measures in particular resulted in renewed optimism on European financial markets, contributing to a fall in the yield on 10-year Slovenian government bonds to about 5% at the end of the year. The yield surged again towards the end of March 2013, as increased uncertainty surrounding the resolution of the debt and banking crisis in Cyprus began driving up the borrowing costs of all vulnerable euro area countries, Slovenia in particular. In the first half of April the yield hovered at over 6.5%; it has since fallen, but remains relatively high. Rating agencies downgraded Slovenia's sovereign debt again: S&P and Fitch by one notch in May, and Moody's by two notches at the end of April (to speculative grade). The downgrades were prompted by the weakening of the banking system and the rising debt, but the agencies also highlighted uncertain economic growth prospects. Fiscal consolidation as envisaged in the 2013 update to the Stability Programme (SP2013) has been slower than forecast last year. The departure from last year's projections is greatest in 2013, when the actual deficit is projected at 7.9% of GDP. One-off expenditure associated with bank recapitalisation and the restructuring of the banking system account for 3.7 GDP percentage points of the deficit. However, even if these specific transactions were excluded, the general government deficit would not narrow this year. Higher interest expenditure and expenditure on social benefits has coupled with significantly higher intermediate government expenditure. Despite additional measures to limit compensation of employees in the general government sector and significantly reduce expenditure on investments and subsidies, the nominal reduction in expenditure forecast last year will not be achieved this year, not least because it was not underpinned by specific measures. Moreover, the revenue projections for this year are also lower as a result of the weak economy, despite additional discretionary measures that will take effect in the middle of the year. Consolidation will also be slower than planned in the following years, due in large part to higher interest expenditure and higher-than-forecast investments. In this year's Stability Programme higher taxation is a key component of consolidation, but that is sensible only as an auxiliary measure in an economic policy mix where structural measures to sustainably reduce expenditure must play the central role. This year's Stability Programme places much greater emphasis on revenue-side measures, which primarily increase the burden on consumption and can raise corporate costs if they do not entirely pass through into prices. Although the higher tax burden in indirect taxes will contribute to fiscal consolidation, it is sensible only as an auxiliary measure in an economic policy mix where measures to reduce expenditure must play the central role. It is important that curbing growth in or even reducing expenditure be achieved via structural changes, and only to a lesser extent via a contraction in investment activity and emergency measures that are not viable in the long term. The SP2013 does not provide a comprehensive response to this challenge, which will require measures to be framed this year and in the coming years that have a sustainable impact and do not cause new imbalances. The discretionary expenditure-side measures specified in the SP2013, some of which are temporary, are focused on limiting compensation of employees and social transfers. In this context the top challenge of economic policy in the short term will be to put in place permanent expenditure-side measures to prevent the introduction of a crisis tax in 2014. The crisis tax would swing the deficit-reduction policy mix strongly to the revenue side. Not only is this a marked departure from the stated goals, it is also questionable what their actual impact would be given the weak economy and the strong contraction in private consumption expenditure. Fiscal consolidation faces the additional challenge of a sensible implementation of the balanced budget fiscal rule, which will be defined in an implementing law. Given the latest simulations of the fiscal rule, which do not envisage any extraordinary circumstances arising, this will require additional fiscal effort over the next two years. Given the rapid growth in the general government debt this year and in previous years, partly as a result of the recapitalisation of banks and state-owned companies, fiscal consolidation coupled with a successful restructuring of the banking system is the key to maintaining the debt at a sustainable level. The general government debt and debt servicing costs have been rising, which has resulted in interest expenditure increasingly crowding out other expenditure and creating a negative feedback loop. In addition to this expenditure and the financing of the primary balance, which will be balanced after 2014 according to Stability Programme projections, the one-off rise in debt this year will be the result of measures to restructure the banking system, which is vital to creating a more stable macroeconomic environment, kick-starting growth and improving Slovenia's standing on the financial markets. The planned government guarantees for the bond issue by the Bank Assets Management Company (BAMC) will increase debt by 11.4% of GDP, but the effect will be mitigated in subsequent years as the transferred assets are sold off and liquidated. Yet even in the event of the entire project being successfully completed, the general government debt would rise to above 60% of GDP at the end of the programming period, and given lower proceeds from the sale of the assets transferred to the BAMC, it would approach 70% of GDP. Other downside risks to faster debt growth remain high. Given the widening differences between the more and less vulnerable euro area countries, bond yields to maturity may rise in a spill-over effect throughout the euro area that will affect Slovenia's borrowing costs. If the financial markets start doubting Slovenia's commitment to consolidation measures and bank restructuring, securing the requisite funds to finance the deficit and roll over debt would be rendered difficult or even impossible, casting doubt on the execution of other measures set out in this year's Stability Programme. Limited government access to financing would also affect the borrowing conditions of the private sector, which would have a further adverse impact on competitiveness and potential growth. Introduction After a substantial narrowing of the general government deficit in 2012, fiscal policy and other economic policies face the challenge of pushing ahead with consolidation and honouring the commitments within the framework of the excessive deficit procedure. This May the European Commission recommended an extension for Slovenia, allowing it to bring its deficit below 3% of GDP not in 2013, but in 2015. This does not however mean that Slovenia can slow the pace of consolidation. Given the continued weakness of the economy and the high costs of restructuring the banking system, fiscal and other economic policy makers face an even greater challenge in how to carry out consolidation in a sustainable way and with minimum adverse impact on economic activity while still providing public services of sufficient quality. Coupled with the effective restructuring of the banking system, successful consolidation will stabilise the macroeconomic environment and make it easier for the government and companies to tap the financial markets. The fiscal chapter of this year's report focuses on analysis of the public finances and an assessment of the fiscal consolidation as envisaged in the 2013 update to the Stability Programme. The first chapters present the developments in public finances in the EU and fiscal aggregates and trends in Slovenia, including an analysis of cyclical and structural factors, financial flows between Slovenia and the EU budget, public debt, and long-term fiscal sustainability in connection with the costs of the ageing population. This is followed by an overview of tax changes in Slovenia and the EU in recent years. The overview is followed by a critical review of fiscal consolidation in this year's Stability Programme, and finally based on all the analysis there is an examination of the challenges for fiscal policy in achieving the set objectives in a manner that will help strengthen the development role of public finances. 1. Fiscal Developments and Fiscal Policy in the EU In the majority of EU countries the general government deficit narrowed sharply in 2011, and the consolidation process continued in 2012, albeit at a slower pace. Deficits surged in 2009 due to the impact of the economic and financial crisis and stimulus measures, and remained roughly at the same level in 2010, but in 2011 they narrowed significantly, by 2 percentage points in the euro area and 2.1 percentage points in the EU overall. Measures geared towards streamlining expenditure were the driving force of consolidation, but several countries also adopted revenue-side measures. Measures to reduce expenditure include curbs on the public sector, and curbs on social transfers and pensions. The majority of EU countries thus froze or cut employment in the public sector, whereas countries with bigger fiscal problems also cut the wages of civil servants. On the revenue side, many countries changed tax legislation with a view to increasing the taxation of consumption1and Table 1: Actual and cyclically adjusted general government balances in EU countries 2 Actual balance (as % of GDP) Structural balance (as % of GDP) 2008 2009 2010 2011 2012 2013 2008 2009 2010 2011 2012 2013 Belgium -1.0 -5.6 -3.8 -3.7 -3.9 -2.9 -2.1 -3.9 -3.4 -3.5 -3.0 -2.3 Germany -0.1 -3.1 -4.1 -0.8 0.2 -0.2 -0.9 -0.8 -2.3 -0.9 0.3 0.4 Estonia -2.9 -2.0 0.2 1.2 -0.3 -0.3 -4.5 -1.1 -1.1 -0.6 0.2 -0.2 Ireland -7.4 -13.9 -30.8 -13.4 -7.6 -7.5 -7.6 -9.8 -9.1 -7.7 -7.4 -6. 9 Greece -9.8 -15.6 -10.7 -9.5 -10.0 -3.8 -9.6 -14.8 -8.8 -5.4 -1.0 2.0 Spain -4.5 -11.2 -9.7 -9.4 -10.6 -6.5 -4.5 -8.5 -7.4 -7.2 -5.5 -4.4 France -3.3 -7.5 -7.1 -5.3 -4.8 -3.9 -4.2 -6.1 -5.8 -4.7 -3.6 -2.2 Italy -2.7 -5.5 -4.5 -3.8 -3.0 -2.9 -3.8 -4.2 -3.7 -3.6 -1.4 -0.5 Cyprus 0.9 -6.1 -5.3 -6.3 -6.3 -6.5 -0.8 -6.5 -5.7 -6.6 -6.7 -5.4 Luxembourg 3.2 -0.8 -0.9 -0.2 -0.8 -0.2 2.7 1.0 -0.1 0.3 0.1 0.7 Malta -4.6 -3.7 -3.6 -2.8 -3.3 -3.7 -6.2 -3.9 -4.6 -3.6 -4.1 -3.8 Netherlands 0.5 -5.6 -5.1 -4.5 -4.1 -3.6 -0.7 -4.1 -4.0 -3.7 -2.6 -2.0 Austria -0.9 -4.1 -4.5 -2.5 -2.5 -2.2 -1.9 -2.7 -3.3 -2.2 -1.5 -1.6 Portugal -3.6 -10.2 -9.8 -4.4 -6.4 -5.5 -4.5 -8.7 -8.8 -6.6 -4.2 -3.6 Slovenia* -1.9 -6.2 -5.9 -6.4 -4.0 -5.3 -4.4 -4.4 -4.7 -4.7 -2.7 -2.4 Slovakia -2.1 -8.0 -7.7 -5.1 -4.3 -3.0 -4.1 -7.2 -7.1 -5.2 -4.1 -3.0 Finland 4.4 -2.5 -2.5 -0.8 -1.9 -1.8 2.5 0.6 -0.7 -0.1 -0.7 -0.6 EMU-17 -2.1 -6.4 -6.2 -4.2 -3.7 -2.9 -3.0 -4.5 -4.5 -3.6 -2.1 -1.4 Bulgaria 1.7 -4.3 -3.1 -2.0 -0.8 -1.3 -0.2 -3.5 -2.1 -1.6 -0.4 -0.8 Czech Republic -2.2 -5.8 -4.8 -3.3 -4.4 -2.9 -4.3 -5.4 -4.5 -3.0 -1.7 -1.6 Denmark 3.2 -2.7 -2.5 -1.8 -4.0 -1.7 2.3 0.2 -0.2 0.3 0.3 0.0 Latvia -4.2 -9.8 -8.1 -3.6 -1.2 -1.2 -5.6 -5.5 -2.9 -1.6 -0.3 -1.4 Lithuania -3.3 -9.4 -7.2 -5.5 -3.2 -2.9 -5.3 -6.6 -4.7 -4.9 -3.2 -2.8 Hungary -3.7 -4.6 -4.3 4.3 -1.9 -3.0 -4.6 -2.3 -3.3 -4.1 -0.7 -1.1 Poland -3.7 -7.4 -7.9 -5.0 -3.9 -3. 9 -5.0 -8.2 -8.3 -5.4 -3.8 -3.3 Romania -5.7 -9.0 -6.8 -5.6 -2.9 -2.6 -7.9 -9.5 -6.2 -4.0 -2.7 -1.7 Sweden 2.2 -0.7 0.3 0.2 -0.5 -1.1 1.5 2.7 1.3 0.2 0.2 -0.1 United Kingdom -5.1 -11.5 -10.2 -7.8 -6.3 -6.8 -5.0 -9.4 -8.9 -6.8 -7.0 -5.7 EU-27 -2.4 -6.9 -6.5 -4.4 -4.0 -3.4 -3.2 -5.0 -4.9 -3.9 -2.8 -2.0 Source: Eurostat, European Commission Spring Economic Forecast 2013. Note: * European Commission forecast. 1 Since the outbreak of the crisis in 2008, 17 EU countries have raised VAT rates (see Chapter 6); many have also raised excise duties on tobacco and alcohol (e.g. Slovakia, France, Ireland, Romania, UK), while several have introduced or increased the taxation of real estate (e.g. Austria, Slovakia, Cyprus, Italy). 2 The European Commission forecast for the actual position for Slovenia in 2013 differs from the projections in the 2013 update to the Stability Programme on account of differing forecasts for one-off factors. The European Commission's forecast for the cyclically adjusted position for Slovenia also differs from the IMAD forecasts (see Chapter 2.1). The differences are to be expected (the calculation hinges on multiple assumptions and forecasts), mostly as a result of different estimates of the output gap (there are several differences in input data on the workforce in employment according to the national accounts statistics due to a break in the series, and in the estimate of capital; the calculation is also affected by differences in GDP forecasts and components) and certain methodological differences (NAWRU calculation). property, and alleviating the burden on the economy. In the majority of countries short-term measures have been coupled with structural changes, aimed in particular at ensuring that age-related expenditure remains at a sustainable level. In 2012 the consolidation process continued in the euro area and the EU, but the deficit reduction was slower in relative terms than in the previous year (0.5 percentage points in the euro area and 0.4 percentage points in the EU). The estimates of structural and cyclical components (European Commission Spring Forecast 2013) show that the slowing of consolidation in 2012 was attributed primarily to a renewed weakening of the economic environment (a higher negative cyclical component) and a slightly more moderate positive contribution by fiscal policy measures than in 2011. A major factor in last year's slowing of consolidation was the deterioration in the public finances of certain EU countries with surpluses or very low deficits. In its Spring Forecast 2013, the European Commission is forecasting a further improvement in the public finances this year and next year in the euro area and the EU (by 0.8 percentage points and 0.6 percentage points respectively). In contrast to previous years, the deficit reduction will be underpinned to a larger extent by discretionary expenditure-side measures, Figure 1: General government balance in the euro area, as % of GDP ^■One-off factors ^■Cyclical balance 2008 2009 2010 2011 2012 2013 Source: Eurostat, for 2013 EC Spring Economic Forecast 2013, Ameco. and less so by revenue-side measures according to the European Commission assessment. As the economic crisis continues, the majority of EU countries remain subject to excessive deficit procedures,3 and eight have so far been granted extensions for the correction of the deficit. In 2009 and 2010 excessive deficit procedures were initiated for 18 EU countries, bringing the total to 20 by 2010. The majority of countries were given until 2012 or 2013 to correct their excessive deficits. So far the procedures have been completed by four countries (Bulgaria, Finland, Malta and Germany) that had reduced their deficits to below 3% of GDP by 2011. Only half of the countries given until 2012 to correct their deficits realised this commitment, i.e. reduced their deficits to below 3% of GDP, with the European Commission Spring Forecast suggesting that some will probably still not comply this year. The EU Council has already granted extensions to four countries (Portugal, Spain, Ireland and Greece) where the economic circumstances changed significantly compared with the original forecasts in the recommendations for the correction of the deficit. Extensions were also granted this year to France, the Netherlands, Poland and Slovenia, while Spain and Portugal were given additional extensions. The termination of the excessive deficit procedure was meanwhile proposed for Italy, Latvia, Lithuania, Hungary and Romania. Faced with financial difficulties, five euro area countries have so far asked the European Commission for financial assistance, which is carried out through several mechanisms, and three countries outside the euro area have requested balance of payments assistance. Access to aid from European financial mechanisms is conditional on strict implementation of policy measures based on a macroeconomic adjustment programme and a thorough analysis of the sustainability of government borrowing, which is carried out by the Commission and the IMF in liaison with the ECB. EFSF/ESM" financial assistance has so far been requested by five euro area countries (Greece, Ireland, Portugal, Cyprus and Spain, the last only for bank recapitalisation). Approval of the first tranche of aid is conditional on the signing of a Memorandum of Understanding in which the recipient country undertakes to carry out an economic policy programme. Approval of subsequent tranches requires approval by the donor 3 Countries subject to the excessive deficit procedure provide regular progress reports to the European Commission on measures to consolidate their public finances. In the event of unforeseen economic circumstances that significantly diverge from the forecast in the recommendation for the correction of the excessive deficit, the deadline may be extended. Closer coordination of fiscal policies in the EU tightened the oversight of measures within the excessive deficit procedure, in particular in euro area countries. Countries that do not follow EU Council recommendations for the correction of the excessive deficit and adjustment to the medium-term fiscal target may even face sanctions under the new regulations and the fiscal compact. 4 EFSF: European Financial Stability Facility (due to be discontinued in mid-2013); ESM: European Stability Mechanism (in place since October 2012). For more on financial mechanisms, see also EI 2012, Chapter 1. countries, which must confirm whether the recipient country meets the conditions from the economic policy programme, which is verified by the European Commission in conjunction with the ECB. Three countries outside the euro area (Romania, Hungary and Latvia) that had serious trouble in securing foreign financing to cover their balance of payments deficits have so far requested assistance via the balance of payments mechanism. Average growth in the general government debt in the EU and the euro area has slowed in recent years following a significant acceleration in 2009, with the widening of the debt-to-GDP ratio increasingly driven by interest expenditure, stock-flow adjustment, and changes in nominal GDP. Since 2008 the average general government debt rose by 23.1 percentage points in the EU and 20.5 percentage points in the euro area. Debt growth peaked in 2009 (at 12.4 percentage points) and then slowed, but the pace remained significantly higher than before the crisis. In 2009 and 2010 in particular the surge in borrowing was primarily a consequence of high deficits and extra-budgetary expenditure targeted at securing the stability of the financial system as part of measures to tackle the crisis. In the last two years the contribution made by interest expenditure has been growing; in 2011 the contribution made by stock-flow adjustment4 was also more pronounced, and in 2012 declining nominal GDP once again contributed to the increase. By contrast, the euro area's average primary balance was positive last year for the first time since 2008, and no longer contributed to widening debt. On top of the measures that directly increased debt, many EU countries last year issued extensive guarantees under the existing state aid rules, which have increased contingent liabilities that will be realised if the guarantees are actually called. Over the entire period the largest rises in the debt-to-GDP ratio in the euro area were recorded by Ireland, Portugal, Greece, Spain, Cyprus and Slovenia. The European Commission is forecasting a renewed increase in growth in debt this year, in the euro area as well as in the EU. The trend will be driven in particular by rising interest expenditure and partially by stock-flow adjustment, which includes differences between cash-based expenditure and expenditure according to the accrual principle, financial transactions and revaluation changes. The debt will also increase in relative terms as a result of the projected decline in GDP this year. Figure 2: General government debt increase in EU countries, 2008-2012 5 Stock-flow adjustments comprise differences between cash-based expenditure and expenditure according to the accrual principle, financial transactions and revaluation changes. The differences in recent years stem largely from net acquisitions of financial assets that exceeded general government deficits and were mainly associated with recapitalisations and operations to support the financial sector and government-owned companies. Growth 2012-2008 I As at 2008 Source: Eurostat. Table2: General government debt, as % of GDP 2008 2009 2010 2011 2012 2013* Belgium 89.2 95.7 95.5 97.8 99.6 101.4 Germany 66.8 74.5 82.4 80.4 81.9 81.1 Estonia 4.5 7.2 6.7 6.2 10.1 10.2 Ireland 44.5 64.8 92.1 106.4 117.6 123.3 Greece 112.9 129.7 148.3 170.3 156.9 175.2 Spain 40.2 53.9 61.5 69.3 84.2 91.3 France 68.2 79.2 82.4 85.8 90.2 94.0 Italy 106.1 116.4 119.3 120.8 127.0 131.4 Cyprus 48.9 58.5 61.3 71.1 85.8 109.5 Luxembourg 14.4 15.3 19.2 18.3 20.8 23.4 Malta 62.0 66.4 67.4 70.3 72.1 73.9 Netherlands 58.5 60.8 63.1 65.5 71.2 74.6 Austria 63.8 69.2 72.0 72.5 73.4 73.8 Portugal 71.7 83.7 94.0 108.3 123.6 123.0 Slovenia 22.0 35.0 38.6 46.9 54.1 61.0 Slovakia 27.9 35.6 41.0 43.3 52.1 54.6 Finland 33.9 43.5 48.6 49.0 53.0 56.2 EMU-17 70.1 80.0 85.4 87.3 90.6 95.5 Bulgaria 13.7 14.6 16.2 16.3 18.5 17.9 Czech Republic 28.7 34.2 37.8 40.8 45.8 48.3 Denmark 33.4 40.7 42.7 46.4 45.8 45.0 Latvia 19.8 36.9 44.4 41.9 40.7 43.2 Lithuania 15.5 29.3 37.9 38.5 40.7 40.1 Hungary 73.0 79.8 81.8 81.4 79.2 79.7 Poland 47.1 50.9 54.8 56.2 55.6 57.5 Romania 13.4 23.6 30.5 34.7 37.8 38.6 Sweden 38.8 42.6 39.4 38.4 38.2 40.7 United Kingdom 52.3 67.8 79.4 85.5 90.0 95.5 EU-27 62.2 74.6 80.0 82.5 85.3 89.8 Source: Eurostat, European Commission Spring Economic Forecast 2013. Note: * European Commission forecast. Table 3: General government debt in the euro area 2009 2010 2011 2012 2013 Gross debt (as % of GDP) 80.0 85.6 88.0 92.7 95.5 Change in gross debt (percentage points) 9.8 5.6 2.4 4.7 2.8 Factors contributing to change in gross debt (percentage points) Primary balance 3.5 3.4 1.1 0.6 -0.2 Interest 2.9 2.8 3.0 3.1 3.1 GDP growth 3.2 -1.5 -1.2 0.5 0.4 Inflation -0.7 -0.6 -1.1 -1.1 -1.4 Adjustments 0.9 1.6 0.5 1.5 0.9 Source: European Commission, Spring Economic Forecast 2013. Figure 3: Spread in yields on 10-year government bonds over the German benchmark, percentage points Slovenia Spain Italy Source: Bloomberg. Yields on the government bonds of the most vulnerable euro area countries rebounded in the aftermath of the Cyprus crisis in March, and they remain relatively high. A variety of factors have affected the mood of financial investors and the yield curves of long-term euro area bonds since the outbreak of the crisis. In principle the yield curves are driven by long-term fiscal and macroeconomic indicators, but since 2011 in particular the mood of investors and the spreads of the most vulnerable countries have been influenced to an ever larger extent by political factors, one-off events and confidence indicators. In 2012 another key driver of spreads was speculation about a possible break-up of the euro area or the formation of a two-speed euro area. While the yields of vulnerable countries were high mid-year, the yield on German bonds dropped below 1% and remained very low for the Netherlands, Austria and France. The widening spreads between countries in the same currency area highlight the problem of insufficient coordination between the single monetary policy and the fiscal policies that remain under the control of the individual countries, which is reflected in substantial differences in the mood and decisions of financial investors. The yields in vulnerable countries and the spreads over German benchmark bonds fell substantially in October 2012, largely on account of the decision by the ECB to purchase on the secondary market the bonds of countries that requested ESM financial assistance, albeit under strict terms. The financial markets were also appeased by decisions adopted at EU level in September last year regarding the convergence of the economic and monetary union and common bank supervision as a precondition for an effective banking union.6 The situation deteriorated in March of this year, when Cyprus requested financial assistance, as the initial lack of clarity as to the substance of the aid programme raised uncertainty about the potential bailouts of other vulnerable countries. Increased demand for safe investments meanwhile drove down the yields of AAA-rated government bonds. Last year the ECB also provided liquidity to banks with limited access to funding, contributing to an easing of tensions on the financial markets. The ECB took a more proactive role at the end of 2011 by tackling tensions on euro area financial markets with non-standard measures. In 2012 it provided funding to euro area banks through long-term refinancing operations7 and adopted measures to expand eligible collateral, while the Eurosystem injected liquidity into banks through ordinary tenders. These measures made it possible for banks with limited access to funding, especially those in the most vulnerable countries, to secure liquidity, thereby contributing to a reduction of tension on the financial markets. In the past two years crucial steps were made towards the strengthening of economic governance and fiscal policy coordination in the EU. Following 6 The principal pillars of the banking union are common supervision, a bank bailout fund, and a deposit guarantee scheme. The supervisory role will be assumed by the ECB, which is designed to restore investor confidence. The bank bailout fund will provide a facility for maintaining banking system stability in the event of a bank bankruptcy, in particular when that would have a negative impact on the stability of the entire euro area. The purpose of the guarantee scheme for deposits of up to EUR 100,000 is to maintain depositor confidence and prevent bank runs when uncertainty spreads. The creation of a banking union will mitigate the negative reaction of the financial markets in the event of bank bailouts (at present bank bailouts by sovereigns are associated with a severe deterioration in the public 7 Three operations were completed: the first (21 December 2011) provided EUR 489.2 bn to banks, the second (29 February 2012) EUR 529.5 bn. the implementation of six pieces of legislation8 binding on the entire EU, and the Treaty on Stability, Coordination and Governance in the Economic and Monetary Union (the fiscal compact),9 which is binding on euro area countries, two additional regulations (the two-pack)10 were adopted in March 2013 and set out in detail the implementation of the fiscal provisions of existing regulations. The measures inter alia enhanced the substantive supervision of national budgets. Draft budgets in all euro area countries thus have to be prepared no later than by 15 October and are then reviewed by the European Commission, which issues opinions by 30 November. If it finds major deviations from the plans presented in the Stability Programme, it requests corrections from the country in question. Failure to rectify the deviations or explain them in substantiated terms could, should this be deemed to pose a serious risk to euro area financial stability, significantly affect the European Commission's opinion of the country's compliance with commitments made within the framework of the excessive deficit procedure. According to the regulations, draft budgets must be based on independent macroeconomic forecasts, and surveillance of compliance with national fiscal rules must be carried out by an independent institution. 8 It comprises five regulations and one directive and entered into force in December 2012. In substantive terms it amends the Stability and Growth Pact, introducing stricter requirements on the budgetary frameworks of EU countries and enhancing oversight of macroeconomic imbalances (see EI 2012, chapter 1). 9 The treaty introduces a balanced budget rule and took effect on 1 January 2013. The signatories must transpose the balanced budget rule into their national legal systems one year after the entry into force of the treaty, either by amending their constitutions or adopting a legislative instrument with equal force (for details of the fiscal compact, see EI 2012, chapter 1). 10 A regulation on enhanced surveillance of euro area member states that are experiencing or threatened with serious financial difficulties, or that request financial assistance (6726/13) and a regulation on enhanced monitoring and assessment of draft budgetary plans of euro area Member States, with closer monitoring for those in an excessive deficit procedure (6727/13). 2. Public finances in Slovenia in 2012 Having remained around 6% of GDP for three years, Slovenia's general government deficit narrowed significantly last year as a result of fiscal consolidation measures, to its lowest level since the outbreak of the crisis in 2008 (4% of GDP). The deficit surged in 2009 and remained roughly at that level thereafter, largely as a result, in particular in 2011, of one-off factors. Excluding one-off factors, the deficit narrowed slightly in 2010 and 2011, but in 2012 the pace of consolidation picked up substantially," primarily as a result of expenditure-side measures. The deficit narrowed by 2.4 percentage points compared with 2011, and by 1.5 percentage points excluding one-off expenditure increases in both years.12 The deficit was generated mostly at the central government level (3.8% of GDP). Local government recorded a small surplus (0.1% of GDP), while the deficit of the social security funds widened significantly relative to the previous year (0.3% of GDP).13 For the first time since the outbreak of the crisis, the adopted measures led to a substantial decline in the cyclically adjusted deficit, from -5.7% of GDP in 2011 to -2.8% of GDP in 2012 (the structural deficit14 narrowed from -4.4% of GDP to -2.4% of GDP; see Chapter 2.1). Last year's fiscal consolidation drive was largely underpinned by expenditure cuts; in contrast to previous years, a significant fiscal effort was achieved as expenditure declined in nominal terms for the first time, and was also down as a share of GDP. General government expenditure contracted by 5.4% or about EUR 1.0 bn last year, declining by 11 In 2010 and 2011 the deficit reduction (excluding one-off factors) was based principally on increasing revenue, and partially on scaling down the flexible part of expenditure and emergency measures involving wages in the general government sector and social transfers. 12 In 2011 due to the recapitalisation of a bank and several government-owned companies and the assumption of debt from several companies (1.3% of GDP), and in 2012 due to the coverage of losses at government-owned companies with recapitalisation, called government guarantees, recognition of the liabilities of government-owned companies and super dividends (0.4% of GDP). The 2012 figures do not include the capital increase at NLB via the issue of contingent convertible (CoCo) bonds in the amount of EUR 320 million (issued in June 2012), which were converted into equity this year on account of the bank's loss in 2012. 13 The deficit of the social security funds is primarily the result of a deficit at the Health Insurance Institute; this category also includes the Pension and Disability Insurance Institute and Kapitalska družba (KAD). The provisional decline in the deficit in 2011 was also affected by a EUR 90 million transfer from KAD to the Pension Fund. 14 The structural deficit is the cyclically adjusted deficit stripped of the impact of specific one-off transactions. Box 1: Estimates of the impact of fiscal consolidation measures on economic activity using a DSGE model Assessments of fiscal consolidation measures using a dynamic stochastic general equilibrium (DSGE) model show consolidation measures have a direct impact on economic activity, but suggest that non-consolidation has the biggest adverse impact. A rough estimate of the direct impact is possible for fiscal consolidation based on a model simulation using a broad dynamic stochastic general equilibrium (DSGE) model, which explains the specifics of the Slovenian economy relatively well. The calculations show that an absence of consolidation has the biggest adverse impact on economic activity. In such circumstances the general government deficit would not be reduced or would even increase, which would further aggravate or indeed completely shut off the already limited access to funding on international financial markets, which in turn would very soon demand bigger and harsher cuts, and affect private sector financing. The model estimate is based on a comparison of the effects of permanent consolidation measures against the effects of a permanent increase in borrowing costs by 100 basis points (close to the limit of sustainability in the current circumstances) that would occur in the absence of consolidation measures. The comparison shows that the costs of non-consolidation are higher than the costs of any of the selected deficit cutting measures, as the negative impact of increased cost of capital at GDP level is highest and permanent, and affects GDP growth (see also EI 2012, Chapter 8). Simulations of deficit-reduction measures show that their direct impact on the weakening of economic activity is greatest in the first three quarters after implementation. Simulation using data for 2011 shows that reducing different categories of expenditure (intermediate government consumption, social transfers and investments) by 1.8% of GDP had a direct negative impact on economic growth around the 1 percentage point range (depending on the assumption of the proportion of households with limited liquidity), with the impact strongest in the first three quarters after implementation. The decline in general government expenditure in 2012 reduced domestic demand, which directly affected economic activity. It is difficult to make a precise estimate of the impact of consolidation on economic growth, as the economy is subject to other domestic and international shocks, with all the impacts interacting and often feeding back into one another. The multi-year contraction in lending activity, a result of banking system woes (see the Impact of the financial crisis on the credit market in Slovenia, Economic Issues 2013), is making it exceedingly difficult to finance investments and working capital, weaker foreign demand is slowing export growth, and fiscal stimulus is not possible, as it would require additional borrowing that is not feasible given the financial markets' deteriorating mood as a result of Slovenia's non-compliance with its commitments to reduce the deficit. An additional factor that has put downward pressure on demand is increased consumer uncertainty, which is partly a result of the expenditure-side measures but also a consequence of the general deterioration in the labour market in recent years (see Challenges of the labour market, Economic Issues 2013). In assessing the direct impact of the measures in 2012, it is necessary to emphasise that the measures largely took effect at the beginning of May and affected last year's GDP growth proportionately, but also continued to exert a strong impact in early 2013. Table 4: General government revenue, expenditure and deficit , as % of GDP 2006 2007 2008 2009 2010 2011 2012 Total general government revenue 43.2 42.4 42.4 43.1 44.5 44.4 45.0 Total general government expenditure 44.6 42.4 44.3 49.3 50.4 50.8 49.0 General government deficit -1.4 0.0 -1.9 -6.2 -5.9 -6.4 -4.0 General government deficit excluding one-off factors -1.4 0.0 -1.9 -6.2 -5.7 -5.1 -3.6 Sources: SURS, Main aggregates of the general government sector, April 2012; calculations by IMAD. 1.8 percentage points to 49% of GDP (or by 3.7% or EUR 0.6 bn excluding one-off transactions in 2011 and 2012, a decline of 0.9 GDP percentage points).15 Last year saw a continuation of cuts in expenditure that do not require legislative changes (investments, subsidies, material costs). However, expenditure cuts stemming from the implementation of three laws (Exercise of Rights to Public Funds Act,16 Additional 15 See footnote 1. 16 Official Gazette, No. 62/2010. 2012 Intervention Measures Act17 and Fiscal Balance Act [ZUJF]18) also made a significant contribution to consolidation. All categories of expenditure declined, other than interest payments, which rose by EUR 54 m. Investments declined the most (by EUR 257 m), in what was the third consecutive year of contraction; in the last two years alone they have declined by almost 17 Official Gazette, No. 110/2011. 18 The Fiscal Balance Act, which amends 39 separate laws, was adopted by the National Assembly on May 12 2012. Table 5: Growth in total general government expenditure and contributions to growth made by individual categories, 2006-2012, percentage points________ 2006 2007 2008 2009 2010 2011 2012 Growth in total general government expenditure, % 6.7 6.1 12.5 6.3 2.4 2.2 -5.4 Contribution of intermediate consumption, percentage points 1.2 0.0 2.1 0.3 0.7 0.5 -0.4 Contribution of compensation of employees, percentage points 1.4 1.2 3.2 1.7 0.6 0.6 -0.8 Contribution of social benefits in cash, percentage points 2.2 1.8 3.9 2.7 1.6 1.4 -0.9 Contribution of gross capital formation and capital transfers, percentage points* 1.7 2.6 2.2 0.3 -0.6 -0.1 -3.4 Contribution of subsidies, percentage points 0.4 0.4 0.2 0.9 0.4 -1.8 -0.1 Contribution made by interest, percentage points -0.1 0.0 -0.1 0.4 0.6 0.6 0.3 Contribution of other expenditure, percentage points 0.0 0.0 1.0 -0.1 -0.8 1.0 -0.1 Source: SURS, Main aggregates of the general government sector, April 2013; calculations by IMAD. Note: * Capital transfers surged in 2011 as a result of the recapitalisation of government-owned companies and the banking sector (EUR 270.4 m) and declined significantly in 2012. Excluding recapitalisation, total expenditure growth was 0.2% in 2011 and -3.7% in 2012 (contributions made by Gross capital formation and capital transfers: -2.7 percentage points in 2011 and -0.6 percentage points in 2012). EUR 550 m. The decline in social benefits and benefits in cash and in kind (EUR 171 m) was largely the result of changes in eligibility criteria, as the conditions for obtaining social rights were tightened. The reduction in compensation of employees in the general government sector (by EUR 151 m) was driven by cuts to wages and other labour costs, and by a restrictive hiring policy. Intermediate government consumption declined (by EUR 67 m) as expenditure on goods and services was curbed, and subsidies also declined marginally (by EUR 13 m). Capital transfers were also down considerably last year (by EUR 359 m), having surged in 2011 as a result of the recapitalisation of government-owned companies and the banking sector. Last year was the first time since 2009 that revenue also declined in nominal terms, though it rose marginally as a ratio to GDP. General government revenue declined by EUR 105 m (-0.7%). Despite the nominal decline, it rose as a ratio to GDP, by 0.6 percentage points to 45%, due to the contraction in economic activity. The revenue dynamics were driven largely by the weakening of the economy and partly by tax changes. Despite a significant increase in certain tax burdens,19 their positive impact was largely offset by declining corporate income tax revenue.20 Moreover, the relatively high price elasticity of demand led to a decline in sales of liquid fuels in quantitative terms and a decline in excise revenue towards the end of the year. Total revenue from taxes and social security contributions fell (by 0.9% and 0.8% respectively), whereas non-tax revenue rose marginally. The decline in tax revenue was chiefly a result of a decline in revenue from corporate income tax (by EUR 165 m or 27.1%). Even as labour income fell (by 0.4%), income tax revenue increased by 0.6% while social security contributions declined by 0.8%. Taxes on production and imports were also up (by 1.3%), owing primarily to higher excise duty revenues on the back of increased excise duties on all excisable products; VAT revenue declined by EUR 108 m or 3.6% as consumption was scaled back. Non-tax revenue, including transfer revenue (funds from the EU budget) rose by EUR 14 m, with EU funds reaching their highest level to date (EUR 842 m). Table 6: Growth in total general government revenue and contributions to growth made by individual categories, 2006-2012, percentage points 2006 2007 2008 2009 2010 2011 2012 Growth in total general government revenue, % 6.6 9.3 7.8 -3.0 3.4 1.4 -0.7 Contribution of taxes on production and imports, percentage points 1.5 2.8 1.4 -1.4 0.6 0.0 0.4 Contribution of current taxes on income, property, etc., percentage points 2.6 2.5 1.0 -2.5 -0.1 -0.2 -0.9 Contribution of social security contributions, percentage points 2.1 2.9 3.5 0.4 0.7 0.2 -0.3 Contribution of other non-tax and transfer revenue, percentage points 0.4 1.1 1.8 0.4 2.2 1.4 0.1 Source: SURS, Main aggregates of the general government sector, April 2013; calculations by IMAD. 19 Higher excise duties on tobacco and beer, adjustment of excise duties on motor fuels, additional tax on motor vehicles with engines of 2,500 cc or more, a crisis tax on real estate of higher value, a tax on gains from changes in land use, an environmental tax on CO2 emissions, higher annual duties for vehicles used in road transport. 20 Against the backdrop of a severe deterioration in the macroeconomic environment, this was also a result of the cut in the tax rate to 18% from 20% and higher tax allowances for R&D and investments. In qualitative terms, we estimate that steps towards a more sustainable restructuring of expenditure were achieved in 2012. Measures underpinned by systemic changes constituted a departure from the previously prevalent approach of temporary interventions in the flexible part of the budget. In contrast to previous years, fiscal consolidation measures to a greater extent involved structural changes backed by legislative changes, which will have a more permanent impact (e.g. changes in eligibility criteria for social benefits, lower unemployment benefits, lower percentage value of health services covered by compulsory insurance). However, some of the measures in the area of social transfers were temporary (e.g. freezing of the indexation of social transfers, tying eligibility for annual allowances for pensioners to the amount of the pension). Wages in the general government sector were cut on the basis of an agreement between the social partners, which, combined with the restrictions on hiring and contract-based work, reduced employee compensation in relative terms. Despite a shift towards more permanent changes, some of last year's measures were still stop-and-go policies, which if discontinued could raise expenditure again. Moreover, over half of the deficit reduction was still achieved by cutting the flexible portion of expenditure (investments, subsidies, expenditure on goods and services; these declined by 7.8% overall relative to 2011), which has not only narrowed the manoeuvring room for further cuts in the coming years, and is unsustainable in the long run, but also has a bigger negative impact on economic activity (see Box 1 and EI 2012, Chapter 8). Some of the revenue-side measures increased revenue from indirect taxes (excise duties and environmental taxes), whereas other measures simultaneously resulted in short-term revenue falls (the cut in the corporate income tax rate is thought to act as a stimulus to economic growth in the medium term, but it will not be possible to gauge the effectiveness of the measure for several years). The best way to roughly estimate the impact of the consolidation measures on households' income position is to evaluate the impact of the cuts in social transfers. One of the aims of the changes that reduced expenditure on social transfers was to more precisely target aid at the poorest, which should result in changes in the socio-economic status of a segment of the population. According to preliminary simulations,21 disposable income should 21 Institute of Economic Research, Microsimulation Model. 22 Social Protection Institute, Ocena učinkov nove socialne zakonodaje (Assessment of the impact of new social legislation), 2013. increase for those in the lowest income brackets and decline for those in higher income brackets, but a certain proportion of those in lower income brackets should also see a deterioration. An assessment of the impact of the new legislation, prepared on the basis of data on the first year of implementation,22 shows a similar result (see Development Report 2013, Chapter 4). Combined with wage and hiring measures in the general government sector, cuts in expenditure on transfers to individuals and households reduced disposable income on aggregate, which was one of the key factors in the decline in private consumption. Fiscal consolidation is only one of the factors driving the yields on government bonds. Based on the responses, it is assessed that consolidation had a positive impact on financial investors' mood, which would have deteriorated had there been no consolidation; it is nevertheless impossible to gauge the direct impact of the adopted deficit-reduction measures on borrowing terms. The impact of the passage of a pension reform was also positive. The reform did not affect last year's expenditure, but will help improve fiscal sustainability over the medium term (see Chapter 5). In general the yield curve in 2012 was strongly affected by other domestic factors associated with weaknesses in the banking sector, indications that Slovenia might have to request a bailout, worsening prospects for economic growth and political instability, and external factors that affected the yield curves of all vulnerable euro area countries (see Chapter 4). Figure 4: General government deficit in Slovenia and the EU, as % of GDP ■ Slovenia ■ EMU-17 ■ EU-27 -8.0 2009 2010 2011 2012 Source: Eurostat. Slovenia recorded one of the most pronounced reductions in the general government deficit in the EU in 2012, but its reduction relative to 2009 was still below the average in the EU and the euro area. Slovenia was one of the few EU countries whose fiscal position deteriorated in 2010 and 2011, but last year's deficit reduction was among the largest in the EU (second only to Ireland and Romania). A comparison with 2009, when public finances deteriorated sharply in all EU countries and Slovenia's deficit was only marginally below the euro area average, shows that Slovenia's consolidation effort throughout the entire period (2.2 percentage points) was below the EU and euro area average (2.9 percentage points and 2.7 percentage points respectively). This is particularly problematic given that Slovenia faces declining revenue against the backdrop of one of the deepest economic downturns in the EU, and it is also in the group of EU countries facing the greatest pressure on public finances due to an ageing population (see Chapter 4). 2.1. Cyclically adjusted and structural general government balance The estimate of the structural balance indicates the stance and appropriateness of fiscal policy, and it is taking on a central role in the mechanism for monitoring fiscal policies in the euro area. Analysis of the cyclically adjusted balance23 provides an additional insight into the impact of past fiscal policy measures, which can contribute to ex post estimates of fiscal policy stance and the determination of the causes of any imbalances in the past. The structural deficit had previously been defined as a medium-term fiscal objective in the Stability and Growth Pact. But the recent adoption of legislation and agreements on closer coordination of fiscal policies in the euro area (see Chapter 1), which amended the 2005 Stability and Growth Pact, strengthened its role as a benchmark in governance and surveillance of fiscal policy measures. The Treaty on Stability, Coordination and Governance in the Economic and Monetary Union (the fiscal compact) sets the structural balance as the reference point for a balanced budgetary position (or surplus) of the general government sector of the signatory countries, stipulating that the structural deficit may not exceed 0.5% of GDP over the medium term (the 23 The cyclically adjusted general government balance indicates the fiscal result that would be achieved merely with the effects of fiscal policy, i.e. without the effect of cyclical factors. The structural deficit is a cyclically adjusted balance of public finances which does not take into account one-off transactions (in line with the ESA 95). time frame of convergence towards the objective is determined by the European Commission taking into account the sustainability risks of individual countries; in Slovenia the structural deficit will be below 0.5% of GDP in 2017 according to the projections in the 2013 update to the Stability Programme [see Chapter 7]). Utmost caution is required in assessing the structural balance considering the volatility of the estimates. The structural deficit is a substantively better indicator of the fiscal position than the actual general government balance, which can be strongly affected by cyclical and one-off factors. However, the role of the structural balance as a principal indicator of the fiscal policy stance and consolidation efforts can be problematic, in particular with regard to influencing decisions for the current and subsequent years and in conjunction with the balanced-budget provisions of the fiscal compact. The latter is particularly relevant, as breaching the provision, which the signatory countries must transpose into their national legislation with binding force and permanence, preferably constitutional,24 may ultimately trigger sanctions. Use of the structural deficit is problematic in that the estimate thereof, coupled with changes associated with fiscal policy measures, is strongly affected by potential growth and output gap estimates, which are inherently volatile (Table 7). This is a consequence of methodological changes25 and revised estimates of past economic growth as well as changes in forecasts precipitated by altered conditions and prospects in the domestic and international environment. Assessment of the structural balance is also affected by ex post revisions of estimates of the general government deficit. All this can radically change the estimate of the fiscal position, not only for the current and coming years but also ex post. This can lead to a situation where, for example, the structural deficit in the previous year is estimated as excessive relative to the balanced-budget provision, but subsequent calculations revise the estimate and show that the provision has not been breached (or vice-versa). Similarly, fiscal policy may be estimated ex post as counter-cyclical, while a subsequent calculation for the same year shows it was actually cyclical. Analysis of the cyclically adjusted balance and structural balance 24 Article 3.2 of the Treaty on Stability, Coordination and Governance in the Economic and Monetary Union (OJ EU C113/1, 18 April 2012; Official Gazette RS, No. 35/2012, 14 May 2012). 25 This year the output gap is calculated based on a revised methodology in the production function. Instead of the Hodrick-Prescott filter (see Economic Issues 2010), a bivariate Kalman filter is being used to smooth out total factor productivity. For a detailed description of the methodology, see F. D'Auria, Cécile Denis, K. Havik, K. Mc Morrow, C. Planas, R. Raciborski, W. Roger and A. Rossi: The production function methodology for calculating potential growth rates and output gaps, Economic Papers 420, July 2010, DG ECFIN. Table 7: Actual, cyclical and cyclically adjusted general government balance, as % of GDP Actual balance 1 Cyclical balance 2 Cyclically adjusted balance 3=(1-2) Change in cyclically adjusted balance Structural balance* Change in structural balance 2000 -3.7 0.3 -4.0 -0.7 -4.0 -0.7 2001 -4.0 0.0 -4.0 0.1 -4.0 0.1 2002 -2.4 0.1 -2.6 1.4 -2.6 1.4 2003 -2.7 -0.1 -2.5 0.0 -2.5 0.0 2004 -2.3 0.1 -2.3 0.2 -2.3 0.2 2005 -1.5 0.4 -1.8 0.5 -1.8 0.5 2006 -1.4 1.3 -2.7 -0.8 -2.7 -0.8 2007 0.0 2.7 -2.8 -0.1 -2.8 -0.1 2008 -1.9 2.7 -4.5 -1.8 -4.5 -1.8 2009 -6.2 -1.6 -4.6 -0.1 -4.6 -0.1 2010 -5.9 -1.2 -4.7 -0.1 -4.5 0.2 2011 -6.4 -0.7 -5.7 -1.0 -4.4 0.1 2012 -4.0 -1.2 -2.8 2.9 -2.4 2.0 2013 -7.9 -1.5 -6.4 -3.6 -2.7 -0.3 Source: SI-Stat data portal - Economy - National accounts - Main aggregates of the general government sector (SURS), 2013 for actual balance; cyclical components calculated by IMAD. Note: 1 Cyclically adjusted balance not including one-off transactions. 2 Positive change represents an improvement in the balance. The figures do not necessarily sum fully due to rounding. Table 8: Estimate of structural components of the general government balance in 2013 and 2012 2013 estimates 2012 estimates Actual balance (% GDP) Cyclical balance Cyclically adjusted balance Structural balance Output gap Potential GDP growth Actual balance (% GDP) Cyclical balance Cyclically adjusted balance Structural balance Output gap Potential GDP growth 2000 -3.7 0.3 -4.0 -4.0 -0.7 4.1 -3.7 0.4 -4.2 -4.2 1.0 4.0 2001 -4.0 0.0 -4.0 -4.0 0.0 3.6 -4.0 0.2 -4.2 -4.2 0.5 3.4 2002 -2.4 0.1 -2.6 -2.6 0.3 3. 5 -2.4 0.6 -3.0 -3.0 1.3 3.1 2003 -2.7 -0.1 -2.5 -2.5 -0.3 3.5 -2.7 0.4 -3.1 -3.1 0.9 3.3 2004 -2.3 0.1 -2.3 -2.3 0.1 3.9 -2.3 0.7 -3.0 -3.0 1.6 3.7 2005 -1.5 0.4 -1.8 -1.8 0.8 3.3 -1.5 1.0 -2.5 -2.5 2.2 3.4 2006 -1.4 1.3 -2.7 -2.7 3.0 3.5 -1.4 1.9 -3.2 -3.2 4.3 3.8 2007 0.0 2.7 -2.8 -2.8 6.2 3.7 0.0 3.1 -3.1 -3.1 7.0 4.1 2008 -1.9 2.7 -4.5 -4.5 6.0 3.5 -1.9 3.2 -5.1 -5.1 7.3 3.3 2009 -6.2 -1.6 -4.6 -4.6 -3.6 1.4 -6.1 -1.1 -4.9 -4.9 -2.6 1.4 2010 -5.9 -1.2 -4.7 -4.5 -2.7 0.3 -6.0 -1.0 -5.0 -5.0 -2.2 1.0 2011 -6.4 -0.7 -5.7 -4.4 -1.5 -0.6 -5.1 -1.2 -5.2 -3.9 -2.8 0.4 2012 -4.0 -1.2 -2.8 -2.4 -2.8 -1.0 -3.5 -1.7 -1.8 -1.8 -3.9 0.3 2013 -7.9 -1.5 -6.4 -2.7 -3.5 -1.1 -2.5 -1.4 -1.1 -1.1 -3.3 0.5 Sources: SURS, Economic Issues 2012 (IMAD), Stability Programme (2013 Update); calculations by IMAD. must therefore be undertaken with utmost caution being exercised in interpreting the fiscal position as a basis for economic policy making. For the first time since 2005, the cyclical component of the deficit diminished significantly last year. Last year's consolidation measures also led to a substantial narrowing in the cyclically adjusted deficit, to 2.7% of GDP from 5.7% in 2011 (the structural deficit26 narrowed to 2.4% of GDP from 4.4%). In the last three years the structural deficit thus narrowed by 2.2 percentage points, or 0.73 percentage points annually on average. This is roughly in line with the European Commission's requirements in the framework of the excessive deficit procedure for an annual reduction of 0.75 percentage points, but practically the entire reduction was achieved in 2012. 26 The structural deficit is a cyclically adjusted deficit stripped of the impact of specific one-off transactions.. The cyclically adjusted deficit for 2012 and 2013 is higher than last year's calculations showed. The difference between last year's and this year's estimates of the cyclically adjusted (and structural) balance are the result of three factors: (i) a severe weakening of the economy, (ii) the slower-than-planned pace of consolidation last year, and (iii) one-off events associated with last year's measures to secure the capital adequacy of the domestic banks. In the calculation for 2012 the weakening of the economy and the growth prospects resulted in a stronger decline in potential GDP and a narrower output gap, which reduced the cyclical component and increased the structural component. Last year's cyclically adjusted balance was also affected, albeit to a smaller extent, by the difference in the actual balance, which was largely a consequence of one-off factors and did not affect the structural balance. In the calculation for 2013, meanwhile, the differences between the estimates of the cyclically adjusted balance were entirely the result of the significantly higher actual balance (see Chapter 7). Over 70% of the difference is attributable to one-off factors (bank recapitalisation in the total amount of 3.7% of GDP, of which 0.9 percentage points was from 2012, which needs to be factored into the 2013 deficit according to ESA 95 methodology). Some revisions were made to the output gap estimates for the previous years, especially for the 2004-2007 period, as a result of certain methodological changes. As a result, the cyclically adjusted deficit for these years is slightly wider than previously estimated. Figure 5: General government balance, Slovenia One-off factors ^■Cyclical balance Structural balance -«-Actual balance (% of GDP) -10 Ot-rNm^fLnvorvcot^Ot-rNm^fLnvorv OOOOOOOOOOt— t— t— t— t— t— t— t— oooooooooooooooooo r\ir\ir\ir\ir\ir\ir\ir\ir\ir\ir\ir\ir\ir\ir\ir\ir\ir\| Despite the volatility of the structural balance estimates, all recent estimates indicate that the structural position of Slovenia's public finances deteriorated substantially in 2008 and improved significantly in 2012. According to our estimates, the structural deficit widened by 1.8 percentage points to 4.6% of GDP in 2008 and remained at this level over the next two years. As a result of the weakened economic situation, the positive cyclical balance turned into a deficit (a deterioration of 4.3 percentage points) in 2009, which in turn led to a significant increase in the general government deficit that year. The cyclical and structural components of the balance remained at that level in 2010 and 2011 due to slow economic growth and negligible consolidation efforts, which were confined to capping wages and transfers with emergency measures (the cyclically adjusted deficit widened in 2011 as a result of the major impact of one-off factors). The structural deficit was thus the key element of the fiscal imbalance for three years, with the presented calculations suggesting that fiscal policy in the year before the crisis was a major contributor to the weakening of the public finances, while the financial and economic crisis further worsened the situation. It was not until 2012 that a notable positive change was achieved, as the structural deficit narrowed by over 2 percentage points as a result of fiscal consolidation efforts (see Chapter 2). A comparison of the dynamics of the cyclically adjusted deficit and the output gap shows whether fiscal policy is cyclical or counter-cyclical. A change in the cyclically adjusted balance in consecutive years indicates the fiscal policy stance, i.e. the fiscal impulse. By comparing the change in the cyclically adjusted balance and the output gap, which indicates fluctuations in the economic cycle, it is possible to assess the fiscal policy stance (i.e. the fiscal position). A positive fiscal impulse, for example, means an increase in the cyclically adjusted deficit in the current year compared with the previous year. The varying distances of individual points from the axes indicate the intensity of fiscal policy. In Figure 6, there are four distinct quadrants of changes in the fiscal impulse and output gap that determine the fiscal position. Fiscal policy is counter-cyclical if the combination of both parameters lies in the first or third quadrant. This means that when economic growth falls below its potential, fiscal policy becomes expansionary; when actual growth exceeds potential GDP growth, it responds in a contractionary manner. Fiscal policy is cyclical if the combination of the two parameters lies in the second or fourth quadrant. This means that when economic growth falls below its potential, fiscal policy becomes contractionary; when actual growth exceeds potential GDP growth, it responds Sources: SURS; IMAD calculations. Figure 6: Cyclical stance of fiscal policy taking into account the cyclically adjusted (left) and structural balances Cyclical Counter-cyclical contractionary < fiscal policy 2012 co ntractionary fiscal policy f 2 002 — 20 10 U001I 1 2005 2007 2009 i 20C2P00\ . 2011 2006 Counter cyclical expansion 2008 ary Cyclical fiscal policy 2013 expansionary fiscal policy -3-11 3 5 Output gap, percentage points 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0 -2.5 -3.0 -3.5 -4.0 Cyclical 2 12 Counter-cyclical contractionary fiscal policy contractionary fiscal policy 002 1 . 0 w 1 2005 2007 2009 fc 2013 2011 2 001 -2000 ' 2006 Counter-cyclical expansionary fiscal policy Cyclical expansionary fiscal policy 2008 -3-1135 Output gap, percentage points Source: SI-Stat data portal - Economy - National accounts - Main aggregates of the general government sector (SURS), 2011 for actual balance; Spring Forecast 2011 (IMAD); cyclical components calculated by IMAD. 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0 -2.5 -9 -7 -5 7 9 -9 -7 -5 7 9 in an expansionary manner. A cyclical stance means that fiscal policy does not allow for the functioning of automatic stabilisers, the result being that, for example, expenditure changes not as planned but in accordance with changes in economic growth. On the revenue side, this means that when economic growth is higher than initially planned, cyclical budget revenue is used to finance tax cuts and increased expenditure, not to reduce the deficit. The calculations show that fiscal policy was fairly neutral in 2009-2011, turning explicitly contractionary and cyclical last year and then again becoming slightly counter-cyclical and expansionary this year (even excluding one-off bank recapitalisation expenditure). Much like in previous years, this year's calculations (with minor changes) indicate that a fiscal deterioration occurred in 2008, when fiscal policy was strongly cyclical and expansionary. In addition to certain factors that are inherently more cyclical than structural,27 2008 saw an increase in the structural component of the deficit as a result of measures taken in 2007 and 2008. These measures are estimated to primarily include increased expenditure on investment and social transfers,28 and 27 The economy and, by extension, public finances, had already started to deteriorate in the final months of2008 as the economic and financial crisis escalated, but this was not yet sufficiently reflected in the output gap. The calculated fiscal position in 2008 does not take into account the fact that the revenue shortfall was caused by a slowdown in economic activity, which per se already amounts to counter-cyclical action. 28 Expenditure on social benefits and assistance to households increased substantially due to measures taken in May 2008 higher wages following the implementation of the new wage system in the public sector which coupled with increased hiring raised expenditure. By contrast, the tax changes in place reduced revenue: the general personal income tax allowance was increased, while the payroll tax was phased out and the corporate income tax rate was cut. In 2009, when the economy contracted sharply and the output gap was negative, fiscal policy was counter-cyclical as the structurally adjusted deficit remained high, but it is assessed as not being expansionary. Fiscal policy retained a similar stance in 2010 and 2011. In 2012, against the backdrop of a significant decline in the deficit, fiscal policy was strongly contractionary and acted counter-cyclically given the wider output gap. Despite reservations as to the calculations of changes in the structurally adjusted deficit, it is estimated that the fiscal policy stance in the past four years, in particular in 2012, was primarily a consequence of the fiscal restrictions linked to the commitments that Slovenia made as part of the excessive deficit procedure, and limited access to funding. In 2013 the commitment will not yet be implemented (see Chapter 7); based on the projections in the 2013 update to the Stability Programme, the stance of fiscal policy will shift slightly towards expansionary and counter-cyclical (even excluding the bank recapitalisation expenditure). to alleviate the negative impact of high inflation on people's livelihood (subsidising of transport, food and rents, and new measures such as free meals for secondary school children and higher kindergarten subsidies), which is probably also related to the election cycle (elections in the autumn of 2008). 2.2. Simulations of the fiscal rule and the impact of altered circumstances on its calculation Amendments to Article 148 of the Constitution and the implementing act on the fiscal rule will implement Slovenia's balanced-budget commitment under the fiscal compact. The Treaty on Stability, Coordination and Governance in the Economic and Monetary Union (the fiscal compact) defines the balanced-budget rule via the structural balance. Slovenia ratified the treaty in May 2012 and amended the constitution by including the fiscal rule to implement the balanced budget provision (see Chapter 1). Below is an examination of the simulation of the fiscal rule as determined by the amended Article 148 of the Constitution of the Republic of Slovenia and last year's draft implementing act for the constitutional fiscal rule. A balanced budget of the general government sector (according to the ESA 95) is achieved by capping expenditure at the level of forecast revenue and multiplying it by the ratio of trend GDP to forecast GDP (the k coefficient).29 The way that the fiscal rule is defined, it is significantly affected by the assessment of the business cycle. Trend GDP is the GDP corresponding to long-term stable economic growth over the duration of the business cycle, and equals the output achieved at full employment of production factors and stable inflation; it can be equated with potential GDP (Figure 7). The difference between actual and potential GDP is the output gap. When actual GDP exceeds potential GDP, the output gap is positive; when it is below potential, the output gap is negative. Put differently, the output gap indicates the position in the business cycle and is incorporated in the fiscal rule via the k coefficient (k=1/(1 + {output gap}/100)). The purpose of the fiscal rule is to have a contractionary impact on expenditure in good times and an expansionary impact in bad times. The fiscal rule limits expenditure by "correcting" the projected revenue for the impact of the business cycle (coefficient k). The rule thus attempts to limit expenditure irrespective of the business cycle. In "favourable" times (positive output gap) the correction is contractionary and allows for surpluses, in "unfavourable" times (negative output gap) the "correction" acts as a stimulus and allows for deficits (Figure 8). 29 The calculations using this coefficient take into account the requirements of the Stability and Growth Pact under the Council Regulation on the strengthening of the surveillance of budgetary positions and the surveillance and coordination of economic policies no. 1455/97. Figure 7: Stylised business cycle: actual and potential GDP, and output gap Potential GDP -Actual BDP -----Output gap Time Source: calculations by IMAD. Figure 8: Simulated action of the fiscal rule ......... Expenditure ceiling -Projected revenue ----- Surplus/deficit Time Source: calculations by IMAD. The simulation of the fiscal rule is an estimate of the expenditure ceilings for the coming years using ESA 95 methodology. According to best practice promulgated by international institutions, such simulations use certain assumptions in the estimation methods (particularly important is the output gap, whose estimates change over time). Using slightly different assumptions or methods for the assessment of individual variables can therefore produce different results. To ensure the comparability of results, we used the same methodology as the European Commission. The rule was simulated at "general government" level, Table 9: Fiscal rule simulation, April 2012 2012 2013 2014 2015 GDP EUR m 35,641 36,589 38,059 39,634 Output gap as % of potential GDP -3.9 -3.3 -2.0 -0.8 K coefficient 1.041 1.034 1.021 1.009 Revenue projection EUR m 15,922 16,146 16,682 17,321 Expenditure ceiling EUR m 16,573 16,692 17,028 17,469 Revenue projection % of GDP 44.7 44.1 43.8 43.7 Expenditure ceiling % of GDP 46.5 45.6 44.7 44.1 Surplus/deficit EUR m -651 -546 -346 -148 Surplus/deficit % of GDP -1.8 -1.5 -0.9 -0.4 MF expenditure projection EUR m 17,188 17,070 17,260 17,479 Difference EUR m -615 -378 -232 -10 Difference % of GDP -1.7 -1.0 -0.6 0.0 Sources: SURS, MF, IMAD; calculations by IMAD.. Table 10: Fiscal rule simulation, October 2012 2012 2013 2014 2015 GDP EUR m 35,700 35,495 36,129 37,324 Output gap as % of potential GDP -2.8 -3.9 -3.1 -1.9 K coefficient 1.029 1.040 1.032 1.019 Revenue projection EUR m 15,983 16,807 16,670 17,098 Expenditure ceiling EUR m 16,441 17,485 17,207 17,426 Revenue projection % of GDP 44.8 47.3 46.1 45.8 Expenditure ceiling % of GDP 46.1 49.3 47.6 46.7 Surplus/deficit EUR m -458 -678 -537 -329 Surplus/deficit % of GDP -1.3 -1.9 -1.5 -0.9 MF expenditure projection EUR m 17,482 17,923 17,682 17,567 Difference EUR m -1,040 -438 -475 -140 Difference % of GDP -2.9 -1.2 -1.3 -0.4 Sources: SURS, MF, IMAD; calculations by IMAD. Table 11: Fiscal rule simulation, May 2013 2012 2013 2014 2015 2016 2017 GDP EUR m 35,466 35,252 35,735 36,810 38,110 39,457 Output gap as % of potential GDP -2.8 -3.5 -2.8 -1.6 -0.4 0.6 K coefficient 1.029 1.036 1.029 1.016 1.004 0.994 Revenue projection EUR m 15,895 16,037 16,727 16,850 17,263 17,698 Expenditure ceiling EUR m 16,351 16,612 17,204 17,120 17,327 17,590 Revenue projection % of GDP 44.8 45.5 46.8 45.8 45.3 44.9 Expenditure ceiling % of GDP 46.1 47.1 48.1 46.5 45.5 44.6 Surplus/deficit EUR m -456 -575 -477 -270 -64 108 Surplus/deficit % of GDP -1.3 -1.6 -1.3 -0.7 -0.2 0.3 MF expenditure projection EUR m 17,313 18,835 17,661 17,630 17,809 17,881 Difference EUR m -962 -2.224 -456 -510 -482 -291 Difference % of GDP -2.7 -6.3 -1.3 -1.4 -1.3 -0.7 Sources: SURS, MF, IMAD; calculations by IMAD. Note: expenditure includes one-off expenditure. which according to ESA 95 methodology includes the national budget, municipal budgets, the publicly funded Pension and Disability Insurance Institute (PDII) and Health Insurance Institute (HII), direct and indirect users of the national and municipal budgets, and legal persons relying on public funding for over 50% of their revenue. The general government sector also includes Slovenska odškodninska družba, the portion of Kapitalska družba that covers liabilities to the PDII, and D.S.U., družba za svetovanje in upravljanje, d.o.o. As a result, the calculations include all legal entities whose conduct affects the size and dynamics of the general government debt and deficit, using the method that is also applied by the European Commission. During the course of the simulations of the fiscal rule, significant changes occurred within the period of a year that were strongly affected by factors that are also critical to the calculation of the structural balance. The simulations presented below were made in April 2012, October 2012 and April 2013, always factoring in the latest available macroeconomic forecasts by IMAD and projections by the Ministry of Finance. Comparison thereof shows that the calculations are very volatile. The results of the simulations are also strongly affected by factors critical to the calculation of the structural deficit, which in turn affects the volatility of the estimate of the deficit ceiling. In addition to ex post revisions of estimates of macroeconomic and fiscal aggregates and methodological adjustments, changes in the forecasts of these aggregates have a decisive impact on the results. Forecasting changes are informed by a variety of factors, in particular altered circumstances in the domestic and international environment, and the impact of economic policy measures adopted in the interim period between two forecasts. A comparison of revised macroeconomic forecasts and revenue estimates also shows that there are divergences that cannot be explained solely by tax policy changes.30 It is due to all these factors that the estimate of the deficit ceiling is not "unchangeable". Forecasting changes, as well as changes in data for previous periods, can change the estimates of the deficit ceiling. According to the simulations, the deficit ceiling in 2015 would be 0.4% of GDP based on IMAD's Spring Forecast from last year, 0.9% of GDP based on the Autumn Forecast and 0.7% of GDP based on the projections made this spring. In future, therefore, revised forecasts will very likely change the estimates of the deficit ceiling. Unchanged estimates of the deficit ceiling would be an exception rather than a rule when updated figures are used. Nevertheless, revised estimates are inherent to practically all methods that allow for the adjustment of the deficit/surplus to phases of the business cycle. Simulations of the fiscal rule through 2017 (Table 11) based on this year's macroeconomic and fiscal projections suggest that its implementation will require additional consolidation efforts (assuming other circumstances remain unchanged).31 Simulations of the fiscal rule were used to assess the deficit ceiling for individual years depending on the phase of the business cycle. In Tables 9-11 general government expenditure projections are based on the current system of revenue, meaning that the projections of the individual categories of taxes, social security contributions, non-tax revenue and other general government revenue take account of the current bases and rates without regulatory changes. Based on these assumptions, the simulations (bottom part of Table 9) show that total expenditure will exceed the fiscal rule ceiling by EUR 2.2 bn or 6.3% of GDP in 2013, EUR 0.5 bn or 1.3% to 1.4% of GDP in 2014-2016, and EUR 0.4 bn or 1% of GDP in 2017. 30 The divergences in GDP forecasts and tax revenue was also highlighted by the Court of Audit in the audit report Effectiveness and Efficiency of Budgeting in the Republic of Slovenia for 2011 and 2012 (Court of Audit, 2012). 31 Deviations from the fiscal rule are possible in exceptional circumstances. They are defined as an "unusual event outside the control of the Contracting Party concerned which has a major impact on the financial position of the general government or to periods of severe economic downturn as set out in the revised Stability and Growth Pact, provided that the temporary deviation of the Contracting Party concerned does not endanger fiscal sustainability in the medium-term" (Treaty on the Stability, Coordination and Governance in the Economic and Monetary Union, Article 3.3.b). The implementing act will also determine the criteria for when circumstances may be considered extraordinary and the course of action when they occur. 3. Financial flows between Slovenia and the EU budget In 2012 the net position of the Slovenian budget against the EU budget was the highest since 2004. Ministry of Finance (MF) figures show that revenue from the EU budget into the Slovenian budget in 2012 (EUR 841.6 m) was the highest since 2004 (as in 2011, the realisation of the forecast revenue for the year was 95%32). Expenditure from the state budget into the EU budget amounted to EUR 390.3 m last Figure 9: Forecast and absorbed funds from the EU budget, 2011 and 2012 I Funds budgeted in supplementary state budget for 2012 I Funds budgeted in supplementary state budget for 2011 ■ Total revenue received in 2012 (Jan-Dec) ■ Total revenue received in 2011 (Jan-Dec) Cohesion Fund Structural Funds Common Agricultural Policy ■ 1 0 100 200 300 400 EUR m Source: Ministry of Finance; IMAD calculations. year, resulting in a net position of the state budget against the EU budget of EUR 451.3 m, the highest figure since Slovenia joined the EU. Structural funds accounted for the majority of the funds received (EUR 434.8 m), two-thirds of which was from the European Fund for Regional Development (EUR 326.3 m) and a third from the European Social Fund (EUR 107.4 m). Realization of revenue from the Structural Funds and the Common Agricultural and Fisheries Policy stood at 105%, while the absorption of funds from the Cohesion Fund, which were earmarked entirely for environmental and transport infrastructure projects, reached only 56% of the forecast revenue. Figure 10: Breakdown of funds allocated from the EU budget to the state budget in the current financial period (2007 -2012) ■ Common Agricultural Policy BOther funds Cohesion Policy hblluuL Source: Ministry of Finance, department for cooperation with EU budget. Table 12: Forecast and actual revenue and expenditure flows between the EU budget and the Slovenian budget, 2004-2012 Revenue Expenditure Forecast Actual Realisation, % Forecast Actual Realisation, % Net position 2004 335.3 183.8 54.8 187.9 170.0 90.2 13.8 2005 483.7 302.4 62.5 305.2 285.6 93.6 16.8 2006 449.6 348.4 77.5 315.0 287.9 91.4 60.5 2007 582.1 347.2 59.7 317.1 355.9 112.2 -8.7 2008 783.0 363.2 46.4 375.3 427.9 114.0 -64.7 2009 814.0 594.9 73.1 452.0 439.3 97.2 155.6 2010 1.037.8 723.2 69.7 412.8 396.8 96.1 326.4 2011 854.2 812.2 95.1 393.6 405.1 102.9 407.1 2012 888.6 841.6 94.7 403.3 390.3 96.7 451.3 Source: Ministry of Finance, department for cooperation with EU budget. 2 Supplementary budget for 2012. 0 500 600 2007 2008 2009 2010 In the 2007-2013 financial period Cohesion Policy accounted for the bulk of Slovenia's eligible funds. In the 2007-2013 financial period grants of EUR 4.2 bn were approved for Slovenia under Cohesion Policy33 funding and EUR 1.8 bn for the implementation of the Agricultural and Fisheries Policies, while the share of funding falling under other policies was much smaller. Slovenia began absorption of Cohesion Policy funds at a brisker pace in 2009 (in 2007 and 2008 it was still mostly absorbing funds from the previous financial perspectives), while the absorption of the Common Agricultural and Fisheries Policy funds has been fairly steady throughout the entire period. In terms of the absorption of eligible Cohesion Policy funds, Slovenia is on the edge of the upper third of all EU countries and among the most successful new member states; nevertheless, certain measures were adopted towards the end of the current financial perspectives last year to improve absorption of these funds. A total of 98% of the grants under Cohesion Policy funding (EUR 4.1 bn) were earmarked for the implementation of the three leading cohesion policy Operational Programmes (OPs): OP RR,35 OP ROPI36 and OP RCV,37 and EUR 104 m for European territorial cooperation. By the end of 2012 Slovenia had absorbed 43.7% of all eligible Cohesion Policy funds for the 2007-2013 period, whereby the funding it has received has been affected heavily by the deterioration in the economic situation since 2008, much as it has been in other EU countries. According to European Commission figures,38 which include member states' biggest and most important Cohesion Policy projects, Slovenia ranked ninth (seventh in 2011) in terms of the absorption of eligible funds in 2007-2011 and eleventh (ninth in 2011) in terms of the absorption of eligible funds in the 2007-2013 period. Of the new member states, Slovenia was fifth in terms of the absorption of eligible funds 2007-2011 and fourth in the 2007-2013 period. Slovenia achieved its highest absorption of eligible funds for OP RR projects (60.8% of eligible funds in 2007-2013) and the lowest for OP ROPI projects (23.7%). The relatively low absorption of eligible Cohesion Policy funds could cost Slovenia a significant portion of grants in the current financial period (N+3/2 rule).39 A portion of the eligible funds was therefore redirected last year to programmes where absorption was more feasible40 and additional, Table 13: Absorption of eligible cohesion policy funds for the 2007-2012 period (as at 4 January 2013) In EUR million % with regard to eligibility 2007-2011 34 % with regard to eligibility 2007-2013 OP ROPI OP RR OP RCV Total all OP OP ROPI OP RR OP RCV Total all OP OP ROPI OP RR OP RCV Total all OP Eligibility 2007 - 2013 (European funds) 1,577.1 1,768.2 755.7 4,101.0 Eligibility 2007 2011 883.2 1,257.7 530.9 2,671.8 Appropriations 1,188.9 1,534.2 696.2 3,419.3 134.6 122.0 131.1 128.0 75.4 86.8 92.1 83.4 Signed contracts 723.5 1,529.3 677.6 2,930.4 81.9 121.6 127.6 109.7 45.9 86.5 89.7 71.5 Disbursements 425.1 1,212.1 410.6 2,047.8 48.1 96.4 77.3 27.0 27.0 68.5 54.3 49.9 Refunds to state budget 373.0 1,074.6 345.8 1,793.4 42.2 85.4 65.1 67.1 23.7 60.8 45.8 43.7 Source: Ministry of Economic Development and Technology. 33 In the 2007-2013 financial perspective Cohesion Policy funds are drawn from structural funds (European Regional Development Fund and European Social Fund) and the Cohesion Fund. 34 The performance in the absorption of Cohesion Policy funds is estimated relative to total eligible funds for the current financial period (2007-2013) as well as against eligible funds for the 2007-2011 period, as the funds allocated in this period are absorbed until the end of 2013/14 (N+2/3 rule). 35 Operational Programme for Strengthening Regional Development Potentials. 36 Operational Programme for Environmental and Transport Infrastructure Development. 37 Operational Programme for Human Resource Development. 38 In addition to the payments registered in the state budget, it also includes payments to final beneficiaries in Slovenia based on centralised EC tenders that do not constitute budget revenue. 39 Funds allocated in year N must be absorbed no later than within two or three years. 40 EUR 58.5 m was reallocated from OP ROPI (transport infrastructure) to OP RR (competitiveness and development excellence). i.e. excess, entitlements were allocated to individual OPs in order to maximise the absorption of eligible Cohesion Policy funds:41 16.56% to OP ROPI, 5% to OP RR and 5% to OP RCV on top of the existing eligible funds. Combined with accelerated certification of projects, these measures should make it possible to replace high-risk projects with feasible projects. Figure 11: Absorption of cohesion funds by EU countries as a proportion of eligible funds for 2007-2011 and 2007-2013 (as at 1 January 2011) 80 70 60 50 £LJlEr^h-lDHNN-lLU>-hmwhND <3 Source: Ageing report 2012. 12 Figure 15: Selected pension parameters, comparison between men and women -----Average time old-age pension is received -women -Life expectancy at age 60 - women .........Average age of new old-age pensioners -women; right scale 26 64 ;/M /1 r / \ \ À !j| I/I.4-'"! ! rNm^mvol^coo^o^rNm^mvol^coo^o^ a\a\a\a\a\a\a\a\ oooooooooo^^-a\a\a\a\a\a\a\a\ oooooooooooo >— >— >— >— >— >— >— >— CNrNrNrNrNrNrNrNrNrNrNrN Sources: Eurostat, Pension and Disability Insurance Institute. - Average time old-age pension is received - men • Life expectancy at age 60 - men ■ Average age of new old-age pensioners -men; right scale \ / I V rNm^mvol^coo^o^rNm^mvol^coo^o^rN a\a\a\a\a\a\a\a\ oooooooooo^^^-a\a\a\a\a\a\a\a\ ooooooooooooo <— <— <— <— <— <— <— <— CNCNrNrNrNrNrNrNrNrNrNrNrN 45 40 35 8 ™30 6 4 &20 2 0 -2 5 -4 0 -6 26 24 24 62 62 22 22 60 60 20 20 ™ 18 58 ro 18 58 16 16 56 56 14 14 54 54 10 52 10 52 47 Expenditure on pensions, health care, long-term care, education and unemployment benefits. 48 The 2012 Ageing Report: Economic and budgetary projections for the 27 EU Member States (2010-2060), European Commission, 2012. Accessible at: http://ec.europa.eu/economy_finance/publications/european_economy/2012/2012-ageing-report_en.htm. 49 Country Fiche on Pension Projections. Update for the Peer Review, April 2013. 50 Recommendation for a Council Recommendation on Slovenia's 2013 national reform programme and delivering a Council opinion on Slovenia's stability programme for 2012-2016, European Commission, May 2012. That Slovenia has problems in particular in ensuring the long-term sustainability of public finances was also highlighted in the latest Stability Report.51 In the report the European Commission notes that fiscal trends in Slovenia are not critical in the short term, but the country has high sustainability risk in the medium and long term, primarily as a result of age-related expenditure, which will require a greater fiscal effort. This is illustrated by the values of the SI52 and S253 indicators of fiscal stability, which measure the size of the required budgetary adjustment to ensure the sustainability of public finances. According to estimates, assuming unchanged policies Slovenia's public debt will exceed 60% of GDP by 2014, swelling to 75.5% by 2020 and as much as 105.5% by 2030. Slovenia should thus adopt long-term consolidation measures to the tune of 7.5 GDP percentage points in the structural primary balance in order to close the fiscal gap according to the S2 indicator (EU-27 average: 2.6 percentage points). The gap is widening primarily as a result of long-term age-related expenditure, most notably pensions (4.6 percentage points). Since these forecasts were made prior to the pension reform, it is thought that the indicators will improve slightly, but the improvement will not be sufficient to pull Slovenia out of the risk group. The persistent economic crisis has further worsened the prospects for managing the sustainability of public finances against the backdrop of an ageing population.The adverse situationon the labour market is reducing the number of payers of social security contributions even as the number of pensioners is increasing. Furthermore, the share of the population with supplementary pension insurance is still too low, and the average premiums are relatively modest. The number of people paying into supplementary pension insurance will probably not increase for the duration of the economic crisis. There is also the probability of the crisis lengthening and deepening, which will reduce GDP compared with the benchmarks used in the calculations, and will raise expenditure as a share of GDP, requiring additional measures to ensure the financing of pensions.54 This gives added urgency to larger systemic adjustments in pension, health care, long-term care and labour market policies. Figure 16: Public expenditure on pensions under the old (ZPIZ-1) and new laws (ZPIZ-2) Public expenditure on pensions under the ZPIZ-1 ■ Public expenditure on pensions under the ZPIZ-2 2010 2020 2030 2040 Source: Country fiche, April 2013; Ageing report 2012.. 51 Fiscal Sustainability Report, 2012, European Economy 8/2012, European Commission, 2012. Accessible at: http://ec.europa. eu/economy_finance/publications/european_economy/2012/ pdf/ee-2012-8_en.pdf.. 52 The fiscal adjustment required for compliance with the Stability and Growth Pact criterion (60% of GDP) by 2030. 53 Compliance with intertemporal budget constraint over an indefinite period, e.g. matching of current and future revenue to current expenditure, comprising outstanding government debt and future expenditure. 54 Ministry of Finance calculations based on data on actual GDP until 2012 already indicate a higher relative level of pension expenditure than European Commission projections (Stability Programme 2013). 2050 2060 Box2: Changes to the pension law* and expenditure trends in the first months of 2013 The new pension law equalises the retirement criteria for men and women. The retirement age and the qualifying years (pensionable service) for old-age pensions were equalised for both sexes, which is in line with the longer life expectancy of women and the resulting extension of the number of years people can expect to receive pensions. Women whose right to an old-age pension expired in 2012 received pensions for an average of 22 years and 4 months, while for men the average figure was 5 years and 8 months less (Figure 15). However women's pensions were about a tenth lower on average, as they averaged 4 qualifying years fewer than men. Under the new law, individuals will qualify for old-age pensions at the age of 65 with 15 qualifying years, or at the age of 60 with 40 qualifying years without buy-back." The retirement age can be reduced on account of child care, compulsory military service or contributions paid before the age of 18. The period used for the calculation of the base rate is gradually being shortened, and the way pensions are indexed has also changed. The new law extends the accounting period for the calculation of the base rate from 18 to 24 years, which will be achieved in 2018 (an extension of one year per year). The old-age pension is assessed as a share of the base rate proportional to the number of qualifying years, amounting to 26% of the base rate for men and 29% for women for 15 qualifying years, rising without limitations by 1.25% for every additional qualifying year. The pension for 40 qualifying years will thus amount to 57.25% of the base rate for men and 60.25% for women. The bonuses for postponing retirement after qualifying for early or old-age pensions are more attractive, while the maluses for an early exit from the labour market are slightly higher than before. Individuals qualify for early retirement at the age of 60 and with 40 qualifying years (including buy-back), but in this case the law stipulates a permanent reduction of the pension by 0.3% for each month short of the normal retirement age. Partial retirement is also possible under the law (for at least half the standard working hours) and the pension is (proportionately) determined as a share of the early or old-age pension increased by 5% until the age of 65. Postponing retirement after the criteria have been met earns individuals bonuses in the amount of 1% for every 3 months of work beyond the meeting of the retirement criteria set out in Article 27(4) of the law (60 years of age and 40 qualifying years excluding buy-back) or Article 27(5) (transitional period referred to in note**) for a maximum period of three years (maximum increase of 12%). Individuals postponing retirement after the criteria have been met and paying contributions in unchanged amounts are eligible for 20% of early or old-age pension while they remain active, but only until the age of 65. Pensions are indexed on the so-called Swiss formula. Indexation is carried out each year in February on the basis of a formula comprising the growth in the average gross wage (60%) and the average growth in consumer prices in the previous year (40%), but the increase cannot be lower than half the growth in consumer prices. In the first four months of this year pension expenditure rose at a slightly faster pace than in the same period last year, a consequence of a jump in old-age retirements before the new law entered into force at the beginning of the year. Expenditure rose by 2.3% in nominal terms and 0.2% in real terms. The entry into force of the new pension law led to an increase in early 2013 in the number of old-age pensioners (up 4.9% year-on-year in the first four months) who qualified for retirement before the end of last year. By April the number of old-age pensioners was up by almost 19,500 on the previous year (the year-on-year increase during the first four months of last year was 14 thousand). For the same reason, increased retirements and growth in expenditure are not expected in the coming months. Expenditure on all types of pensions*** totalled EUR 1,381.9 m in the first four months of the year, an increase of EUR 31.7 m over the previous year. *Pension and Disability Insurance Act (ZPIZ-2), Official Gazette of the Republic of Slovenia, No. 96/2012; Ministry of Labour, Family and Social Affairs - Modernizacija pokojninskega sistema (ZPIZ-2) (Modernisation of the pension system), available at http://www.mddsz.gov.si/. The act entered into force on 1 January 2013. ** These criteria are being phased in over a transitional period. For retirement with at least 15 qualifying years, the retirement age for women will rise from the baseline 63.5 years by half a year, reaching 65 in 2016. For retirement with 40 qualifying years excluding buy-back (Article 27(5)) the retirement age will rise by four months each year reaching the target in 2018 for men and in 2019 for women; in 2013 men will be able to retire at the age of 58 years and 4 months given 40 qualifying years (excluding buy-back) and women at the age of 58 with 38 qualifying years and 4 months. *** According to the PDII balance sheet, which includes the following types of pensions: old-age, disability and family pensions, farmer's pensions, veteran's pensions, pensions claimed in other republics of the former SFRY, pensions transferred to other republics of the former SFRY, pensions transferred abroad, annual pension allowance, other pensions. 6. Tax changes in the EU and Slovenia The decline in the ratio of taxes and contributions to GDP ended in the EU in 2011. The ratio of total taxes and contributions to GDP, which had started to decline in the EU overall after the outbreak of the economic and financial crisis in 2008, increased for the first time in 2011, and preliminary estimates indicate that the increase continued in 2012. Most countries mitigated the decline in tax revenue as the macroeconomic situation deteriorated in that period with proactive tax instruments in order to cut budget deficits. In Slovenia taxes and contributions began to decline as a ratio to GDP prior to the start of the economic crisis, three years before the same process in the EU overall. Following the convergence of the tax system before EU accession, Slovenia came very close to the EU average in 2005 in terms of the ratio of taxes and contributions to GDP. After 2005 the ratio declined to significantly below the EU average. The decline in what had been a favourable macroeconomic environment was largely the result of tax reforms introduced before the crisis. All tax changes had been geared towards cutting taxes, which was favourable in terms of easing the tax burden on the economy, but was not coupled with measures to restructure and sustainably reduce expenditure. During the economic crisis the public finances deteriorated sharply. In previous years Slovenia mitigated the impact on tax capacity predominantly via changes to excise duties Source: Taxation trends in the European Union, 2013 Edition. and environmental taxes, but it employed fewer proactive tax measures than other EU countries; in certain segments additional tax cuts were made (cut in the corporate income tax rate, increases in allowances) that had a direct negative impact on fiscal consolidation. During the economic and financial crisis countries have resorted mainly to measures to increase taxes on consumption,55 which have a more moderate impact on economic growth compared with other taxes. In the EU overall there has been a noticeable trend since 2008 to raise the standard VAT rate. Between 2008 and 2013, VAT rates rose in over half of all EU countries. The average standard rate increased by 1.8 percentage points in this period, and is projected to hit 21.3% in 2013 according to European Commission forecasts. Figure 18: Average standard VAT rate in the EU 22 oooooooooooooo CNrNrNrNrNrNrNrNrNrNrNrNrNrN Source: Taxation trends in the European Union, 2013 Edition. Note: arithmetic average VAT rates were raised in Slovenia in 2013 too. Under the Act Amending the Republic of Slovenia Budget for 2013 and 2014 Implementation Act (June 2013), in July the standard VAT rate was raised 2 percentage points to 22% and the reduced rate was raised 1 percentage point to 9.5%. So far 17 EU countries have raised standard VAT rates. 55 VAT accounts for the largest proportion of taxes on consumption. Table 17: VAT rates in EU countries, % Standard rate Reduced rate 2008 2013 2008 2013 Belgium 21 21 6 and 12 6 and 12 Bulgaria 20 20 7 9 Czech Republic 19 21 9 15 Denmark 25 25 -6.9 Germany 19 19 7 7 Estonia 18 20 5 9 Ireland 21 23 13.5 and 4.8 13.5 and 4.8 and 9 Greece 19 23 9 and 4,5 6.5 and 13 Spain 16 21 7 and 4 10 and 4 France 19.6 19.6 5.5 and 2.1 5.5 and 7 and 2.1 Italy 20 21 10 and 4 10 and 4 Cyprus 15 18 5 and 8 5 and 8 Lithuania 18 21 5 and 9 5 and 9 Latvia 18 21 5 12 Luxembourg 15 15 6 and 12 and 3 6 and 12 and 3 Hungary 20 27 5 5 and 18 Malta 18 18 5 5 and 7 Netherlands 19 21 6 6 Austria 20 20 10 10 Poland 22 23 7 and 3 5 and 8 Portugal 20 23 5 and 12 6 and 13 Romania 19 24 9 5 and 9 Slovenia 20 20 8,5 8,5 Slovakia 19 20 10 10 Finland 22 24 8 and 17 10 and 14 Sweden 25 25 6 and 12 6 and 12 United Kingdom 17.5 20 5 5 Source: Taxation trends in the European Union, 2013 Edition Adopting appropriate measures to expand the tax base for the levying of VAT remains a notable economic-policy challenge. As a result of exemptions, reduced rates, and tax evasion and avoidance, European countries actually collect only half the theoretical VAT, according to European Commission estimates. Although the comparison of actual collected VAT with theoretically calculated VAT does not take account of the lower revenue associated with reduced VAT rates,56 it indicates that tax receipts could be raised by curbing the grey economy and with other measures to prevent tax avoidance and evasion. Similar conclusions apply to Slovenia; for 2009 SURS calculated a tax gap of EUR 330 m caused by tax evasion and avoidance compared with total tax revenue of EUR 2,838 m that year. Some EU countries have already started to introduce measures to clamp down on tax evasion and avoidance, and Slovenia is considering mandatory software monitoring of turnover this year in a bid to prevent VAT evasion. During the crisis other taxes on consumption have also been raised in EU countries, in particular excise duties and environmental taxes. Slovenia is among those levying higher excise duties in order to raise budget revenue. Duties on all excisable products have been increasing, resulting in arise in the ratio of excise duties to GDP from 3.2% before the crisis to 4.4% in 2012, significantly above the EU average (2011: 2.7%). Figure 19: Implicit tax rate on consumption, as % of base 2008 2011 EU-27 2011 2013 -PS Slovenia Source: Taxation trends in the European Union, 2013 Edition; 2013 figures for Slovenia calculated by IMAD. The calculation and comparison of implicit tax rates on consumption shows that the average taxation of consumption rose in the EU between 2008 and 2011, while it declined in Slovenia but remained above the EU average. Consumption is taxed more heavily in Slovenia than in the EU on average, and the burden will increase further as VAT rises in mid-year; the estimated increase is about 25%. 30 25.0 24.2 25 23.0 20.1 19.7 20 10 5 0 2008 56 In this indicator the European Commission estimates theoretical VAT at the standard VAT rate (without reductions) relative to final consumption. In 2011 the trend of rising taxation of labour was reversed overall in the EU. Calculations of the implicit tax rate on labour reveal a decline in the EU average in 2009 and 2010 and a slight increase in 2011. The trends are similar in Slovenia, where taxation of labour has been declining largely as a result of the phasing out of payroll tax after 2007. At the outbreak of the crisis many EU countries resorted to tax policy measures to mitigate the effects of the crisis by unburdening labour to help taxpayers while also improving competitiveness. The measures were largely targeted at increasing tax allowances for the lowest tax Figure 20: Implicit tax rate on labour, as % of the base Source: Taxation trends in the European Union, 2013 Edition; 2013 figures for Slovenia calculated by IMAD. Figure 21: Top marginal income tax rates, % ■ EU I EMU-17 ■Slovenia brackets, but the top marginal income tax rates were cut at the same time. Subsequently, the need for fiscal consolidation led some countries to raise the top marginal income tax rates again to redistribute the burden of the crisis to a greater extent to those with higher income. The average top marginal income tax rate has been increasing moderately since 2011 in the EU overall and since 2009 in the euro area. Under the ZUJF, Slovenia raised the top marginal income tax in a new fourth bracket in 2013. In 2011 the trend of rapid decline in statutory corporate income tax rates came to a halt in the EU. The rapid decline in corporate income tax rates that was a feature of the period after 1995 slowed in 2005, and came to a virtual standstill in 2010. The average corporate income tax rate in the euro area actually rose slightly in the past two years. The less-wealthy countries were the first to cut taxes in order to lure foreign investors, but other European countries subsequently followed suit as a result of convergence. The average tax rate in the EU fell to 23% in 2012 from 31.9% in 2000. Aside from changing the statutory tax rates and the tax allowance policy, many EU countries have also worked to expand the tax base, in particular via measures in connection with the recognition and restriction of tax-deductible expenses. Slovenia is notable in Europe as a low-tax country for corporate income tax. The actual collected taxes are affected by exemptions, which are present in all countries. The statutory corporate income tax rate was below the EU average in the entire observation period (1995-2011), and has even been among the lowest in Europe in recent years. Tax allowances can significantly reduce the effective rate, which is the case across the EU, though the differences between individual countries are significant (Taxation trends in the EU 2013). Slovenia's corporate income tax rate was meant to fall further in the next two years according to current legislation, but according to the 2013 update to the Stability Programme it will remain at the 2013 level (17%). rNrNrNrNrNrNrNrNrNrNrNrNrsrN 36.2 36.1 35.8 35.6 35.4 35.2 35.0 50 40 30 20 10 0 Source: Taxation trends in the European Union, 2013 Edition. Note: arithmetic average for EU and EMU. Figure 22: Average statutory corporate income tax rate, as % of the base EMU-1 7 I Slovenia Source: Taxation trends in the EU, 2013 Edition; Note: arithmetic average for EU and EMU There has been a significant push in the EU recently for revenue-side fiscal consolidation as a means of raising other taxes, in particular property taxes, which, like taxes on consumption, have a smaller impact on economic growth. Higher property taxes typically do not have a big financial impact, but their demonstration effect via taxation of the wealthier matters in a crisis. Under the ZUJF, Slovenia raised property taxes in 2013 with the introduction of additional taxes on boats, motor vehicles with bigger engines and real estate of higher value, while the introduction of a new real estate tax as of 2014 is planned in the 2013 update to the Stability Programme. Some countries have put in place special taxes as part of fiscal consolidation efforts (Portugal, Croatia), introducing progressive taxation of all types of income for a shorter, specified period. The 2013 update to the Stability Programme sets out the introduction of a crisis tax as a contingency measure if expenditure-side measures do not have the desired impact on fiscal consolidation in 2013. 7. Assessment of fiscal consolidation 7.1. Excessive deficit procedure In December 2009 the European Commission initiated an excessive deficit procedure against Slovenia, setting 2013 as the deadline for correcting the deficit, before extending the deadline to 2015 this year. In its October 2009 report on the general government debt and deficit, Slovenia estimated the general government deficit at 5.9%; in November 2009 the European Commission initiated an excessive deficit procedure against Slovenia under the Treaty establishing the European Community (TEC) as set out in the revised Stability and Growth Pact of 2005.57 Based on an assessment of the public finances and the European Commission's factors for determining whether an excessive deficit has arisen,58 the EU Council made recommendations and set 2013 as the deadline for correction, warning that the manoeuvring room for Slovenia's fiscal policy is additionally limited because of the challenges to the long-term sustainability of the public finances and the contingent liabilities arising from government guarantees. It recommended that over the 20102013 period Slovenia provide for an average annual structural budgetary improvement of 0.75 GDP percentage points, and outline the requisite measures to correct the excessive deficit. The recommendations stressed that fiscal consolidation should ensure a permanent improvement in the public finances and the quality thereof, and enhance potential GDP growth. The European Commission highlighted that Slovenia needs to improve the enforceability of its multi-year budget plans and improve public spending efficiency and effectiveness to make room for enhanced expenditure on research, innovation 57 Article 104(3) of the TEC Treaty stipulates that whenever a Member State's general government deficit exceeds the reference value of 3% of GDP, the European Commission must prepare a report on the existence of an excessive deficit for the Council, which takes a decision on the matter. When the Council establishes than an excessive deficit does exist, it addresses the recommendations put forward by the European Commission to the Member State in accordance with Article 104(7) of the TEC. The Council recommendation sets a deadline of no more than six months for the adoption of effective measures by the affected Member State. It also determines a deadline for bringing the situation to a close. 58 The assessment includes all factors affecting the realisation of fiscal policy goals: the general government debt and deficit at the start of excessive deficit procedure; indicators of external balance; the government's contingent liabilities in connection with issued guarantees, in particular for measures to stabilise the financial sector during the crisis; interest rates and yields on government bonds; medium-term changes in ageing-related general government expenditure. 40 35 30 25 20 5 0 and human capital creation. At the same time it needs to increase the involvement of young people and senior citizens in the labour market and to improve its functioning. In the draft Council recommendations for the correction of the excessive deficit,59 the European Commission proposed an extension of the deadline for the correction of the deficit to 2015 (Box 4). in 2013. The planned fiscal consolidation was based predominantly on expenditure cuts, though measures were also planned to improve the efficiency of revenue collection and the quality of revenue, and tax allowances were introduced for R&D and investment with a view to stimulating economic activity. In contrast to previous years, some of the measures in the SP2012 were based on passed legislation and confirmed agreements,60 while only to a smaller extent was there a reliance on interventions in the flexible portion of the budget. The measures nevertheless included linear expenditure cuts in some segments, and were not sufficiently underpinned by a structural approach to the streamlining of expenditure (see also EI 2012, Chapter 9.2.2). In last year's Stability Programme the deficit was forecast to narrow by about EUR 1 bn, to 3.5% of GDP (2.9 percentage points less than in 2011). The 2012 update to the Stability Programme (SP2012) of April 2012 laid out measures to correct the excessive deficit in accordance with European Commission recommendations. Following a renewed failure in 2011 to achieve the planned correction of the deficit, primarily as a result of a worsening economy and high expenditure on recapitalisation (see also EI 2012, Chapter 9.1), last year's Stability Programme put forward more ambitious measures in order to meet the excessive deficit procedure commitments Box3: Council opinion on the 2012 update to the Stability Programme and recommendations 61 The Council opinion on the updated Stability Programme for the 2012-2015 period (24 July 2011), which is based on the European Commission assessment, states that the programme plans a broadly appropriate adjustment towards the medium-term target, and an annual pace of progress towards the medium-term target in line with the 0.5% benchmark set in the Stability and Growth Pact, while growth in government expenditure, taking account of discretionary revenue measures, is in line with the expenditure benchmark of the Stability and Growth Pact. The macroeconomic scenario underpinning the budgetary forecasts in the programme is assessed as optimistic compared with European Commission's 2012 spring forecasts. The opinion highlights that additional efforts will have to be made in 2013 to achieve the recommended consolidation over the entire period. Taking into account the current policies and projections, the medium-term objective is said to not ensure sufficiently rapid progress towards long-term stability. The opinion also highlights risks that the deficit outcomes could be worse than targeted, due to (i) a lack of specification of the measures foreseen, in particular for the 2014-15 period; (ii) a track record of primary current expenditure over-runs; (iii) a decline in revenue given the relatively optimistic macroeconomic scenario and the uncertainty surrounding the impact of the recently decided tax measures; and (iv) possible additional capital support operations and calling of guarantees. According to the Council opinion, Slovenia's medium-term budgetary framework and expenditure rule, as defined in last year's programme, remain insufficiently binding and insufficiently focused on meeting the medium-term target and securing long-term sustainability. Based on this opinion, the Council recommended that Slovenia implement the 2012 budget and reinforce the budgetary strategy for 2013 with sufficiently specified structural measures, standing ready to take additional measures in order to ensure a correction of the excessive deficit in a sustainable manner and the achievement of the structural adjustment specified in the Council recommendations under the excessive deficit procedure. Thereafter it is to provide for a sufficient structural fiscal effort to make progress towards the relevant medium-term target for the budgetary position, including the expenditure benchmark. It is to enhance the medium-term budgetary framework, including the expenditure rule, by making it more binding and transparent. The Council further recommended that Slovenia take urgent steps to ensure the long-term sustainability of the pension system, while preserving the adequacy of pensions, by: (i) equalising the statutory retirement age for men and women; (ii) ensuring an increase in the effective retirement age, including linking the statutory retirement age to life expectancy; (iii) reducing early retirement possibilities; and (iv) reviewing the indexation system for pensions. It is to increase the employment rate of older workers, partly by further developing active labour market policies and lifelong learning measures. 59 ec.europa.eu/europe2020/pdf/nd/edp2013_slovenia_sl.pdf 60 Agreement on measures related to wages, benefits and other public sector earnings for fiscal consolidation for the period between 1 June 2012 and 1 January 2014, and ZUJF. 61 Council Recommendation on Slovenia's 2012 national reform programme and a Council Opinion on Slovenia's stability programme for 2012-2015, Official Journal of the EU, 2012/C 219/23; 24 July 2012. Figure 23: Realisation of general government debt and deficit in 2012 compared with SP2012 forecasts ISP2012 forecast 12012 realisation 44.7 45.0 -3.5 -4.0 Total general government revenue Total general government expenditure Net lending/ borrowing General government Source: SURS: main aggregates of the general government, April 2013, Stability Programme (2012 Update) A slightly higher deficit in 2012 relative to the projections in the SP2012 was primarily the result of unbudgeted specific transactions in the amount of 0.4% of GDP and deviations from the planned revenue structure. In 2012 the realised general government deficit and debt (EUR 1.42 bn and EUR 19.2 bn respectively) were slightly higher than forecast in the SP2012 (EUR 1.25 bn and EUR 18.5 bn) and roughly in line with the notification of September 2012. The general government deficit was EUR 171 m or 0.5 GDP percentage points higher than projected in last year's Stability Programme, and roughly in line with the SURS autumn estimate in the excessive deficit procedure (see Table 15). The key factor in the differences were specific transactions (one-off factors) in the amount of EUR 134 m (0.4% of GDP), which are shown in the deficit calculation as current capital transfers. Specifically, these transactions involved coverage of losses at several government-owned companies including recapitalisation, recognition of receivables at government-owned companies, super dividends62 and the payment of called government guarantees. Excluding these one-off transactions, the general government deficit would have been 3.6% of GDP in 2012. Revenue was only marginally lower than planned in the SP2012 (by EUR 27 m,63 which includes a lower estimate of taxes as a result of lower tax settlements, corporate income tax in particular). Deviations from the targets were slightly more pronounced on the expenditure side (EUR 126 m higher), where there were also differences between the forecast structure and the realised structure. Compensation of employees and intermediate consumption expenditure were significantly higher than forecast (by EUR 380 m in total). Expenditures on social benefits (by EUR 70 m), interest (by EUR 144 m),64 subsidies (by EUR 106 m) and investment (by EUR 90 m) were lower than projected. A larger decline in economic activity (-2.3%) than forecast in the SP2012 (-0.9%) did not significantly contribute to a wider deficit, as GDP at current prices was only EUR 175 m or 0.5% lower. The debt-to-GDP ratio was 2.2 percentage points higher than the SP2012 forecast owing to the wider primary deficit (interest expenditure was 0.4 percentage points of GDP lower than forecast) and additional borrowing to pre-finance the payment of principal this year (see Chapter 4). Figure 24: Nominal revenue growth, %, contributions by category, percentage points and Transfers, payable Subsidies, payable Social benefits, payable Koni: Intermediate consumption 2 J2 1 ? 0 £ -oz •M 3 5 "o M c o 3 ® O a- íü C (U Summary The situation on the labour market in the EU and Slovenia continues to be affected by the economic crisis. The decline in economic activity has triggered a process of labour market adjustment to lower activity. In the EU as a whole, the employment rate of the population (aged 20-64 years) in 2012 was 1.8 percentage points lower than in 2008, while the unemployment rate in 2012 totalled 10.4%, 3.4 percentage points more when compared to 2008. In Slovenia, the employment rate (20-64 age group) fell to 68.3%, which is 4.7 percentage points less than in 2008, while the unemployment rate doubled and amounted to 8.9% in 2012.1 Greater deterioration of the labour market situation in Slovenia when compared to that in the EU is due to, among other reasons, a significant decline in economic activity as a result of structural weaknesses in the Slovenian economy, and partly to the impact caused by the substantial increase in the minimum wage on the fall in competitiveness during the crisis in Slovenia. With the crisis persisting, structural problems on the labour market continue to have more of an impact. In 2012, the long-term unemployment rate rose to 4.6% in the EU as a whole, which is 2 percentage points more than in 2008. In Slovenia, long-term unemployment rose even faster and more than doubled in 2008-2012. Countries responded to the worsening situation on the labour market by strengthening active labour market measures and introducing labour market reforms. In 2009, all countries increased the level of funding for labour market policy measures, while in 2010 and 2011 some of the countries, under the influence of fiscal consolidation, reduced these expenses despite a further worsening of the labour market situation. The majority of countries strengthened their educational and training programmes during the crisis, while several countries increased access to unemployment benefits at the beginning of the crisis. Since the ability to adjust to the labour market, which is significantly influenced by labour market institutions, became vital during this crisis, numerous countries began to implement labour market reforms. During the crisis period, reforms of active employment policy were most frequent, while a significant rise was also seen in the number of reforms in the area of employment protection and unemployment insurance. Slovenia responded to the deteriorating situation on the labour market by adopting interventional acts aimed at preserving jobs and enhancing the implementation of active employment policy programmes, but over time the policy became more passive. In 2009, two interventional acts were adopted, aiming to preserve jobs, thus temporarily alleviating the drop in employment in Slovenia. The number of unemployed persons that participated in active labour policy programmes increased significantly in 2009 and 2010. After 2010, as unemployment continued to increase and the unemployment benefits system became slightly more favourable for the unemployed, the volume of passive financial support, in particular, began to rise. In 2011 and 2012, the participation of the long-term unemployed, older persons and low-skilled unemployed in active employment policy programmes dropped sharply. A decline was also seen in the participation of the unemployed in training and educational programmes, which, in view of the growing imbalances on the labour market, is considered to be an inappropriate policy. Slovenia falls within a group of countries which allocate a relatively low level of funds for labour market policy (measured in % of GDP), however, the volume of this passive support is rising. Given the growing number of structural problems on the labour market, it would be highly recommended to strengthen the implementation of active employment policy programmes, particularly those that are targeted at the needs of employers, and to increase the efficiency of active employment policy programmes. Since the beginning of the crisis, Slovenia has amended the system of unemployment insurance on a number of occasions and in 2013 it also enforced amendments in the area of employment protection. However, these amendments were not introduced early enough. With the adoption of the Labour Market Regulation Act in 2010, Slovenia slightly improved (by change in eligibility criteria) access to, and increased the level of, unemployment benefits. The Act, improving the income security of the unemployed, came into force in 2011 when the policy in other countries was no longer aimed at enhancing the income security of the unemployed, but already at reforms that increased work incentives. Greater income security for the unemployed in Slovenia was in force for a relatively short period of time, as already in mid-2012 the level of benefits was reduced due to public finance consolidation. Changes to employment protection were adopted only in April 2013 with the Act Amending the Employment Relationships Act. Amendments to the labour legislation were aimed at increasing flexibility, since they lowered the costs for the dismissal of some categories of workers and simplified the dismissal procedure. Even though they did not involve any radical changes, they led to a decline in the employment protection legislation (EPL) index 1 The source of the indicated data is Eurostat and is based on the labour force survey. (developed by the OECD for the purpose of comparing international labour market regulations) below the OECD average; this points to the fact that the labour legislation in Slovenia can no longer be considered rigid, as it once was. As the objective of the amendments was to reduce segmentation on the labour market, other amendments, which the EPL index does not include, were also adopted, which might act towards reducing flexibility (e.g. the introduction of severance payments for fixed-term employments and the introduction of quotas in employing agency workers on fixed-term contracts). The adopted amendments are thus a consequence of pursuing two different primary objectives (increasing the flexibility and reducing the segmentation) and compromises in the negotiations with social partners. Nevertheless, the amendments were indeed a step in the right direction, since the econometric estimates of the effects of the adopted amendments reveal positive, yet modest, effects on employment. However, Slovenia was slow to move with the amendments aiming to achieve greater flexibility of contractual relationships because in 2010, when the amendments concerning the determination of the minimum wage and the Labour Market Regulation Act were adopted, it missed the opportunity to formulate a comprehensive reform. Following the decline in economic activity, the adjustment to the changed conditions was less pronounced in wages than in employment. The modest adjustment of wages was largely due to a rise in the minimum wage, as well as to the wage formation mechanism (mostly at the sectoral level). In addition to one of the largest drops in economic activity in the EU during the crisis, Slovenia recorded the greatest increase in the minimum wage, raising it by almost 30% in real terms in the period 2008-2012. Various studies2 indicate that the decisive factor in the system of wage formation (and hence the movement of wages) in Slovenia is that wages are determined by collective agreements at the level of sectors, which might reduce the responsiveness of wages to changed economic circumstances. The austerity measures of the public sector wage policy, which during the crisis, in addition to freezing or cutting the basic wages of civil servants, also abolished most of the elements designed to stimulate wages, have led to increasingly smaller differences between wages, which has a fairly negative effect on the motivation of employees. The main challenges of the economic policy are increasing the scope of labour activity and enhancing the ability to adapt to the changed economic circumstances. Due to the notable deterioration on the labour market and significant structural imbalances, the Slovenian objective (EU 2020) to achieve a 75% employment rate by 2020 (of the population aged 20-64) has become unattainable, since the number of employed persons fell significantly during the 2008-2012 period. To reverse this trend and to gradually achieve the set objective, Slovenia should develop, as soon as possible, a set of measures aimed at increasing the scope of labour activity and ensuring greater coherence of individual policies that go beyond labour market policies. In addition to further structural reforms, efforts should concentrate on public finance consolidation, efficient rehabilitation of the banking system and the creation of an environment that fosters entrepreneurship (for details see the Development Report 2013). The changes that were brought about this year to the labour market regulation were a step in the right direction, however, it is necessary to monitor the effects of changes that were already made regarding the labour market regulation, their corrections and further reforms of labour market institutions, whereby particular emphasis should be placed on enhancing the efficiency of active employment policy programmes and the functioning of the employment service. Because student work is one of the main reasons for the strong segmentation of the labour market in Slovenia, a different arrangement for student work is another challenge to be met. Such a challenge also includes enhancing the ability to adapt to the changed economic circumstances, not only by achieving a more flexible regulation of the employer-employee relationship, but also by strengthening the role of active employment policy programmes and by a wage setting system that would allow a more timely response to changes in economic activity, mostly by means of collective agreements negotiated at company level. Also, it would be worth examining the system for determining the minimum wage. Formulating measures in the field of wages and changes to the wage system in the public sector would offer more incentives and would not lead to a levelling of wages is another challenge amid continued fiscal consolidation. 2 Analyses and surveys in the framework of the Wage dynamic network project. Introduction The EU labour market is still adjusting to the circumstances brought about by the economic crisis. The decline in economic activity has triggered a process of adjustment of the EU labour market to a lower level of activity. When the crisis began, the decline in employment was relatively modest when compared to the decline in economic activity, as in the majority of states the first response to the crisis was shortening work hours. For this reason, and also due to the usual delay in the effects of lower economic activity on the labour market, labour hoarding and a subsequent decline in employment took place in the time when the economy was already slightly recovering. Employment adjustment still continues, since in 2012 (when another reduction was recorded), the level of economic activity in the EU on average still lagged behind the level from 2008. In the EU as a whole, employment was on average 2.6% lower in 2012 than in 2008. Contrary to this, the unemployment rate in the EU was on average 3.4 percentage points higher in 2012 over 2008 (totalling 10.4%). The adjustment of wages, however, was relatively modest (ECB, 2012). Labour market adjustment is influenced by labour market institutions where an intensive process of reforms is taking place. Among labour market institutions, the ones most frequently emphasised are: the importance of employment protection or different forms of flexibility, the measures of active labour market policy, unemployment insurance and the wage bargaining system. Lesche, J. and Watt, A. (2010) note that labour market performance (at least at the onset of the crisis) has generally been best in those EU countries that are characterized by high internal workplace flexibility and well-developed and responsive institutions and government On the other hand, the combination of high external flexibility3 with weak labour market institutions and strong dualism produced poor outcome for workers and led to a significant rise in unemployment. ECB experts note that multi-year collective agreements which determine wages, were an important reason for the delay in wage adjustment at the beginning of the crisis. This led to the fact that, in some countries where measures aimed at achieving fiscal consolidation were adopted, wages in the public sector responded to the crisis more quickly than in the private sector (ECB, 2012). Several studies show that employment adaptation is much more pronounced in countries with a less regulated labour market or with weaker employment protection (e.g. the USA and Great Britain) than in central Europe (e.g. Germany and France). Given the poor prospects for economic recovery, considerable macroeconomic imbalances and growing problems on the labour market, reforms became a necessity. The European Commission estimates that this was the reason underlying the strengthening of the reform process on the labour market in the EU during the crisis. In the framework of the European semester, numerous states received recommendations in relation to amendments in the field of employment protection, wage bargaining, labour taxation, active labour market policy, early retirement, pension systems and education. This section presents the labour market developments during the crisis and the response of the labour market policy in the EU and Slovenia. The first chapter outlines the labour market developments in the EU and Slovenia. The second chapter presents the active labour market policy in the EU. Furthermore, we also provide an analysis of the active employment policy in Slovenia, which is intended to contribute to reducing labour market mismatch, facilitating transitions from school to work, and improving the employability of unemployed and employed persons. In the third chapter, we focus on labour market reforms, highlighting the reforms of unemployment benefits and changes in employment protection implemented in EU Member States over the last four years. Furthermore, we present changes in employment protection in Slovenia in more detail, which reflect the European Commission's recommendation on bridging the gap between the rights and responsibilities arising from temporary and permanent employment contracts. We also provide an assessment of changes in labour market regulation which have been adopted this year, and conclude by presenting the challenges faced. 3 The term external flexibility denotes relatively modest employment protection, which allows a rapid adjustment of labour. 1. Changes in the labour market situation in the period 2008-2012 1.1. Changes in the labour market situation in the EU After 2008, the conditions on the labour market tightened notably due to the global economic crisis and the continuation of low economic activity. After the onset of the crisis in 2008, the first major adjustment to the labour market took place at the beginning of 2009, while throughout the year 3.9 million jobs (EMU 2.7 million) were lost in the EU. With economic activity declining, the majority of the Member States adopted measures aimed at temporarily alleviating the effects of the crisis on the labour market, which slowed down a worsening of the situation. In 2010, unemployment soared the most in countries which were most severely affected by the crisis and had rather little leeway to act at the state level (Greece), or which have a flexible labour market, allowing rapid adjustments (Ireland, the Baltic countries). In 2011, the labour market situation in the EU as a whole eased off slightly, since the number of persons in employment rose by 0.2%, while the unemployment rate remained at a similar level as the year before. In the EU, in 2012 the labour market situation again deteriorated. Due to a decline in economic activity, a further 1 million jobs were lost in the EU in 2012, a total of 5.8 million jobs (EMU 4.2 million) since 2008. In the EU, the unemployment rate, on average, totalled Figure 1: Unemployment rates in the EU in 2008 and 2012 Ö. 12 E 10.4% in 2012, 3.4 percentage points more than in 2008. The gaps in unemployment rates among the Member States continued to grow further, reflecting different responses of labour markets to the crisis. In 2012, the employment rate (20-64 age group) totalled 68.5% in the EU as a whole, which is 1.8 percentage points less than in 2008. Due to lower adjustment costs, the drop in the number of persons in temporary employment was more pronounced than in the number of persons with permanent employment contracts. The gaps in unemployment rates between Member States widened considerably, reflecting the different effects of the crisis on individual countries and the differences in labour market adjustment to lower economic activity. In the majority of countries, the average number of actual hours worked per week in the entire period fell (schemes stimulating the shortening of working hours), resulting in a higher share of employment for shorter working hours (partial employment). During 2008-2012, employment opportunities for men and the young worsened markedly. The employment rate for men decreased more than the employment rate for women. This was largely due to a decline in activity in sectors that mainly employ men with lower education (e.g. construction). The decline in activity in the entire period drastically reduced employment opportunities particularly of the young population, with the youth unemployment rate (aged 15-24) rising and reaching 22.8% in 2012 (EMU 23.0%), which is 7.2 percentage points more than in 2008. In Greece and Spain, the unemployment rate of the young exceeded 53% and in 2008-2012, it more than doubled in both countries. The problem of youth employment is generally more pronounced Figure 2: Employment rates in the EU, by age group 50 48 46 44 42 ç 40 38 36 34 32 -15-24 55-64 86 84 82 80 78 76 74 fNfNfNfNfNfNCNfNfNfNfNfNfN Source: Eurostat. Vir: Eurostat. 2008 24 20 16 8 4 0 among less-educated people, however, the declining employment rate of young people who have at least a secondary education reveals increasing problems in the transition from education to employment (EC, 2012b). Unlike in other age groups, the employment rate of older people (aged 55-64) climbed by 3.3 percentage points to reach 48.9%, which is a result of pension system reforms. However, differences between individual states remain significant. In 2008-2012, the long-term unemployment rate rose, while a strong increase was also seen in the share of the long-term unemployed. Since the crisis began, the long-term unemployment rate rose in all EU countries, except in Germany, particularly in countries which were most affected by the crisis. In 2012, 4.6% (EMU 5.3%) of the active population was unemployed for more than 12 months; unemployment increased most markedly among young people and those with low education levels. The share of long-term unemployed in the total number of unemployed in the EU amounted to 44.4% in 2012, which is 7.5 percentage points more than in 2008. The increasing number of structural problems in a number of countries also shows in a rise in the very long-term unemployment rate,4 amounting to 2.5% in 2012, which is 1 percentage point more than in 2008. Due to the system of wage bargaining, a relatively modest response to the crisis was seen in wage movements. ECB experts note that the multi-year collective agreements which determine wages constituted an important reason for the delay in wage adjustment at the beginning of the crisis. This led to the fact that, due to fiscal consolidation, wages in the public sector in some countries responded to the crisis more quickly than in the private sector (ECB, 2012). According to the European Commission's assessments, wages in 2010 were still relatively unresponsive to the worsening of the labour market (EC, 2011). Only in 2011 was the movement in the nominal compensation per employee influenced by the need to lower unemployment, which increased substantially due to the labour market adjustment by reducing employment (EC, 2012a). 1.2. Changes in the labour market in Slovenia Due to the economic crisis, employment in Slovenia declined in 2008-2012, particularly in the private sector. As a result of the fall in economic activity in 2009 and the consequent labour market adjustment to the 4 The term very long-term unemployment is used to refer to a person whose unemployment lasts for two or more years. lower level of economic activity in the following years, the number of persons in employment in Slovenia recorded a decrease. In 2012, their number (according to the statistical register) was around 69,000 persons or 8.0% lower compared to 2008. The number of people in employment was in decline only in the activities of the private sector where, in 2012, there were 78,000 or 11 % fewer employed persons than in 2008, while in this period the largest decrease was seen in construction (by 32%). Public services, however, recorded an increase in the number of employed persons in 2008-2012, rising by 9,000 persons or 5.2%. Figure 3: Economic growth and employment -GDP, growth in % -Employment, SNA, growth in % aaaaaaaa Source: SORS; calculations by IMAD. The decline in employment was larger in Slovenia than in the EU overall, which is a result of a larger decline in economic activity. Since the drop in economic activity in 2009, the employment rate is decreasing faster than on average in the EU. In the period from 2008, when it attained the highest level (68.6%), considerably exceeding the EU average, it dropped to 64.1% in 2012 and was thus slightly below the EU average. In Slovenia, the employment rate (15-64 age group) decreased by 4.5 percentage points in 2008-2012 (on average by 1.6 percentage points in the EU). Similarly, as in the EU, the contraction in employment was more severe for men than for women5, mainly due to the sharp fall in the construction sector. Likewise, the unemployment rate in Slovenia witnessed a greater increase than in the EU as a whole.6 Greater deterioration of the 5 Since 2008, when it totalled 72.7% and was equal to the European average, the number of employed men has dropped below the EU average, reaching 67.4% in 2012. In 2012, the employment rate for women totalled 60.5%, which is 4 percentage points less than in 2008. 6 In Slovenia, the unemployment rate totalled 8.9% in 2012, 4.5 Table 1: Employment rates in Slovenia and the EU, by age groups (in %) Slovenia EU27 15-24 years 25-54 years 55-64 years 15-64 years 15-24 years 25-54 years 55-64 years 15-64 years 2008 38.4 86.8 32.8 68.6 37.4 79.5 45.6 65.8 2009 35.3 84.8 35.6 67.5 35.0 78.0 46.0 64.5 2010 34.1 83.7 35 66.2 34.0 77.6 46.3 64.1 2011 31.5 83.1 31.2 64.4 33.7 77.6 47.4 64.3 2012 27.3 83.3 32.9 64.1 32.9 77.2 48.9 64.2 Source: Eurostat. Table 2: Unemployment rates in Slovenia and the EU, by age group (in %) Slovenia EU27 15-24 years 25-49 years 50-74 years 15-74 years 15-24 years 25-49 years 50-74 years 15-74 years 2008 10.4 3.8 3.3 4.4 15.6 6.3 5.0 7.0 2009 13.6 5.5 3.9 5.9 19.9 8.2 6.1 8.9 2010 14.7 7.3 4.4 7.3 20.9 8.9 6.6 9.6 2011 15.7 7.8 6.5 8.2 21.3 9.0 6.6 9.6 2012 20.6 8.5 6.3 8.9 22.8 9.9 7.1 10.4 Source: Eurostat. labour market situation in Slovenia relative to the EU is linked to a significant fall in economic activity due to structural weaknesses of the Slovenian economy, but also to the impact of the significant increase in the minimum wage and the effects on the drop in competitiveness. The deterioration of the labour market situation in Slovenia was also most notable among the young. As shown in Table 1, the youth employment rate (aged 15-24) dropped by 11.1 percentage points in 20082012. On the other hand, the youth unemployment rate almost doubled. The significant deterioration in the situation of young people on the labour market was a result of the following factors: (i) an increasing share of temporary employment among the young population (non-extension of employment contracts and cuts in the number of employees in companies); (ii) low labour demand or number of job vacancies, where young people often have fewer job opportunities due to a lack of work experience (iii) a reduction in the volume of student work which was more pronounced in the second half of 2012;7 (iv) mismatch between the structure of tertiary graduates according to their fields of education and labour market demands, and a considerable increase in the number of graduates. With low demand and an increased number of the Bologna programme percentage points more than in 2008, while in the EU as a whole it rose from 7% in 2008 to 10.4% in 2012. 7 We estimate that the reduction in the volume of student work was partly due to the rise in concession levies to 23%, which came into effect on 1 June 2012 with the Fiscal Balance Act. graduates entering the labour market in the period 2008-2012, the unemployment rate of persons with tertiary education almost doubled, thus amounting to 6.1% in 2012. The deterioration of job prospects for young people raises the probability and scope of brain drain and calls for the formulation of innovative and effective programmes and approaches for the implementation of employment guarantees for young people8 In 2008-2012, the employment rate among low-skilled people dropped markedly. The employment rate of low-skilled people, which in 2008 amounted to 42.9%, fell to 34.6% by 2012, which is largely due to a decline in the construction sector. A similar drop was observed in the employment rate of people with a secondary education. In 2008, it was above the EU average, totalling 72%, but dropped to 65.8% by 2012, thus falling below the EU average. The employment rate of people with a higher education fell from 87.5% in 2008 to 85.5% in 2011, recording an even greater drop in 2012, to 84.2%, which is still higher than in the EU overall (81.8%). Slovenia has the lowest employment rate of older people, but it will increase in the years to come due to the adopted pension reform. The employment rate in the age group of 55-64 was 32.8% in 2008, climbing 8 Young people became the first priority group in the European employment policy. In the framework of the Youth Guarantee scheme, the funding is intended for the formulation of programmes tackling youth unemployment. to 35.0% by 2010 as a consequence of the structural demographic effect and the pension reform from 2000 (particularly for women). In 2011, the employment rate of older people witnessed a substantial decline (to 31.2%), while last year it recovered slightly (to 32.9%), but is still among the lowest in the EU. The reforms to the pension system adopted at the end of last year could, by extending the period of activity, raising the retirement age and making the retirement age for women the same as for men, increase the employment rate of older people in the years to come. Figure 4: Employment rates of older workers (aged 5564) in the EU in 2012 Figure 5: Long-term unemployment to unemployment in Slovenia and the EU, in % ---EU -Slovenia total "jdïû-m- Source: Eurostat. Structural unemployment has been rising ever since 2009 and almost half of the unemployed are long-term unemployed. The rising levels of long-term and very long-term unemployment are a sign of growing structural problems on the labour market. The long-term unemployment rate more than doubled in 2008-2012, amounting to 3.9% in 2012. Also the very long-term unemployment rate more than doubled in the 2008-2012 period, totalling 2.3% in 2012, and nearly caught up with the EU average. As seen in Figure 5, the share of long-term unemployed has continued to rise since 2009 and amounted to 47.9% in 2012 according to the labour force survey (17.8 percentage points more than in 2009). Long-term unemployment also reduces the possibilities to reemploy the unemployed and the possibilities to substantially reduce unemployment in the coming years. Research conducted by the OECD (2012) states that long-term unemployed persons have a 50% chance of leaving unemployment, while among the short-term unemployed, this chance is approximately 80%. This highlights the relevance of this problem so as to improve the situation on the labour market. \ \i X \ V \ s \ \ \ \ \ \ \ / / / / / ^ / ✓ / / \ \ \ \ \ \ \ \ \ \ \ / / // // // V/ 2005 2006 2007 2008 2009 2010 2011 2012 Source: Eurostat. Wage growth in the private sector slowed gradually during the crisis, however, adjustment in response to the crisis was less pronounced in wages than in employment. The first response of the private sector to the crisis was reducing the volume of overtime work and shortening working hours, followed by a significant reduction in employment, and in 2009 by a slowdown in wage growth, which was more evident and faster in industry than in market service activities. During the past years, a considerable decrease was also seen in extraordinary payments, which reflect the successful performance of companies. Nevertheless, the significant improvement in wage growth in the private sector in 2010 and 2011, amid low economic activity, rising unemployment and relatively low inflation, was mainly a result of the increase in the minimum wage9 and changes in employment structure due to layoffs of workers with relatively low wages.10 In 2009-2012, wage growth in the private sector resulted only from the increase in the basic wage, while the contributions to growth arising from overtime and extraordinary payments were negative. Without increasing the minimum wage and changing the employment structure, the growth of 9 According to our estimates, the gross wage increase in private sector activities in 2010 (5.1%) contributed around 3 percentage points In 2011-2012 the gradual increase in the minimum wage (estimated at less than 1 percentage point) had only a minor influence on the growth of the private sector's average wage. 10 This was underpinned by layoffs of workers with relatively low wages which statistically increased the level of the average wage. According to our estimates, 0.9 percentage points of the average wage growth in the activities of the private sector in 2009 was a consequence of this effect; in the following two years, this share was 0.5 percentage points and 0.2 percentage points respectively. 50 45 40 35 80 30 70 60 25 50 40 30 20 10 0 Box 1: Minimum wage in Slovenia during the crisis1 According to the ratio of the minimum to the average gross wage, which, in Slovenia, rose significantly during the last three years, Slovenia ranks at the top of EU Member States. The growth rates of the minimum and average gross wage in the period 1996-2009 were identical, while the crisis and an increase in the minimum wage in 2010 led to a considerable gap in terms of their growth. Consequently, the ratio of the former to the latter increased from 41.2% in 2009 to 50% in 2012, and is expected to continue to rise this year. In addition to Slovenia, a similarly high ratio was observed only in Malta (2012; 50.4%) and in Greece (2011; 50.1%), while in other Member States it ranges between 33% and 47%. Following the last legislative amendment of the minimum wage, the share of the minimum wage recipients, relative to the total number of employees, rose markedly (from 3% in 2009 to 7.5% in 2012). Figure 6: Growth of the minimum and average gross wage Ifl N W ® OS OS OS OS OS OS OS OS OS OS o^rNm'imvol^coaso^rN* OOOOOOOOOO'— >— >— m OOOOOOOOOOOOO^T CNrNrNrNrNrNrNrNrNrNrNrNrNO Figure 7: Growth of the minimum wage and GDP during the crisis -15 ♦ SI LV 4 SK BG ♦ PT FR LU *BE ES M T ................i ♦ RO HU c UK EE Z ♦ PL 4 GR LT -25 -20 Source: SORS, calculations by IMAD. -15 -10 -5 0 5 GDP, real growth 2012/2008 Source: Eurostat, calculations by IMAD. During the crisis, Slovenia recorded one of the greatest falls in economic activity among EU countries, as well as the largest increase in the minimum wage, which created significant pressures on cost-effectiveness of the economy and job losses. In 2008-2012, the increase in the minimum wage in real terms was almost 30% in Slovenia. Slovenia significantly stands out from other countries with regard to this trend. In the period since the beginning of the crisis, the minimum wage remained unaltered for several years in some countries (in Belgium, Bulgaria, Estonia, Lithuania, Ireland and Portugal), while in seven countries it even decreased in individual years (in the Czech Republic, Poland, Greece, Romania, Hungary, the United Kingdom and Latvia). In Slovenia, the real increase in the minimum wage in 2008-2012 otherwise had a positive effect on reducing wage inequality and the share of low-wage earners, but above all it created a lot of pressure on the cost-effectiveness of the economy and job losses2. This rise in the minimum wage may create further pressures in this direction, since this year's increase is substiantially higher than the forecast for this year's growth of the average wage. 1 See IMAD (2013). Minimum Wage in Slovenia During the Crisis. Available at ttp://www.umar.gov.si/informacije_za_javnost/posebne_ teme/ 2 See Working Paper 3/2010, IMAD (Brezigar et al.: Estimation of the Impact of the Minimum Wage Rise) and Economic Issues 2012 (Framework 2: Effects of the Rise in Minimum Wage in 2010 on the Loss of Jobs - Updated Estimation on the Labour Demand Function and Estimation of the Effects of the Rise in Minimum Wage and Labour Costs on Employment). 30 25 20 10 , 5 0 -5 -10 private sector wages would have been lower by more than half in this period, or by around 1.5 percentage points on average in the year as a whole.11 Excluding these two factors, the response of the wage policy of the private sector to the crisis was significant, but it would have been even more pronounced 11 In 2009, 2011 and 2012 by around 0.9 percentage points, whereas in 2010 by as much as 3.5 percentage points Table 3: Growth of average gross wage per employee, 2006-2012 Nominal growth of gross wage per employee, in % Real growth of gross wage per employee, in % Year Total Private sector Public sector of which general government Total Private sector Public sector of which general government 2006 4.8 5.8 4.1 3.7 2.2 3.2 1.6 1.2 2007 5.9 6.0 6.9 4.1 2.2 2.3 3.2 0.5 2008 8.3 7.8 9.7 10.2 2.5 2.0 3.8 4.3 2009 3.4 1.6 5.3 7.0 2.5 0.7 4.4 6.1 2010 3.9 5.6 0.8 0.0 2.1 3.7 -0.9 -1.8 2011 2.0 2.6 1.0 0.0 0.2 0.8 -0.8 -1.8 2012 0.1 0.5 -0.9 -2.2 -2.4 -2.0 -3.4 -4.7 Source: SORS. had the system of wage formation been to a larger extent based on company-level agreements rather than sectoral collective agreements. Following the period in which the movement of wages was mainly influenced by the increase in the minimum wage and the effect of changes in employment structure as economic activity slowed and companies were trying to maintain a competitive position, the average wage in the private sector has been stagnating ever since the end of 2011. In the period since the beginning of the crisis, wage movements in the government sector, constituting the major part of the public sector, were first affected by the amended wage system, and later mostly by the government's austerity measures, which so far, have been mainly focusing on the level of wages, and not so much on employment restrictions. The latter is also an important factor in determining the wage bill, which is also reflected in the movements thereof in the private sector. A drop in employment in the private sector and a slow wage growth led to a decrease in the wage bill. In 2012, it dropped by 2.3% in nominal terms over 2008, while it rose by 10.7% in the government sector during the same period. The government sector did not stop employing during the crisis, but only slowed it down. Moreover, wage adjustment in the government sector was slower than in the private sector. In fact, the beginning of the crisis coincided with the initiation of an implementation of long planned wage reform aiming to eliminate wage disparities among individual occupational groups in the sector, which resulted in a relatively high wage growth precisely during the period when wages in the private sector already started to slow. In 2009, the wage growth was already slightly lower, since during the course of the year the first austerity measures were adopted, partially restraining growth, while bringing it to a complete halt in 2010 and 2011. Last year, the gross wage in the government sector was lower by 2.2% relative to the year before, which was primarily the result of the 3% decrease in wages with the Fiscal Balance Act that came into force in June. In June, wages of all civil servants were lowered by 8%, while at the same time the last two quarters of funds to eliminate wage disparities were paid. In addition to the fall in wages in the government sector, representing most of the public sector, the growth of wages in public companies also marginally slowed down. Significantly lower extraordinary payments of wages of these companies by the end of the year relative to the previous year slightly decelerated their wage growth, which still remained above average (2.0%) The austerity measures of the government sector wage policy, which during the crisis, in addition to freezing or cutting the basic wages of civil servants, also abolished most of the elements designed to stimulate wages, result in greater equality among employees, which has had a rather non stimulating effect. Since April 2009, the payment of regular performance bonuses has been abolished. The funds allocated for payments based upon increased workload have also been limited ever since. From 2011, civil servants are no longer entitled to promotions. With the latest agreement between the government and the public sector trade unions, a compression of the wage scale was achieved, meaning that a greater decrease will be seen in higher wages than in lower wages. All the indicated measures are leading to increasingly smaller differences in the wages of employees and have a discouraging effect. 2. Labour market policy in 2008-2012 The majority of countries responded to the worsening of the labour market situation by strengthening active measures on the labour market and amending the unemployment insurance system. In 2009, all countries increased the level of funding of labour market policy measures, while in 2010 and 2011 some countries, influenced by fiscal consolidation, reduced these expenses, despite further deterioration of the labour market situation. At the onset of the crisis, a number of states increased access to benefits by reforming the unemployment insurance system, while at a later stage they mainly implemented reforms of the said insurance, aiming to return the unemployed to work. Changes in the implementation of active and passive measures on the labour market in the EU and Slovenia are briefly presented below. Slovenia's first response to the deteriorating labour market situation was the adoption of interventional acts aimed at preserving jobs and enhancing the implementation of active labour policy programmes, however, over time the policy became all the more passive. In 2009, two interventional acts were adopted aiming to preserve jobs, thus provisionally alleviating the drop in employment in Slovenia. The number of unemployed persons that participated in active labour policy programmes increased significantly in 2009 and 2010. After 2010, as the number of unemployed continued to increase and the unemployment benefits system became more favourable for the unemployed, the volume of labour market supports, in particular, began to increase. Slovenia falls within a group of countries which allocate a relatively low level of funds for labour market policy (measured in % of GDP). 2.1 Labour market policy measures in the EU At the beginning of the crisis, a number of countries introduced provisional labour market measures, mainly encouraging shorter working hours. The provisional measures to tackle the crisis on the labour market comprise measures aimed at stimulating the shortening of working hours, enhancing active employment policy programmes and increasing accessibility to unemployment benefits. The majority of EU countries (20 out of 27) introduced different schemes stimulating shorter working hours. These schemes were implemented in the form of subsidies paid to the employer or employee from public funds or from a special fund co-financed also by the employers, or in the form of a partial unemployment benefit. Along with implementing this measure, some countries also stimulated and often subsidised the further training of employees on shorter working hours. Schemes were designed as a measure to preserve employment and encourage internal flexibility. To strengthen programmes of activation and assistance to the unemployed, numerous states reorganised their public employment services. Aiming to enhance the efficiency of services, public employment services were reorganised in Lithuania, Luxembourg and Ireland already in 2009 and 2010, activation programmes were decentralised (Lithuania, Luxembourg) and the number of employees in public employment services were also increased (Sweden, Spain, France). New strategies to improve the matching and provision of quality services to unemployed persons were developed, whereby special programmes for individual groups of the unemployed were often formulated. Early activation programmes, particularly aimed at young people and the long-term unemployed, were developed in Figure 8: Expenditure on labour market policies in the EU, in % of GDP 2007 2008 2009 Source: Eurostat. Note: *According to Eurostat's definition, the labour market policy interventions comprise (i) labour market services comprising all the activities of employment services together with any other publicly financed services for job seekers; (ii) active labour market measures comprising interventions which provide temporary support to disadvantaged groups on the labour market and which reinforce "activation" of unemployment and include training, rotation and job sharing programmes, employment incentives, supported employment and rehabilitation, direct job creation and start-up incentives; (iii) labour market supports which involve financial assistance intended to compensate for the shortfall in income due to wage loss and to serve as support in searching for a new job, or accelerate an early retirement. France, Spain, Denmark, Ireland, Sweden, Portugal and Luxembourg. This was also reflected in higher expenditure for services on the labour market which, in the EU on average, grew by 16.8% in 2009, and by 7.6% in 2010 The overall expenditure for labour market policy also increased, with the most significant increase seen in expenditures for the labour market supports. In 2009, the total expenditure for labour market policy equalled 2.2% of GDP (0.57 percentage points more than in 2007). As shown in Figure 8, the highest increase was seen in expenditure for labour market supports, which includes the financial resources that are intended to compensate for the shortfall in income due to loss of salary and serve as support in searching for a new job (unemployment benefits) or accelerate an early retirement. The expenditure for labour market supports totalled 1.4% of GDP in 2009 in the EU, 0.45 percentage points more than in 2007. During the crisis, the majority of countries increased expenditure on active labour market policy measures. In 2009, countries in the EU used, on average, 0.54% of GDP for such measures, which is 0.08 percentage points more than in 2007. This expenditure rose by 9.5% in 2009 and was 18.4% higher in 2010 than in 2007, according to our estimates.12 In 2010, only Romania, Bulgaria and Italy appropriated fewer funds for active labour market policy measures than in 2007. Figure 9: Change of expenditure on active labour market policy measures (relative to GDP) in 20072010, in percentage points Figure 10: Expenditure on active labour market policy measures in the EU in 2010, in % of GDP Source: Eurostat; calculations by IMAD. 12 The estimate is based on the assumption that in the United Kingdom (no data were available) expenditure on active measures in 2010 was equal to that in 2009. --■llllllllll Source: Eurostat. Differences between countries in the level of active expenditure increased in 2009. The highest level of expenditure on active measures during and before the crisis was recorded in Denmark, which is also one of the countries where this expenditure increased the most (Figure 10). On the other hand, Romania, Bulgaria and Malta recorded the lowest levels of such expenditure, which even during the crisis, did not increase. Within the framework of the active labour market policies, the majority of countries increased training and education opportunities. The measures were Figure 11: Structure of expenditure on active measures by purpose in the EU in 2007 and 2009, in % 40 35 30 as 25 c OJ ™ 20 m 15 10 5 Source: Eurostat; calculations by IMAD. 1.6 1.4 1.2 1.0 3.8 0.6 3.4 3.2 0.0 0.5 45 0.4 0.3 0.2 « 0.1 X 0.0 0 aimed at maintaining employability, improving labour market matching and enhancing skills. The purpose of these measures was to facilitate the transition from education to employment where a number of countries used apprenticeship schemes and strengthened their worker training programmes. As seen in Figure 11, in 2009 the largest part of expenditure in the EU was used for such training (41.2%), which also saw the greatest rise compared to 2007. Duringthecrisis,anumberofcountriesreformedtheir unemployment insurance system. Unemployment insurance systems play an important role in providing income security to the unemployed. Thus, several states reformed their insurance systems aiming to enhance automatic stabilizers and support aggregate demand. Unemployment benefits for unemployed people in the initial phase of unemployment were increased in Belgium, the Netherlands, Finland, Greece, Bulgaria, the Czech Republic and Poland. In the last few years, the duration of benefits was extended in Romania, Latvia and Finland, while in Ireland, the Czech Republic, Sweden and the Netherlands it was reduced. By adopting changes, the countries were also increasing accessibility to benefits (for more information see Chapter 3.1). Figure 12: Expenditure on labour market support in the EU in 2012, in % of GDP 1 III the number of recipients of support was up by 42% in 2010 relative to 2007, whereas the number of unemployed rose by 36.2%. The rapid rise in the number of recipients of support is a result of the policy aimed at offering the unemployed greater accessibility to benefits. According to the labour force survey, in the EU the share of the unemployed receiving benefits thus increased to 80% in 2009 (10 percentage points more than in 2007), which was also due to a high inflow of unemployed persons qualifying for unemployment benefits. However, in 2010 the said share of unemployed persons dropped again to the level seen in 2008 (around 73%). The expenditure on labour market support rose more than other expenditure for labour market policies. In 2010, the highest level of this expenditure was observed in Spain which also recorded the highest unemployment rate in the EU (3.14% of GDP), whereas the lowest rate was seen in the United Kingdom. In 2007-2010, the highest increase in expenditure on support was witnessed in Estonia (almost seven-fold). Figure 13: Trends in the number of unemployed and recipients of supports in the EU - No. of recipients - No. of unemployed Source: Eurostat. Source: Eurostat; calculations by IMAD. 2.2 Labour market policy in Slovenia 3.5 3.0 2.5 115 2.0 1.5 35 1.0 0.5 0.0 Due to changes in the systems and the rising number of the unemployed, expenditure on labour market support rose faster than other expenditure. In 2007, the EU countries on average used 0.96% of GDP for labour market support (unemployment benefits and other forms of financial assistance), and 1.37% of GDP in 2010. As shown in Figure 13, Slovenia's first response to deteriorating situation on the labour market was the adoption of interventional acts aimed at preserving jobs and enhancing the implementation ofactivelabour policyprogrammes, however over time the policy became all the more passive. In 2009 two intervention acts were adopted aiming to preserve jobs, thus provisionally alleviating the drop in employment in Slovenia13. The share of people included in these schemes was highest in mid-2009 (around 4.8% of the total active population according to the statistical register (for more see Economic Issues 2011)). The two schemes, intended to preserve jobs came to an end by the end of 2010. The number of persons participating in the active employment policy programmes in 2009 grew by 77% when compared to 2008, and by a further 38% in 2010. After 2010, as the number of unemployed rose even further and the unemployment benefits system became more favourable, the volume of passive financial support started to increase. Slovenia supports the labour market policy, yet with significantly fewer financial resources than, on average, other EU countries. In 2009, Slovenia's total expenditure on labour market policy equalled 0.96% of GDP, while in the EU, on average, twice as much was spent (2.18% of GDP). Relatively speaking, the greatest gap in expenditure on labour market services was seen in 2009. Upon examination of the results of international surveys regarding the efficiency of labour market policy, we may conclude that modest levels of such expenditure reduce the possibilities to significantly influence the situation on the labour market with employment policy. Kluve (2006) in fact notes that different counselling and job search assistance programmes for the unemployed during their job searching phase, i.e. the programmes Figure 14: Total expenditure on labour market policies in Slovenia, in % of GDP 2007 2008 2009 2010 2011 Source: Eurostat. 13 In January 2009, Slovenia adopted the Partially Subsidising of Full-time Work Act. At the end of May, the Government also adopted the Partial Reimbursement of Payment Compensation Act, regulating the partial reimbursement of wage compensation for employees on temporary layoff ("on waiting" at home). that combine "services and sanctions", are the most successful in increasing the participant's employability. These programmes include all activities that increase the effectiveness and intensity of job searching and counselling for the unemployed, as well as sanctions against those that are not particularly active or fail to satisfy the imposed obligations. The share of expenditure on labour market supports to total expenditure on labour market policies increased markedly during the crisis. In 2011, the total labour market policy expenditure rose by 167% over 2008, with expenditure on supports rising the most (by 215%). The share of expenditure on supports to total expenditure climbed to 70.1% in 2011, 11 percentage points more than in 2008. In 2009, (the latest available figures for the EU) the share of expenditure on supports totalled 63.8% in Slovenia, which is slightly less than the EU average (64.1%). Due to increased expenditure on labour market supports, the total labour market policy expenditure in Slovenia did not decline in 2011, totalling 1.23% (0.78% more than in 2008), while expenditure on supports amounted to 0.87% of GDP (0.6 percentage points more than in 2008). Nevertheless, Slovenia allocates substantially fewer funds for labour market support than the EU average.14 Strengthened implementation of active labour policy programmes and the implementation of intervention acts resulted in a significant increase in expenditure on active labour market measures in 2009 and 2010, but since 2010 this expenditure has been falling. The expenditure on active measures more than doubled in 2009, largely as a result of acts of interventions aimed at preserving jobs.15 The rapid growth of this expenditure continued in 2010, as it rose by a further 41.8% according to Eurostat data. In 2009 and 2010, the share of expenditure on active labour market measures thus increased, but has decreased in subsequent years. In 2011, the volume of expenditure on active measures dropped by 35.8%, and by our estimates spending cuts also continued in 2012. In 2009, the structure of expenditure on active measures witnessed a rise in the share allocated for training programmes, similar to those in the EU, yet with regard to start-up incentives, Slovenia stands out. The share of funds for start-up incentives rose markedly in Slovenia, which is the result of the introduction and expansion of schemes subsidizing self-employment of the unemployed. Other EU 14 In 2009, the expenditure on labour market support on average represented 1.4% of GDP in the EU, and 0.61% of GDP in Slovenia. 15 In 2009, around EUR 32 m was used for both schemes aimed at preserving jobs. Figure 15: Structure of funds for active labour market measures in Slovenia I Start-up incentives ■ Direct job creation ■ Employment incentives ^Training 100 90 80 70 60 1 50 40 30 20 10 2007 2009 Source: Eurostat; calculations by IMAD. countries did not increase the amount of funds intended for start-up incentives during the crisis (see Figure 11). Even though the ESS considers the measure aimed at promoting self-employment as highly successful, it would be sensible to also carry out an evaluation of the programme that would show the success and factors of success of the unemployed in moving to self-employment. After the substantial increase in the number of people involved in active labour market measures in 2009 and 2010, the number dropped sharply in 2011 and 2012. In 2009 and 2010, the number of participants in active employment policy measures more than doubled, compared to 2008. The number of unemployed persons participating in active employment policy programmes slumped, even though the structural problems on the labour market further increased in 2011 and 2012. This was also seen in a reduced number of unemployed persons participating in active employment policy measures, which after the increase recorded in 2009 and 2010, fell sharply in 2012. The share of unemployed persons participating in these programmes amounted to 60% in 2010, which is twice as much as in 2007. However, in 2012 this share was even lower than before the crisis (26.5%), despite the fact that labour market mismatch increased during the crisis. A considerable fall in the share of long-term older and low-skilled unemployed persons was seen in 2011 and 2012, which is problematic from the aspect of eliminating structural problems. To analyse the scope and targets of the active employment policy programmes, we calculated the ratio of the number of unemployed people from a certain group participating in the active employment policy programmes to the total number of unemployed persons in this group, naming it the participation rate, which serves as an approximate indicator of Table 4: Participation rate of the unemployed in active employment policy programmes, in % 2007 2008 2009 2010 2011 2012 Total unemployed persons (UP) 25.7 37.1 48.3 59.2 35.0 26.5 UP aged over 50 9.2 15.9 18.5 20.5 12.9 12.6 UP for one or more years 30.7 33.2 33.5 45.6 25.4 22.4 UP with low education 21.3 22.0 30.3 35.6 21.0 15.5 UP aged below 26 34.9 42.9 53.3 63.6 37.6 28.9 UP recipients of benefits 7.2 14.4 25.4 29.3 21.3 14.9 UP recipients of social benefits 31.5 35.5 71.3 48.3 25.2 17.3 Source: ESS; calculations by IMAD. Table 5: Participation rate of the unemployed by type of programme, in % 2007 2008 2009 2010 2011 2012 Training and education 19.4 20.5 24.9 28.7 15.6 11.2 Employment incentives 0.6 1.6 5.2 4.3 2.5 1.7 Job creation 5.0 7.2 5.6 6.7 2.8 6.0 Promotion of self-employment 0.6 7.7 12.6 19.4 14.2 7.5 Total 25.7 37.1 48.3 59.2 35.0 26.5 Lifelong career orientation 8.2 8.9 11.4 11.8 9.2 8.2 0 Source: ESS; calculations by IMAD. participation in an individual group. As shown in Table 4, in 2010-2012 a strong decline was recorded in the participation rate of the unemployed younger than 26 and older than 50 years, and the low-skilled and the long-term unemployed.16 During the crisis, the unemployed were most often included in education and training programmes. The share of unemployed persons participating in active employment policy programmes peaked in 2010. The highest participation of the unemployed in training and educational programmes by programme type was observed in 2010 (28.7%), but this subsided considerably over the last two years. This is indeed inappropriate, considering the growing imbalances on the labour market. The analyses of the effectiveness of active employment policy programmes (Kluve, 2006) show that practical training programmes and other short-term training programmes aimed to equip people with new knowledge and skills have positive effects on employability and exit rates from unemployment. As in other countries, the number of recipients of unemployment benefits rose faster than the number of the unemployed. In 2012, the average number of people registered as unemployed in Slovenia increased by 74.3% over 2008, while the number of recipients of unemployment benefits was up by 139%. The trend in the number of recipients of unemployment benefits was, in addition to the structure of the unemployed (a large part of older population), also affected by changes in eligibility criteria for benefits, which is elaborated upon in more detail in Chapter 3.2.1. Figure 16: The share of recipients of unemployment benefits among the registered unemployed 2008 2009 Source: ESS; calculations by IMAD. The share of unemployed persons receiving unemployment benefits in Slovenia increased during the crisis, yet it still lags way behind the EU average. The biggest increase in the share of the registered unemployed receiving unemployment benefits in Slovenia was recorded in 2011, totalling 32.8%, which was 10 percentage points more than in 2008. If we compare the EU states in terms of unemployment benefit coverage, which is calculated as the ratio of the number of recipients to the number of the registered unemployed, we can see that Slovenia is ranked among the countries with low coverage rates. Figure 17: Unemployment benefit coverage rate, in % II Source: Eurostat; calculations by IMAD. Note: The unemployment benefit coverage rate is calculated as a ratio of the number of recipients of benefits to the number of registered unemployed persons. The coverage may exceed 100, since in some countries also people in part-time employment still receive unemployment benefits even though they are no longer registered as unemployed persons. 16 Long-term unemployed persons are those who have been without employment for a year or more. 80 60 40 20 0 40 35 32.8 31.7 30.8 30.1 30 25 22.4 c 20 10 5 0 2010 3. Changes in the labour market regulation in 2008-2013 The impact of the regulation of the labour market on its performance regained importance over the course of the crisis. The impacts of labour market institutions are often at the centre of empirical and theoretical debates. With an increase in the number of problems on the labour market, labour market reforms were brought back rapidly on the agenda of economic policy makers. This chapter will focus on the changes concerning employment protection and insurance against unemployment, i.e. the institutions that underwent frequent reforms during the crisis period. The following is a brief overview of the relevant reforms carried out in the EU, as well as a presentation of reforms in Slovenia, including an assessment of the impacts of changes made this year. Figure 18: Number of major reforms on the labour market of EU Member States « Unemployment benefit reforms ■ EPL reforms IALM reforms Other welfare reforms I Working time policy reforms I Wage system refor 90 80 70 I ° 60 ° 50 0J -Q | 40 30 20 10 0 2007 Source: EC - LABREF database. 110 2008 2009 2010 3.1 Reforms on the EU labour market During the course of the economic crisis, the number of labour market reforms in the EU rose. The economic crisis and the consequent worsening of conditions on the labour market prompted the EU Member States to adopt numerous reforms. The situation in the EU economies tightened toward the end of 2008; the countries in general responded by adopting reforms in the field of active labour market policy (job-search assistance, additional education and training, job-creation subsidies, etc.), interventions in the wage systems (freezing or cutting wages in the public sector, adjustment of the minimum wage), and other welfare-centred reforms (entitlement to social assistance and other subsidies). The first fiscal stimuli aimed at mitigating the impacts of the deceleration of economic activity on the labour market included incentives for labour demand, supports for job-seekers, and financial assistance to companies coping with lower demand. As indicated in Chapter 2.1., in addition to the intense implementation of active measures on the labour market, a significant share of anti-crisis measures comprised changes in the system of unemployment benefits. In 2010, in view of the growing need for fiscal consolidation in several countries, the number of reforms concerning the income status of the unemployed and welfare preservation began to decrease; focus was instead put on structural reforms regulating long-term deficiencies and imbalances of the labour market, such as reforms relating to employment relations and, in particular, employment protection, the number of which grew considerably compared to the pre-crisis period. Countries are trying to reduce structural imbalances on the labour market with reforms of employment protection legislation. Employment protection legislation comprises rules and procedures regulating the dismissal of individuals, and groups of individuals, and their fixed-term and permanent employment. The respective reforms are intended to reduce structural imbalances on the labour market. It is, therefore, no Figure 19: Number of adopted employment protection reforms by key areas ■ Procedural rules Notice period and severance pay I Definition of justified dismissal 8 E 3 2007 2008 Source: EC - LABREF database. 7 6 5 4 2 0 2009 2010 surprise that employment protection reforms were undertaken mainly by countries with traditionally large labour market structural imbalances. Less strict dismissal rules were adopted in Italy, Portugal and Spain, the reasons for justified dismissal were broadened in Spain and Portugal, and longer probationary periods were introduced in Romania and Slovakia. Likewise, Portugal, Spain, Greece, Slovakia, the Czech Republic and the United Kingdom reduced the costs of dismissals and defined clearer criteria for justified and unjustified dismissals. Romania and Lithuania enabled the possibility to extend fixed-term contracts, Romania, Slovakia and the Czech Republic prolonged the time of the possible duration thereof, while the Czech Republic and Slovakia increased the number of possible successive contracts. The introduced reforms regulate individual and collective dismissals and temporary employment contracts. Empirical studies (OECD 2004, EC 2012) generally confirm that less rigid redundancy procedures and rules improve the labour market capacity to adjust to changing economic conditions, and reduce segmentation and long-term unemployment. Reforms in the field of employment protection were carried out by numerous countries: - Spain, where the unemployment rate is among the highest and the labour market is heavily segmented, passed a comprehensive reform of the labour market in 2012, including changes of the employment protection legislation. The country set clear criteria for justified dismissal, abolished the companies' obligation to pay off the individuals involved in court proceedings against the company concerning the justification of dismissal, and reduced severance payments in cases of justified dismissals, while in case of fixed-term contracts, severance payments slightly increased. A new form of permanent contract was launched, which comprised a probationary period of one year and was intended for jobs on the basis on state subsidies to employ vulnerable groups. The prior administrative authorisation required for collective dismissals was removed. - Italy, which is also tackling labour market segmentation, adopted a package of reforms to enhance employment and dismissal flexibility. As regards flexibility of employment, Italy increased the admissible number of apprenticeships within firms, while on the other hand, raised social contributions for temporary employment, to make the latter less appealing and similar to regular forms of employment. In terms of flexibility of dismissal, Italy tightened the conditions for reemployment in cases of unfair dismissal on economic or disciplinary grounds, whereby individuals will be more often entitled to compensation. - Poland, where rigidity (measured by the employment protection legislation index) is not particularly notable, records one of the largest shares of temporary employment in the EU. This is a consequence of numerous contracts being drawn up under civil, rather than labour law. In order to minimise the appeal of such contracts, Poland introduced legislative amendments regulating in detail the conditions under which a specific form of contract can be concluded. - France passed a reform with the view of enhancing the protection of both companies and workers and reducing labour market segmentation; a special emphasis is placed on the budgetary neutrality of reforms. The country introduced the possibility of an in-company agreement on the temporary reduction of wages and working hours in exchange for job preservation; if the workers refuse such agreement, they may be dismissed on economic grounds. - in the Netherlands, an agreement was reached between the government and social partners to pass a reform providing for severance pay for all dismissals, reduced by and depending on, the individual's years of service rather than age. Moreover, the country restricted the maximum duration of successive fixed-term employment contracts and abolished probationary periods in the event of very short-term contracts. The number of reforms concerning unemployment benefits in the EU did not change notably over the 2008-2010period. In 2008, their number somewhat decreased compared to the year before since in Figure 20: Number of adopted reforms in the area of insurance against unemployment ■ Benefit level ■ Benefit duration ■ Eligibility and preservation criteria 2007 2008 2009 2010 Source: EC - LABREF database. 16 14 E 10 8 6 4 2 0 several countries economic activity slowed down only in the second part of the year and countries began to implement the reforms only in 2009. As a result, the number of reforms involving unemployment benefits rebounded slightly in 2009 and 2010. As a general rule, reforms in the field of unemployment benefits relate to the level of benefits, the duration of benefits, and the eligibility and preservation criteria. Empirical studies (OECD 2011) indicate lower benefit levels imply lower unemployment rates, and that the restriction upon the duration of benefits received also reduces the persistence of unemployment. Hence, reforms concerning unemployment benefits were introduced with the aim either to improve start-up incentives while supporting fiscal consolidation, or to stabilise the income security of those who lost their jobs. Incentive-friendly measures including the reduction of the unemployment benefit level were adopted by Ireland, Latvia, Romania, Portugal and Slovenia, while the unemployment benefit level was increased in Belgium, Bulgaria, Estonia, Poland and Italy. Sweden opted for lowering the accrual percentage, in proportion to the time spent in unemployment (Hemstrom, 2011). Cuts in benefit duration were introduced in Portugal, Hungary, Slovakia, Finland, the Czech Republic and Ireland, whereas in Denmark, Latvia and Romania benefit duration was lengthened. 3.2 Changes in the labour market regulation in Slovenia Since the onset of the crisis, Slovenia has often changed its unemployment insurance system; in 2013, it also introduced changes in the field of employment protection. With the adoption of the Labour Market Regulation Act in 2010, Slovenia changed eligibility criteria and increased the level of unemployment benefits. The above Act, which improved the income security of the unemployed, entered into force in 2011 when other countries were already adopting reforms to increase work incentives. Greater income security of the unemployed was in force for a relatively short period of time, with the amount of benefits already being reduced in mid-2012 due to fiscal consolidation. 3.2.1 Changes in the unemployment insurance system In 2008-2013, Slovenia made several changes in the field of unemployment insurance. The main change was brought about by the adoption of the Labour Market Regulation Act, which came into force on 1 January 2011. The new Act, primarily aimed at enhancing the income security of job-seekers (a move towards flexicurity), also provided new solutions in the field of active employment policy. Regarding unemployment insurance, the Act broadened the circle of compulsory insurance holders and those who can be voluntarily insured against unemployment, as well as beneficiaries of unemployment benefits. The Labour Market Regulation Act eliminated some of the deficiencies of unemployment insurance. Thus, it improved youth access to unemployment benefits and slightly enhanced the income security of the unemployed. One of its major achievements was the broadening of the circle of unemployment benefit beneficiaries (a beneficiary is any unemployed person who, prior to becoming unemployed, had been insured for at least nine months during the past two years; previously: at least 12 months in the past 18 months). Moreover, the Act raised the value of the benefit for the first three months of entitlement (from 70 to 80% of the base, whereby the base is the average monthly wage received over a period of eight months prior to unemployment). The duration of benefit for older unemployed persons was extended by one month. Despite the intention of the Labour Market Regulation Act to increase the income security of the unemployed (i.e. the amount and accessibility of benefits), the amount once again fell in the middle of 2012. Dolenc et al. (2012) noted that the new Act increased the unemployment replacement rate, while the probability of receiving the benefit (accessibility) improved only slightly. As seen in Chapter 2.2., expenditure on supports in Slovenia rose significantly in 2011, also as a result of the new Act. Table 6 below indicates that the Fiscal Balance Act reduced the level of accrual percentage determining the amount of benefit for the period following the first three Table 6: Accrual percentage of unemployment benefit amount of benefit as a % of previous wage Benefit duration Employment and Insurance against Unemployment Act (1998-2010) Labour Market Regulation Act 2011 until Fiscal Balance Act -June 2012 Fiscal Balance Act Labour Market Regulation Act - April 2013 first three months 70 80 80 80 after three months 60 60 4th-12th month 60 60 after 12 months 50 50 Source: Employment and Insurance against Unemployment Act, Labour Market Regulation Act, Fiscal Balance Act, Act Amending the Labour Market Regulation Act months of unemployment. Likewise, it decreased the maximum and minimum benefit. This year's change in unemployment benefits aims at improving the accessibility for young people. The amendments to the Labour Market Regulation Act, in force since mid-April 2013, additionally introduce the possibility for people under 30 years old to obtain unemployment benefits for two months, provided that in the prior 12 months they had had 6 months of paid insurance coverage. Table 7: Insurance period as a condition for entitlement to unemployment benefits_ Benefit duration (in months) Insurance period Employment and Insurance against Unemployment Act (1998-2010) Labour Market Regulation Act 2011 Act Amending Labour Market Regulation Act -April 2013 6 months 2(c) 9 months - 5 years 3(a) 3 1-5 years 3(b) 5-15 years 6 6 6 15-25 years 9 9 9 25 years and more 12 12 12 people aged over 50 with more than 25 years of insurance 18 19 19 people aged over 55 with more than 25 years of insurance 24 25 25 Source: Employment and Insurance against Unemployment Act, Labour Market Regulation Act, Fiscal Balance Act, Act Amending the Labour Market Regulation Act. Note: (a) 9 months of insurance in the past 24 months, (b) 12 months of insurance in the past 18 months, (c) 6 months of insurance in the past 12 months. An important new feature of the Labour Market Regulation Act is the possibility of integrating workers whose employment is at risk, into life-long career counselling. In order to prevent the transition to unemployment or enable the fast transition from unemployment to new employment, the Labour Market Regulation Act (2011) allowed workers whose employment was at risk to also register at the Employment Service as job-seekers.17 These workers are entitled to in-depth career counselling at the Employment Service. Unfortunately, however, such form of early intervention did not evolve into practice owing to limited human resources of the Employment Service. Pursuant to the amendments 17 A job-seeker whose employment is at risk is any worker who has received notice pending termination of regular employment or whose job - as indicated by the employer's documentation - is to become redundant, or any person whose fixed-term employment contract is to terminate within three months. to the Labour Market Regulation Act and the new Employment Relationships Act of 2013, employers must allow workers, who have received notice of dismissal on economic grounds or due to a lack of capability, to be absent from work at least one day per week to participate in the labour market programmes. Such a solution is indeed positive in order to increase the possibilities of a faster re-entry into the work force. Rather unusual, on the other hand, is the solution that the above absence from work is paid for by the workers themselves as the unemployment benefit is reduced by the time of such absence. The new provision should be defined in more detail by implementing regulations in order to avoid abuse and ensure a broad and effective use thereof. 3.2.2. Changes regarding employment protection The latest changes in labour market regulations in Slovenia werebrought about by thenew Employment Relationships Act and by the amendments to the Labour Market Regulation Act adopted at the beginning of the year. Both acts came into force mid-April 2013 and relate to employment protection. The purpose of the amendments was to: (i) reduce labour market segmentation, (ii) enforce the concept of flexicurity, and (iii) increase the efficiency of labour law protection and abuse prevention. The new Labour Market Relations Act simplifies the dismissal procedure in the event of an individual dismissal of a worker in permanent employment, reduces the costs of dismissals of workers in regular employment (notice period and severance pay), and applies some new restrictions to the drawing up of fixed-term contracts. The amendments to the Labour Market Regulation Act introduce the possibility of temporary and occasional work of pensioners and improve the accessibility of unemployment benefits for young people under 30. With the aim of reducing labour market segmentation, the costs of dismissal of workers in regular employment were decreased, while new restrictions were applied to the conclusion of fixed-term contracts. To minimise the differences between fixed-term and permanent employment, the new Employment Relationships Act: (i) introduces severance pay in cases of termination of fixed-term contracts drawn up for one year or less, in the amount of 1/5 of the average monthly wage18, (ii) introduces additional restrictions upon the chaining of fixed-term contracts for the same work, with a legal definition of 18 Article 79 of the new Labour Relations Act. what the "same work" means,19 (iii) sets limitations to fixed-term contracts in case of agency workers20, (iv) shortens the maximum period of notice of dismissal in case of regular employment, and (v) decreases severance pay for workers at 5-10 and 15-20 years of tenure. The new Employment Relationships Act simplifies dismissal procedures. The new Act simplifies the regulation of objection procedures and abolishes the legal form of a (written) invitation to offer a defence, which had to have prescribed content and be delivered personally. In case of dismissal on economic grounds, workers no longer need to be notified in advance of the intended dismissal. The possibility of delaying the effects of termination of an employment contract based on the negative opinion of the workers' representatives is now limited to the above workers only, while previously it had applied to all. Likewise, there has been a reduction regarding the delay before a notice can take effect. All the above lowers the employment protection score, measured by the OECD employment protection legislation index (see Chapter 3.2.2.1). The new Employment Relationships Act modified notice periods, which even prior to the implementation of this reform had not exceeded the OECD average. The amount of severance payments and the duration of the notice period represent a Figure 21: Comparison of notice periods in case of dismissal on economic grounds according to the old and new Employment Relationships Act -New Employment Relationships Act -Old Employment Relationships Act Years of service with the employer Source: Old and new Employment Relationships Act. 19 Article 51 of the new Labour Relations Act. 20 The Employment Relationships Act limits the number of agency workers hired, which may not exceed 25% of the workers employed by the employer (Article 59). significant expense to the company, which influences the adjustment to the optimum level of employment and reduces dismissals, yet at the same time also hinders new employment (Mortensen and Pisarides (1994)). The maximum notice period was reduced from 120 to 60 or 80 days.21 As indicated in Figure 21, notice periods declined considerably for workers with less than 1 year of service (from 30 to 15 days) and for those with more than 25 years of service with the employer (from 120 to 80 days), while increasing for workers with 2-4 and 9-14 years of service. Since data on the distribution of workers by duration of service are only available for the public sector, it was possible to calculate that shorter notice periods now apply for more than a half of public employees, while 23% of them are subject to longer notice periods. Notice periods in Slovenia are below the OECD average. An international comparison of notice periods is provided by the OECD database on employment protection covering notice periods and severance payments for three categories of workers, namely at 9 months, 4 years and 20 years of tenure. A comparison of notice periods for the above categories of workers among OECD countries reveals that notice periods in Slovenia, according to both versions of the Employment Relationships Act, are below the OECD average (see Table P1 in Appendix). The new Employment Relationships Act also slightly reduces severance payments. The maximum amount of severance payment continues to be 1/3 of the Figure 22: Amount of severance payment by years of service according to the old and new Employment Relationships Act -New Employment Relationships Act -----Old Employment Relationships Act 14 ^^^^^rNrNrNrNrNmmmmm Years of service with the employer Source: Old and new Employment Relationships Act. 21 For more than 25 years of service with the employer, the notice period is 80 days. wage for each year of service with the employer, but can only be claimed after 25 years of service. As seen in Figure 22, severance payments were reduced for workers with 5-10 and 15-20 years of tenure. Data on the distribution of workers by years of service in the public sector reveal that the new Act decreased severance payments for 31.6% of public employees. As regards the amount of severance payment, Slovenia departs from the OECD average only in the category of older workers. A detailed comparison of severance payments in cases of dismissal of workers with 9 months, 4 years and 20 years of tenure shows that Slovenia ranks among the countries with an above-average amount of severance pay only regarding dismissal of workers with 20 years of tenure, who, according to the old Employment Relationships Act, were entitled to 6.7 monthly wages (according to the new Act: 5 monthly wages). Regarding dismissal of workers with 20 years of tenure, Slovenia remains above the OECD average even after the entry into force of the new Employment Relationships Act. (see Table P1 in Appendix). 3.2.2.1 Assessment of this year's changes in the labour market regulation This year's changes to the labour market regulation were made in the right direction and could have positive, although modest impacts on employment. Amendments in the field of protection of regular employment were aimed at increasing flexibility, as they lowered dismissal costs for some categories of workers and simplified the dismissal procedure. As another objective thereof was to reduce labour market segmentation, some amendments were adopted that might act in the sense of reducing flexibility (e.g. severance payments for fixed-term employment and quotas for temporary recruitment of agency workers). The adopted amendments are thus the result of pursuing two different fundamental goals (increasing flexibility and reducing segmentation) and the compromises reached in negotiations between the social partners. Nevertheless, the amendments were indeed a step in the right direction, since the econometric estimates of effects of the adopted amendments reveal positive, yet modest effects on employment. The employment protection index enables a comparison of labour market regulation among selected countries. For international comparisons of labour market regulations and for the classification of countries in terms of employment protection, OECD experts developed what is known as the employment protection legislation (EPL) index (OECD, 1999). The index incorporates 21 elements of labour market regulation that can be combined into three groups or sub-indices: (i) protection of permanent workers against individual dismissal;22 (ii) regulation of temporary forms of employment23 and (iii) specific requirements for collective dismissal24). The weighing of 25 indicators of labour market regulation, assessed on a scale of 0 to 6, gives the total EPL index. The EPL index is valued on a scale of 0 to 6, whereby higher values indicate a more rigid labour market regulation i.e. greater employment protection (OECD 1999). To our estimates, the new regulation alters more than a third of the indicators of the EPL index. The April amendments to the Employment Relationships Act and the Labour Market Regulation Act altered the values of 9 of the total 25 indicators, namely: (i) dismissal notification procedure, (ii) delay involved before notice can start, (iii) length of notice period at 9 months of tenure, (iv) length of notice period at 4 years of tenure, (v) severance pay at 20 years of tenure, (vi) definition of unfair dismissal, (vii) possibility of reinstatement following unfair dismissal, (viii) maximum cumulated duration of successive temporary work agency contracts, and (ix) authorisation and reporting requirements for temporary work agencies (see Table P2 in Appendix). This leads to changes in two of the three sub-indices since the regulation of collective dismissals remains unchanged. Table 8: Values of the EPL index and sub-indices in 2008 and 2013 2008 -previous regulation 2013 - new regulation 1. protection of regular employment 2.98 1.99 2. regulation of temporary employment 2.50 2.13 3. regulation of collective dismissals 2.88 2.88 Total EPL index 2.76 2.19 Source: for previous regulation OECD, for new regulation IMAD. The value of the EPL index, which is now below the OECD average, shows that the Slovenian labour law legislation can no longer be considered rigid. 22 12 indicators are evaluated: dismissal procedure, notice period and severance payment in case of dismissal of a worker at 9 months, 4 years or 20 years of tenure, difficulty of dismissal, probationary period duration, definition of unjustified dismissal, and possibility of reinstatement upon unjustified dismissal. 23 Here, the legal regulation of fixed-term employment and the operation of work agencies are assessed, mainly in terms of the number of successive temporary contracts and restrictions to the duration of temporary or fixed-term employment. 24 These indicators include the definition of collective dismissals, the notification of trade unions and competent public institutions, the required negotiating procedures, dismissal criteria and severance pay amounts. The recent amendments diminished the rigidity of regulation mainly as regards the protection of regular employment against individual dismissal. The decline of the value of the sub-index protection of regular employment against individual dismissal, falling from 2.98 to 1.99, is particularly important for the adjustment capacity of companies. A lower value is recorded also by the sub-index regulation of temporary forms of employment. Slovenia thus ranks below the OECD average (2.26). Prior to the amendments, Slovenia ranked among the countries with a rather rigid regulation of dismissal of regularly employed workers and - in general - a rigid labour law regulation. Following the amendments, the value of the total index brings Slovenia closer to the Netherlands, Slovakia and Hungary. Figure 23: EPL index in OECD countries in 2008 and in Slovenia in 2013 OECD ave. CC^XI^ICCCCI— COOUJUJH I— _IL^MZT Source: OECD, for Slovenia 2013 IMAD. Some of this year's changes in the labour market regulation that cannot be evaluated with the EPL index methodology could result in reduced flexibility. Although following this year's amendment, the EPL index points to a considerable decline of rigidity, it needs to be pointed out that the index does not cover all the changes brought about by the new legislation. As regards temporary employment, the EPL index cannot estimate all the expected changes in legal regulation. In fact, there have been changes that might even lower the flexibility of the labour market. Among these, mention needs to be made of the introduction of severance payments in the case of fixed-term contracts, which reduces the difference between fixed-term and permanent employment protection and could have a positive influence on dualism or segmentation. Yet in a time of great uncertainty, such a change might decrease employers' interest in fixed-term employment, thus reducing the already modest employment situation. Likewise, the introduction of quotas in the employment of fixed-term agency workers could represent a restriction to some companies, reducing their flexibility in adjusting to increased, or decreased business opportunities. With the new regulation, work agencies are no longer required to annually report on their work, which decreased the EPL index, although this means that there is also less of a basis to monitor and control their operations. Within the framework of regulating the operations of temporary work agencies, the mandatory reporting thereof is also being evaluated but, according to our estimate, it has no impact on the ability of companies to adjust. This year's amendment to the Labour Market Regulation Act abolished the obligation of annual reporting. In our opinion, the change did not improve the flexibility of the labour market but rather removed the basis to control the operation of work agencies and monitor the scope of such employment which, with the crisis in Slovenia, more than doubled. The changed values of sub-indices indicate the possibility of reducing labour market segmentation, yet such an impact could be reduced by other regulations. Strong protection of regular employment generally increases the use of temporary employment and leads to labour market segmentation. Some empirical studies show that the rigidity of the subindex protection of regular employment intensifies the use of temporary forms of employment. As seen in Figure 24, the countries where regular employment protection is stronger normally record a higher share of Figure 24: Regular employment protection index and extent of temporary employment in 2008 0 5 10 15 20 25 30 Temporary employment as a % of total employment Source: OECD, Eurostat. 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 Box 2: Assessment of the labour demand function The impact of the adopted changes in labour market regulation, measured by the employment protection legislation (EPL) index, on employment and labour flexibility in Slovenia was assessed by means of the dynamic function of labour demand. The assessed dynamic labour demand function, deriving from Hamermesh's labour-demand model, indicates the capacities and possibilities of employers to rapidly modify employment rates in companies and, in particular, specifies what mostly affects their decisions (labour costs, sales income, capital costs, etc.) and to what extent. To assess the latter, the generalised method of moments (GMM) or the Blundell-Bond estimator was used: lnEMPtf aj lnEMP,t_] +£¡] lnLCEMP, t_]+£Y] lnS, ^(lnLCEMP,t_] xEPLt_]) + j-i ]-i ]-i ]-i (lnLCEMP, t_] x EPLt_ ] x Dkrizat) + tDkrizat + » M V AK\ it. ....... V '250) 50 40 Sources: AJPES; calculations by IMAD. relative to total liabilities continues to grow. In 2008 long-term financial liabilities to banks started to rise at all categories of enterprises, which was largely attributable to the restructuring of short-term debt into long-term debt whereby the banks eased the liquidity pressure on enterprises. The decline in sales revenues meant that corporate debt servicing capacity (in particular at micro, small and medium-sized enterprises) declined Figure 18: Share of financial liabilities to banks in total liabilities by maturity, and their growth by size of enterprise at enterprises in the private sector, 2008 and 2011 ■ Micro (<5) 45 Small (6-50) «Medium-sized (51-250) «Large (>250) 40 35 30 25 20 * 15 10 5 0 -5 -10 -15 .2 tn iS £ is £ iS tn ° ° ° ° 2008 2011 2008 2011 Share of debt by maturity Growth in debt by maturity Sources: AJPES; calculations by IMAD. 90 80 70 60 30 20 10 0 substantially in the first two years of the crisis. In 2011 it improved slightly at all firms, but remained problematic. The highest debt-to-EBITDA ratio was recorded by micro enterprises (26), while the lowest was at large enterprises (approximately 7). 2.2.1.2 Analysis of indebtedness by export orientation of enterprises17 Analysis of indebtedness by export orientation of enterprises as measured by the ratio of debt to total liabilities reveals that firms focusing on the domestic market are more indebted than those focusing on foreign markets. During the crisis indebtedness has declined at non-exporting and export-oriented firms (by 1 percentage point and 2.8 percentage points respectively), but with different dynamics. The indebtedness of non-exporters had already increased slightly in 2010 and 2011, primarily in connection with the recovery of export markets. The increase in indebtedness at exporters was largely the result of an increase in accounts payable to suppliers, in contrast to bank loans, which have declined throughout the crisis. Indebtedness at non-exporters increased in the first two years of the crisis (by nearly 1 percentage point), before declining in 2011 (by almost 2 percentage points). The decline in indebtedness at non-exporters was thus a result of Figure 19: Share of debt in total liabilities, in %, debt-to-EBITDA ratio by export orientation of private sector enterprises, 2008-2011 Exporters Non-exporters 2008 2009 2010 2011 Share of debt in total liabilities (in %) 2008 2009 2010 2011 Debt-to-EBITDA ratio Sources: AJPES; calculations by IMAD. 17 Export-oriented firms are those whose sales revenues on foreign markets exceed sales revenues on the domestic market. Export-oriented firms make up 10% of the total database, and domestic-oriented enterprises 90%; the latter account for roughly 65% of the total value added generated by firms with financial liabilities to banks. both a decline in bank loans and a decline in accounts payable to suppliers. Measured as the ratio of debt to EBITDA, indebtedness at exporters declined to the pre-crisis level in 2010, and then declined again slightly in 2011. Indebtedness at non-exporters was still more than a quarter higher than in 2008. Non-exporters are also more dependent on bank financing. The share of their financial liabilities to banks is more than 8 percentage points higher than at exporters. However, long-term lending to non-exporters also came to a halt in 2011, while long-term financial liabilities to banks were still rising at exporters. Nevertheless, the share was much lower than that of non-exporting firms. Figure 20: Share of financial liabilities to banks in total liabilities by maturity, and their growth by export orientation at private sector enterprises, 2009-2011 Sources: AJPES; calculations by IMAD. 2.2.1.3 Analysis of indebtedness by activity of enterprises18 Analysis of private sector indebtedness by activity shows that in 2006-2011 the most heavily indebted firms were in the sectors of financial intermediation activities, construction, wholesale and retail trade, and real estate, leasing and business services (real estate activities).19 In the period before 18 In order to ensure greater sample consistency, the data is broken down according to the 2002 Standard Classification of Economic Activities (SKD 2002). 19 In addition to these most indebted sectors, manufacturing was also analysed, as an important part of the Slovenian economy. The coverage of firms in financial intermediation is very modest, as the database lacks the figures for banks and insurance corporations, which account for the majority of this sector. The financial intermediation sector was therefore not analysed in detail. 40 30 20 10 0 80 70 60 50 40 30 20 10 0 Figure 21: Share of debt in total liabilities by different private sector activities, 2008-2011 Sources: AJPES; calculations by IMAD. the crisis (2006-2008), the share of debt in total liabilities increased across all sectors, while the debt dynamics in 2009-2011 were fairly uneven. In real estate activities, construction and manufacturing indebtedness declined, while in other sectors it rose at a much more moderate pace. One of the reasons for the decline in indebtedness in the most heavily indebted activities was corporate failures (bankruptcies) in these sectors, as a result of which these firms no longer submit financial accounts and are not included in the database as of the year of filing for bankruptcy. However, this does not lessen the pressure on the banks, as they have to create additional impairments and provisions, because the claims against these firms remain on their balance sheets. According to the Bank of Slovenia's Financial Stability Review (2013), non-performing claims against firms undergoing bankruptcy proceedings account for a large (and increasing) proportion of the banks' non-performing claims. In March they totalled EUR 2.6 bn, or 48% of all non-performing claims against non-financial corporations, compared with 38% in December 2011. The proportion of total classified claims against non-financial corporations accounted for by firms in bankruptcy stands at 11.7%. The debt-to-EBITDA ratio, which measures corporate debt servicing capacity, has increased significantly during the crisis, particularly in the most heavily indebted sectors, which shows that firms are finding it increasingly difficult to repay maturing liabilities. The increase was the result of free cash flow decreasing by almost a fifth between 2009 and 2011.20 The debt-to-EBITDA ratio in the 20 In the first two years of the crisis EBITDA declined (in 2009 in particular), while in 2011 it rose almost by 6%. analysed sectors ranged from 7 (manufacturing) to 56 (construction) in 2011. The breakdown of financial expenses from financial liabilities is similar across sectors, with the exception of real estate activities (see Figure 22). As is evident from the figure, all firms in the sectors analysed primarily take out bank loans and therefore have high financial expenses for interest repayments. They rarely opt for borrowing from affiliates and almost never issue bonds. In 2009 financial expenses for loans received from banks declined considerably, only to start growing again in 2010 (except in wholesale and retail trade and real estate activities), as in addition to indebtedness,21 interbank interest rates also began to rise at the end of 2010, although they started to fall again at the end of 2011 and are currently historically low. Financial expenses for bank loans thus declined in construction (by 12.8%)22 and wholesale and retail trade (by 5.4%), while increasing in manufacturing (by 4.8%) and real estate activities (by 1.9%). Figure 22: Ratio of financial expenses from loans to sales revenues by different private sector activities, 2011 ■ Financial expenses attributable to other financial liabilities ■ Financial expenses attributable to loans received from enterprises in the group ■ Financial expenses attributable to issued bonds ■ Financial expenses attributable to loans received from banks 7.0 6.0 1.5 Manufacturing Construction Wholesale and Real estate retail trade Sources: AJPES; calculations by IMAD. Of the exposed sectors, the largest shares of financial liabilities to banks in total liabilities were recorded in construction and real estate activities. In the construction sector the figure actually increased slightly, while total exposure decreased as a result of the decline in the share of accounts payable 21 In 2010 indebtedness rose in all exposed sectors other than real estate activities, where it was down 2.3 percentage points. 22 This is also estimated to be the result of the bankruptcies of certain major construction firms, which are thus no longer included in the database. Box2: Private sector credit-to-GDP gap The private sector credit-to-GDP gap is an instrument of macroprudential supervision1 of the financial system of a country or group of countries. The credit-to-GDP gap illustrates time-varying systemic risk, and is important from two aspects. The first is the early identification of excessive imbalances and vulnerabilities in a country, for policymakers to be able to establish proper tools and take appropriate action even in the period of economic and financial expansion and thus prevent excessive contraction in times of financial and economic crisis. The second relates to indications of when a crisis is going to end and when sustainable growth will return to the economy and financial markets so that preventive mechanisms and measures will no longer be needed. Various research2 has shown that measures that reveal excessive debt growth are a good indicator of borrowers' future inability to repay loans. However, as pointed out in a Bank of England study (2011), they should be used with caution as they tend to be effective only in good economic times, while they lag during a crisis. The Basel Committee on Banking Supervision nevertheless suggested regular monitoring of the private sector credit-to-GDP gap as the main tool for the calibration and introduction of counter-cyclical capital buffers in compliance with Basel III rules. The private sector credit-to-GDP gap is the deviation (expressed in percentage points) of the ratio of private sector debt to GDP from its long-term trend. The Basel Committee on Banking Supervision recommends that the latter should be computed by means of a one-sided Hodrick-Prescott filter3 with a smoothing coefficient of 400,0004 (for details see Basel Committee on Banking Supervision, 2010). At EU level, the credit-to-GDP gap also started to be calculated by the European Systemic Risk Board (ESRB),5 which uses it as one of the indicators for the assessment of macroeconomic risks. Its results are different from the IMAD results because of a different definition of the measure for debt (the ESRB uses a narrower definition, i.e. debt securities and loans to non-financial corporations) and a different filter used to compute the long-term trend (for more on the filter used see Alessi and Detken, 2011). Nevertheless, the ESRB results also show a positive credit-to-GDP gap in Slovenia, albeit a narrower one. 1 Macro-prudential supervision prevents financial instability as a result of macroeconomic developments and the development of the financial system as a whole. 2 Borio and Lowe, 2002 and 2004; Derehmann, M., Borio, C., Gambacorta, L., Jiménez, G., Trucharte, C., 2010; Schularick and Taylor, 2012. 3 In the calculation of the one-sided long-term trend, the one-sided Hodrick-Prescott filter uses only information available at the time when assessments are made. 4 Empirically, the duration of business cycles ranges from 4 to 8 years in OECD countries (see Cotis and Coppel 2005. When analysing business cycles by quarterly data, a smoothing parameter of 1,600 is used by default and also as recommended by Hodrick and Prescott; when using frequency analysis, a 7.5 year duration of the business cycle is implicitly assumed. Far less is known about the duration of credit cycles. An indication is provided by the length between two systemic crises, which ranges from 5 years to around 20 years. The median is around 15 years, implying that the credit cycle is three to four times the length of the business cycle (Drehmann, Borio, Gambacorta, Jiménez, Trucharte, 2010). In their working paper Drehmann et al assessed the impact of different smoothing parameters: 1,600 (assuming that credit cycles have the same length as business cycles); 25,000 (assuming that credit cycles are twice as long as business cycles); 125,000 (assuming that credit cycles are three times as long as business cycles); and 400,000 (assuming that credit cycles are four times as long as business cycles). 5 The ESRB is an independent EU body tasked with the macro-prudential oversight of the financial system within the EU. It analyses risks, issues warnings and recommendations (which can be public or confidential), and monitors the follow-up to warnings and recommendations. The ESRB (2013) points to a potential vulnerability of the financial system on the basis of a set of quantitative indicators for six areas (interlinkages and composite measures of systemic risk, macro risk, credit risk, funding and liquidity, market risk, and profitability and solvency). Figure 23: Private sector ratio of debt to GDP and trend in Slovenia (left scale), and comparison of credit-to-GDP gaps in Slovenia and the euro area Credit-to-GDP gap: Slovenia (left scale) -Credit-to-GDP gap: euro area (left scale) PS ratio of debt to GDP: Slovenia (right scale) ----Trend: Slovenia (right scale) 15 150 000000000 Sources: Bank of Slovenia, ECB, SURS; calculations by IMAD. Note: PS: private sector. It is estimated that in Slovenia excess debt accumulated mainly in the period between the second quarter of2007 and the third quarter of 2009 inclusive. The ratio of private sector debt to GDP was on average approximately 3.8 percentage points above the long-term trend or sustainable level. The positive credit-to-GDP gap in 2009 was mainly the result of the pronounced real contraction in economic activity (7.8%), given that the credit flow that year was already fairly modest. Excessive lending activity was recorded in 2007 and 2008, when Slovenia exceeded the threshold for private sector credit flow (15% of GDP) used by the European Commission to determine macroeconomic imbalances. These years saw excessive borrowing at non-financial corporations in particular, which later proved unable to service their debts, which were often economically unjustified, particularly at firms focusing on the domestic market. The contribution of Slovenian households to the credit bubble was moderate (it was largest in 2007, but even then was merely around 5%). The negative credit-to-GDP gap remained wide in 2012, as a result of an even tighter credit crunch (loan growth in 2012 stood at -4.3%) and low economic activity, which also had a profound impact on investment by sound export-oriented high-technology firms, and thus on a further deepening of the economic and financial crisis. Our calculations also show that the credit-to-GDP gap in Slovenia in that period exceeded the euro area average, where an excessive build-up of debt was mainly seen from the third quarter of 2005 to the third quarter of 2009 inclusive. The ratio of private sector debt to GDP was on average 2 percentage points above the long-term level in that period. In 2009 the positive credit-to-GDP gap in the euro area was also a result of modest lending activity and the contraction in economic activity, which was almost half smaller than in Slovenia in real terms (-4.4%). Figure 24: Share of bank loans and accounts payable to suppliers in total liabilities of private sector enteprises, 2009-2011 45 2009 2010 2011 2009 2010 2011 Financial liabilities to banks in Accounts payable to suppliers in total liabilities total liabilities Sources: AJPES; calculations by IMAD. to suppliers.23 The increase in the share of financial liabilities to banks was primarily a consequence of the substantial contraction in total liabilities, as financial liabilities to banks declined less, by around 15%.24 In contrast to previous years, long-term financial liabilities to banks also fell in 2011, which we estimate was attributable to the banks significantly restricting the restructuring of short-term loans into long-term loans; the decline was nevertheless much smaller than the decline in short-term loans. 23 It is still relatively high compared with other sectors. 24 The decline in total liabilities is also attributable to the bankruptcies of certain major construction firms, which are thus no longer included in the database. 2.2.1.4 Bank exposure25 by sector in 201226 The Slovenian banking system's exposure to the Slovenian economy declined in 2012 for the first time since the outbreak of the financial crisis. This was a consequence of both lower borrowing by the sector of public administration, defence and compulsory social security, and a much stronger reduction in other sectors' liabilities to domestic banks. The total exposure to all sectors thus declined by around EUR 900 m. The banks were still primarily financing the least risky sectors, such as public administration, defence and compulsory social security,27 where exposure rose by just over EUR 730 m, only 7% less than in the previous year. According to our estimate, this was primarily the result of government loans and investment in treasury bills by government-owned banks. Exposure to the electricity, gas and water supply sector also increased relatively sharply (by around EUR 240 m). Of the other sectors, only information and communication is notable, with exposure increasing by around EUR 60 m. In 2012 the banks were increasingly reducing their exposure to most other sectors. Exposure to the wholesale and retail trade sector declined for the 25 In addition to loans and securities of individual firms at banks, total exposure comprises other bank claims against firms measured at repayment value. This category also includes offbalance-sheet exposures, such as guarantees and warranties. 26 The figures used to describe 2012 developments in individual sectors are classified according to the SKD 2008, and are therefore not fully comparable with those used in the analysis in previous paragraphs. 27 The proportion of total exposure accounted for by public administration, defence and compulsory social security has thus more than doubled during the crisis, reaching 6.1% at the end of 2012. Figure 25: Share of financial liabilities to banks and growth in the exposure of the Slovenian banking system to individual sectors Public administration and defence, compulsory social security Electricity, gas and water supply Mining and ^quarrying Human health and social work * Manufacturing Construction 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0 Share of financial liabilities to banks in equity Sources: Bank of Slovenia, AJPES; calculations by IMAD. fourth consecutive year, and was down more than EUR 480 m on the previous year.28 Exposure to the manufacturing sector dropped only slightly less (EUR 460 m), while exposure to the transportation and storage sector also declined significantly, by around EUR 280 m. For the first time since the outbreak of the crisis, the banks reduced their exposure to the construction sector (by around EUR 210 m). Exposure to manufacturing declined for the second consecutive year, by EUR 120 m, just over 35% more than in 2010. Last year's decline was again primarily the result of a decline in exposure to industries of higher technological intensity, such as the chemical industry and the manufacture of computer, electronic and optical products and electrical equipment; among other manufacturing activities, there was also a significant decline in exposure to the manufacture of textiles, clothing, leather and leather products. 2.2.1.5 International comparison of the indebtedness of the Slovenian economy Indebtedness at non-financial corporations and NFIs in Slovenia is above the euro area average. Although the stock of loans raised at domestic banks has declined substantially in the last three years (by around 12%) and is only 5% above the 2007 figure, the indebtedness of the Slovenian economy is still much higher than before the crisis. This is primarily due to a significant decline in equity at non-financial corporations and NFIs as a result of adverse Figure 26: Indebtedness at non-financial corporations and NFIs in Slovenia and the euro area ■ Securities other than shares Other liabilities Loans 2004 2005 2006 2007 2008 2009 2010 2011 2012 Sources: Bank of Slovenia, Eurostat; calculations by IMAD. developments on capital markets. Given their poor performance, Slovenian firms are no longer able to strengthen their equity base, which has significantly increased the indebtedness of the Slovenian economy. In 2013 total corporate indebtedness as measured by the overall debt-to-equity ratio thus stood at 130%, down approximately 10 percentage points on 2011. Only Greece, Italy and Spain recorded higher corporate indebtedness than Slovenia.29 The poorly developed capital market has a significant impact on the financial structure of the Slovenian economy, which is thus more dependent on short-term financing. In addition to lower equity, this is also reflected in a negligible level of financing via debt securities, one of the lowest in the euro area (less than 15% of the euro area average). This is also partly a result of the small size of the Slovenian economy, where the majority of firms are small and medium-sized, for whom financing via debt securities is not cost-effective because of the relatively high cost. It is nevertheless our assessment that the share of this type of financing could also be higher in Slovenia. However, it would first be necessary to provide for an efficient and liquid capital market to help issuers and holders of these securities reduce transaction costs. 2.2.2 Modest economic growth forecast Given the weak economic activity, demand for loans is expected to decline further. The modest economic activity is also being reflected in lower corporate 35 30 25 20 ? 80 60 Ï 5 40 0 20 0 10 15 28 Since the end of 2008 exposure to this sector has declined by around EUR 1 bn. 29 Figures for other euro area countries refer to 2011. demand for loans, both for working capital and for investment, as capacity utilisation is still low. Unable to settle maturing liabilities, firms are mainly raising loans for debt restructuring, and banks are mitigating their liquidity problems to a certain extent by granting these loans. Corporate loan demand declined more than in the euro area overall, according to the Bank of Slovenia figures. In addition, Slovenian banks tightened their credit standards more than those in the euro area overall, albeit slightly less than in 2008 and 2009. Figure 27: European Commission economic growth forecasts for Slovenia and other euro area countries for 2013 and 2014 2013 2014 ----Euro area 2013 -Euro area 2014 0 -1 ; : -2 -3 -4 -5 -6 -7 -8 rrpI gaiiPiififi Source: European Commission (2013). Demand for loans will remain low. The prospects for economic growth in Slovenia are quite unfavourable. IMAD30 is forecasting a decline of 1.9% in GDP in 2013, and growth of 0.2% in 2014.31 The growth forecasts for both years are much lower than the euro area average, and Slovenia is also in the group of countries whose GDP growth forecasts were revised significantly downwards by the European Commission in the spring. The projections for Slovenia's GDP growth are thus similar to those for the euro area countries most exposed to the financial crisis. The main downside risks to economic growth in Slovenia are related to the state of the Slovenian financial system and the indebtedness of the Slovenian economy, and any delay in structural reforms could additionally reduce the forecasts (European Commission, 2013). To emerge from the crisis, it is therefore essential to establish an efficient institutional framework 30 See Spring Forecast. 31 The European Commission is forecasting a decline in GDP of 2.0% in 2013 and a decline of 0.1% in 2014, while the Bank of Slovenia is forecasting a decline of 1.9% in 2013 and growth of 0.5% in 2014. that would improve the rule of law and ensure the efficacy of regulatory and supervisory functions, and to ensure the withdrawal of the government from the corporate sector to prevent it from directly intervening in the decision-making of economic entities (see Development Report, 2013). 2.2.3 Modest household demand for loans Household demand for loans is also declining more and more as a result of low economic activity. It is thought that this is the result of a further deterioration in the labour market situation, and government fiscal consolidation measures such as the reduction of the net wage bill in the public sector and more restrictive social transfer policy. Household disposable income thus continues to decline, as does household purchasing power, all of which is increasing uncertainty in household consumption and investment. The decline in disposable income is also reducing creditworthiness of households, particularly those with lower disposable income. In view of the extremely uncertain economic situation, households are fairly cautious about their spending. This is also indicated by a decline in private consumption, one of the largest recorded in 2012, even though Slovenian households are among the least indebted in the euro area. Households remain very cautious in purchasing housing. They are postponing real estate purchases because they expect prices to fall further. Their creditworthiness also declined. The fall in housing loans (see 1.2.2) is also related to the deterioration in Figure 28: Percentage ratio of liabilities to GDP at households and NPISHs in the euro area ^m 2001 ^m 2008 2011 --Euro area average 2001 ----Euro area average 2008 Euro area average 2011 Source: Eurostat. 5 4 3 2 -9 80 60 40 20 0 the conditions on the supply side as a result of the significant tightening of credit standards.32 According to SURS figures, in 2012 the number of housing transactions was down around 35% on its peak of 2007. In 2011 aggregate household indebtedness rose slightly, but remained low compared with euro area countries. Indebtedness as measured by the ratio of liabilities to financial assets rose in Slovenia relative to 2010 (by 0.8 percentage points to 33.1%), the highest figure since comparable data have been available.33 According to the annual financial accounts, household liabilities declined for the first time, by 0.4%, but slightly less than financial assets, which fell by 3.1%. Despite the increase, household indebtedness was still slightly lower than in the euro area overall, while indebtedness as measured by the ratio of liabilities to GDP was significantly lower. As a result of a decline in liabilities and an increase in GDP, it declined by 0.7 percentage points in 2011 to 34.8%, compared with more than 69% in the euro area overall. Household indebtedness declined again in 2012. The ratio of financial liabilities to financial assets was at 32.6%. Given the further fall in disposable income, household financial assets34 continued to decline (by 0.7% in 2012). Higher household deleveraging was reflected in a larger decline in financial liabilities (-2.6%) and therefore a modest fall in indebtedness, while household indebtedness as a ratio to GDP declined to 34.5%. 32 In addition to the imposition of higher premiums, which mainly poses a risk in the event of a potential future rise in interbank interest rates, requirements for additional loan collateral have increased markedly. 33 Since 2001. 34 Currency and deposits, securities other than shares, loans, shares and other equity, insurance technical reserves, other accounts receivable. 3. Corporate financial structure It is estimated that one of the reasons that the latest financial crisis has had a greater adverse impact on the economy in Slovenia than in the euro area overall is the unfavourable financial structure of non-financial corporations and NFIs. Non-financial corporations and NFIs in Slovenia typically have a lower ratio of financial assets to financial liabilities than their counterparts in the euro area overall. Slovenian firms also have fewer liquid financial assets such as currency, deposits and debt securities that are readily convertible to cash (provided that there is an efficient capital market) at low transaction costs. By contrast, they have an above-average proportion of short-term financial liabilities, which is putting them under severe liquidity pressure in the current situation of highly restricted financing. 3.1 Structure of financial assets The financial structure of Slovenian non-financial corporations and NFIs again deteriorated slightly in 2012. The ratio of financial assets to financial liabilities at non-financial corporations and NFIs in Slovenia totals just 57.1%, compared with 80% in the euro area overall.35 The Slovenian economy has an above-average proportion of less-liquid financial assets, such as trade credits, which given the pervasive lack of payment discipline is additionally stifling liquidity, Figure 29: Structure of financial assets of non-financial corporations and NFIs in Slovenia and the euro area, 2004-2012 I Loans I Debt securities I Shares and other equity I Other accounts receivable I Trade credits I Currency and deposits 90% 80% 70% 60% 50% 40% 30% 20% Sources: Bank of Slovenia, Eurostat; calculations by IMAD. 35 Data for EMU refers to 2011. 0% 2004 2005 2006 2010 2012 while the proportion accounted for by currency and debt securities, some of the more liquid assets if the capital market functions properly, is much lower than in the euro area overall. In 2012 the stock of financial assets of Slovenian non-financial corporations and NFIs declined for the third consecutive year. At 2.7%, the decline was only slightly smaller than in the previous two years. This time the greatest contribution to the decline (around 2 percentage points) came from a fall in loans granted (down more than a tenth). This indicates that in having to cope with increasing liquidity pressures the Slovenian economy is reducing investment (including inter-company loans), which is putting additional liquidity pressure on firms. Other accounts receivable36 contributed approximately half less to the decline in corporate and NFI financial assets than loans. They have been falling since 2009, partly as a result of modest economic activity in our assessment. By contrast, investment by non-financial corporations and NFIs in securities other than shares strengthened significantly, primarily as a result of an increase in this type of investment by insurance corporations, which placed free financial assets in government securities. This is attributable to the higher valuation of government securities in view of the slight improvement in the situation on financial markets. 3.2 Structure of financial liabilities The structure of financial liabilities did not improve much in 2012,and remained relatively unfavourable. The stock of financial liabilities of Slovenian non-financial corporations and NFIs declined by around 2% or EUR 2 bn, which can primarily be attributed to a decline in loans as the Slovenian economy rapidly deleveraged. Having recorded the sole significant increases since 2009 (which in our assessment was also the result of maturity debt restructuring), the stock of long-term loans to non-financial corporations and NFIs declined by as much as 5.7% or EUR 1.6 bn in 2012. Given the adverse economic situation, firms continued to reduce other accounts payable. By contrast, the stock of debt securities strengthened slightly in 2012, and was up 2.5% on the previous year. However, given the small proportion of total liabilities that it accounts for, it was unable to significantly compensate for the decline in financing. The maturity structure of debt securities was also unfavourable, as short-term securities recorded the strongest growth. 36 Around 86% of other accounts receivable are trade credits and advance payments. The stock of equity rose by just over 1%, but this was largely attributable to positive developments on the Ljubljana Stock Exchange. Figure 30: Structure of financial liabilities of non-financial corporations and NFIs in Slovenia and the euro area, 2004-2012 Other Debt securities Trade credits Equity ■ Loans 100% 90% 80% 60% 50% 40% 30% 20% 0% Slovenia Purr, aroa Slovenia Euro area Slovenia Euro area Slovenia Euro area Slovenia ian Slovenia Fi irn arpa Slovenia Euro area Slovenia Euro area Slovenia Euro area ov 2004 2005 200 6 2007 2008 2009 2010 2011 2012 Sources: Bank of Slovenia, Eurostat; calculations by IMAD. A comparison with the euro area reveals that Slovenian non-financial corporations and NFIs are still more dependent on short-term financing than their counterparts in the euro area overall, while long-term financing remains relatively insignificant. In the past changes in capital in Slovenia were influenced by general developments on the capital markets, and much less by owners taking an active role in supporting the development of their firms via capital increases. This was to a large extent also a result of the ownership structure, given that a significant part of the Slovenian economy is still owned by the government or by state-owned firms. As a result of the poorly developed capital market, debt securities are also a relatively insignificant source of financing. Slovenian non-financial corporations and NFIs thus mainly rely on short-term financing, which puts them under more liquidity pressure in times of crisis. They thus have to expend a lot of energy dealing with financial problems instead of focusing on their core business. 3.3 Foreign corporate financing A major feature of foreign financing for Slovenian firms is that direct foreign financing, which is reflected in an increase in foreign liabilities of 'other sectors, exceeded the pre-crisis level in 2012, with only foreign loans still down. Nevertheless, the inflow of foreign financing via these channels has been very modest since 2008; the increase in 2012 was again significantly smaller (EUR 145.4 m) than that in 2011 (EUR 1,017.6 m). With regard to the banks' foreign liabilities that represent a potential source of corporate credit, the situation is even worse: these are still far below the pre-crisis level. Moreover, since 2009 there has been a significant outflow (return) of foreign financing via these channels, which intensified in 2011 and even more so in 2012. In short, foreign sources of corporate financing have been declining drastically since 2009, particularly in 2012. To be more precise, there has been a massive (and increasing) outflow of foreign financing, which hit a record high of EUR 2,407.1 m in 2012. Firms now in particular lack the foreign financing that they used to obtain via intermediation by domestic banks. The major sources of foreign corporate financing are liabilities of 'other sectors' (including other firms) and the banks' foreign liabilities37 that represent a potential source of corporate credit (Table 1). The former are direct sources of corporate financing, while the latter are indirect. The stock and trends in foreign corporate financing were examined in analysis of Slovenia's international investment position between 2002 and 2012. Until 2008 the total stock of foreign financing for firms, i.e. actual and potential (via banks) financing, had been rising very rapidly (it increased by almost 3.3 times between 2002 and 2008); since then it has declined continually. The decline was entirely the result of a fall in bank lending from foreign funding, while direct foreign financing continued to increase, albeit at a significantly slower pace. Between 2008 and 2012 firms received EUR 3,319.2 m in additional foreign financing via an increase in direct foreign liabilities, but at the same time there was also an outflow of foreign financing via banks in the high amount of EUR 7,230.2 m. Actual and indirect corporate foreign financing thus declined by EUR 5,911.0 m during this period, and by EUR 1,555.2 m in 2011 alone and as much as EUR 2,407.1 m in 2012. Between 2002 and 2008 the total stock of direct foreign corporate financing, which is reflected in foreign liabilities of 'other sectors', was continuously increasing; it declined slightly in 2009, then started rising steadily again, albeit at fairly modest rates. That foreign liabilities of 'other sectors' have been rising throughout this period except in 2009 reveals that firms have consistently recorded positive inflows of foreign financing. This also holds true for the years of the economic crisis, i.e. from 2008 onwards. Although growth in foreign financing slowed markedly in 2009 (-2.4%) and 2010 (2.0%), it rose notably in 2011 (5.2%) Table 1: Liabilities of 'other sectors' and bank liabilities that are a source of corporate credit in the International Investment Position of Slovenia: liabilities by variable, 2002-2012, EUR m ______ 2002 2005 2007 2008 2009 2010 2011 2012 DIRECT INVESTMENT IN SLOVENIA 9052.6 13974.8 17707.6 19489.4 19028.4 19413.9 20431.5 20808.6 Equity and reinvested earnings 3308.6 5427.9 8547.1 9787.2 9055.9 9401.1 10277.6 10423 Net liabilities to affiliates 2974.2 4901.7 5558 6023.7 5958.3 6094.3 6120.1 6112 PORTFOLIO INVESTMENT 334.4 526.2 2989.1 3763.5 3097.6 3306.8 4157.5 4311 Equity securities 96.4 274.6 1215.6 544.3 849.4 894.4 870.3 885.8 Debt securities (bonds and notes) 74.8 261.3 1209.4 540.5 578.3 644.3 629.9 648.3 TRADE CREDITS 21.6 13.3 6.2 3.8 271.1 250.1 240.4 237.5 LOANS 1730.3 2855.2 3855.5 4018.7 3429.4 3716.1 3868 4112.1 OTHER LIABILITIES 3831.7 5319.5 4057.9 5102.5 5693.7 5402.3 5415.6 5387.7 BANK LIABILITIES THAT ARE A POTENTIAL SOURCE OF CORPORATE CREDIT (total) 85.6 97.6 31.5 36.7 133.6 133.8 155.9 178.2 Debt securities (bonds and notes) 2425 8643 16216.4 17886.5 16414.2 16013.2 13440.5 10656.3 Loans 19.6 336.3 352.7 436.9 2033 2771.7 2450.5 1129.5 Currency and deposits 1633 5929.6 11374.9 12704.7 9740.2 9127 7678.2 6717.2 Other liabilities 662.3 2312.6 4450 4701.3 4621.8 4106.4 3307.6 2805.5 Ostale obveznosti 110.1 64.5 38.8 43.6 19.2 8.1 4.2 4.1 SKUPAJ 11477.6 22617.8 33924 37375.9 35442.6 35427.1 33872 31464.9 Source: Bank of Slovenia, 2013. 37 Debt securities (bonds and notes), loans, currency and deposits and other liabilities. and then eased significantly again in 2012 (1.8%). The banks' foreign liabilities that represent a potential source of corporate credit reveal a different picture. After rising rapidly until 2008, they began to slow, suggesting that this potential source of corporate financing is declining. A dramatic fall was seen in 2011 (-16.1%) and particularly in 2012 (-20.7%), when direct foreign corporate financing was already improving slightly. Since 2008 the total (actual and potential) stock of foreign corporate financing has thus been falling solely as a result of a decline in foreign financing reaching firms via bank intermediation, while direct foreign corporate financing has continued to increase, albeit slowly (Figure 31). Figure 31: Liabilities of 'other sectors' and bank liabilities that are a potential source of corporate credit in the International Investment Position of Slovenia, 2012-2012, total, EUR m ■ Liabilities of 'other sectors' ■ Bank liabilities that are a potential source of corporate credit ■ Total Table 2: International investment position of Slovenia's 'other sectors': liabilities by variable at the end of 2012 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Source: Bank of Slovenia, 2013. The most important foreign source of corporate financing is foreign direct investment (FDI), followed by loans. At the end of 2012 FDI accounted for 50.1% of all foreign financing of 'other sectors'; 29.4% thereof comprised equity and reinvested earnings while 20.7% comprised Slovenian subsidiaries' net liabilities to parent companies arising from intracompany loans. Loans accounted for 25.9% of foreign financing and trade credits for 19.8%. Portfolio investment accounted for merely 4.3%, of which 3.1% comprised equity securities and 1.1% debt securities (Table 2). However, in light of the figures for direct foreign financing via domestic bank intermediation, the dominant form of inflows of foreign financing is certainly loans. FDI equity has been the most important foreign source of financing of 'other sectors' during the EUR m % LIABILITIES OF 'OTHER SECTORS': total 20808.6 100.0 DIRECT INVESTMENT IN SLOVENIA 10423 50.1 Equity and reinvested earnings 6112 29.4 Net liabilities to affiliates 4311 20.7 PORTFOLIO INVESTMENT 885.8 4.3 Equity securities 648.3 3.1 Debt securities: bonds and notes 237.5 1.1 TRADE CREDITS 4112.1 19.8 LOANS 5387.7 25.9 OTHER LIABILITIES 178.2 0.9 Source: Bank of Slovenia, 2013. crisis, while net liabilities to affiliates and trade credits have also risen above the pre-crisis level after an initial fall. Liabilities from issued debt securities increased sharply in 2009, i.e. during the crisis, but the increase was one-off and remained modest. Loans and equity securities have recorded the lowest figures during the crisis. They have still not recovered from very rapid and dramatic falls - loans in 2007 and equity securities in 2008 - and are far lower than before the crisis. In 2012 the stock of loans continued to decline, meaning that the corporate sector was making net repayments of loans to foreign creditors. Figures 32 and 33 show the trends in the stock and structure of foreign liabilities of 'other sectors'. The most obvious feature of the flows in Figure 32 is a substantial increase in the stock of liabilities from FDI after 2006. Only to a very small extent was this increase the result of an increase in equity and reinvested earnings; it was primarily the result of an increase in Slovenian subsidiaries' net liabilities to affiliates, i.e. in net liabilities via business-to-business lending at Slovenian subsidiaries. This was primarily due to a methodological change, which extended the statistical monitoring of intracompany loans from parent companies to all firms in a group. The stock of loans plummeted in 2007 and has yet to return to the pre-crisis level. The stocks of trade credits and net liabilities to affiliates declined in 2009 alone, and have already reached their pre-crisis values. The stocks of equity and debt securities remained modest throughout this period; after falling dramatically in 2008, the stock of equity securities remains around half that recorded in 2007, while the stock of debt securities remains unchanged after a substantial increase in 2009 (Figure 32). Despite this divergent movement in individual types of foreign corporate financing (taking into account the impact of the methodological change in monitoring intracompany loans between affiliates within FDI, which has not only raised the proportion accounted for by 35,000 30,000 25,000 20,000 15,000 10,000 5,000 this component, but has also reduced the proportions accounted for by other components), the structure of financing remains relatively stable (Figure 33). Figure 32: Stock of liabilities of 'other sectors' in the International Investment Position of Slovenia: liabilities by variable, 2002-2012, EUR m FDI: total o FDI: equity and reinvested earnings —a— FDI: net liabilities to affiliates ---------Equity securities ---Debt securities: bonds and notes —— Trade credits 1 -----Loans o >— «— Source: Bank of Slovenia, 2013. Figure 33: Structure of liabilities of 'other sectors' in the International Investment Position of Slovenia: liabilities by variable, 2002-2012, % FDI: total o FDI: equity and reinvested earnings —&— FDI: net liabilities to affiliates - Equity securities ----Debt securities: bonds and notes —■■— Trade credits ----- Loans Source: Bank of Slovenia, 2013. 4. Risk migration between the banking system and the public finances It is assessed that there is a high level of mutual risk migration between the banking system and the public finances. One of the main reasons for Slovenia's sovereign downgrading is the bad shape of its banking system. The bad situation at the banks is impeding lending to the Slovenian economy. This is keeping economic activity low, which is reducing general government revenue and increasing general government expenditure. Recapitalisations of Slovenian banks are a major factor in the widening of the deficit, and are therefore significantly increasing the government borrowing requirement. Access to funding for the government has declined strongly in the last two years. The government again increased its short-term borrowing at domestic banks, which can use government securities as collateral for refinancing operations with the ECB, so that their liquidity remains unaffected. In view of the deteriorating situation, the banks have even become averse to financing clients with higher credit ratings, which given the increasing stock of non-performing claims is additionally raising the share of non-performing claims and is aggravating the situation in the Slovenian banking system. The performance of Slovenian banks is worsening from year to year, which is increasing the pressure on the capital adequacy of the Slovenian banking system and hence the need for fresh capital. The deterioration in bank performance is the result of increased creation of additional impairments and provisions and a sharper fall in net interest income. The latter is attributable to a decline in high-quality clients, which do not fall into arrears on payments of maturing liabilities, and the faster fall in asset interest rates than in liability interest rates. 4.1 Banking sector's impact on the public finances The bad shape of its banking system makes Slovenia particularly vulnerable on the international financial markets, which tend to react strongly to any deterioration in the euro area. For instance, after the Cyprus bailout at the end of the first quarter, the yields to maturity on Slovenian bonds recorded the largest rises of any euro area country. We estimate that alongside domestic factors this is also a result of the perceptions of foreign investors, who are now paying closer attention to other countries with banking system problems, even though the situation 10,000 8,000 3 6,000 4,000 2,000 0 60% 50% 40% 30% 20% 10% 0% in Slovenia is quite different to that in Cyprus.38 Previously, a strong impact on public finances from the banking sector had also been seen in the case of Ireland, where the state of public finances deteriorated dramatically in just one year, entirely as a result of the bad situation in the banking system, Ireland having previously been regarded as a financially sound country, with a fiscal surplus before the international financial crisis. Figure 34: Yields-to-maturity on government bonds of certain euro area countries Slovenia Germany Spain - Slovakia Italy Source: Bloomberg. In the absence of other funding, the growing need of the Slovenian banking system for fresh capital is putting pressure on the public finances. Since the outbreak of the financial crisis,39 the government has spent over EUR 700 m on direct recapitalisations from the budget, not including recapitalisations of state-owned firms. The recapitalisations have nevertheless barely sufficed to satisfy the minimum capital requirements of regulators; capital adequacy has not improved much in this period, and has actually increased less than in the euro area overall (see 2.1.4). In 2011 and 2012 bank recapitalisations contributed 0.7 percentage points and 0.2 percentage points respectively to the widening of the budget deficit relative to GDP, while in 2013 they are projected to contribute 3.7 percentage points. The bank recapitalisations after the transfer of the most toxic assets are projected to significantly exceed the 38 The Slovenian banking system is much smaller than that of Cyprus (in terms of both the absolute level of the banks' total assets, and, in particular, the ratio of total assets to GDP). Its structure is also quite different. 39 After the collapse of Lehman Brothers. amount spent for improving the capital adequacy of state-owned banks between the outbreak of the financial crisis and the end of the first quarter of this year (approximately EUR 700 m). Figure 35: General government revenue and expenditure in connection with bank ownership as of the initial bank restructuring Revenue Expenditure Sources: Ministry of Finance; calculations by IMAD. A comparison of revenue and expenditure related to bank ownership reveals a negative balance from state ownership in the Slovenian banking system. The cash flow from dividend payments has declined significantly during the crisis, and amounted to around EUR 4 m in the period from 2009 to 2011. In the period after the first bank restructuring40 and before the intensification of the financial crisis, cash flows from dividends were much larger, at over EUR 130 m; this is however still a fairly modest return in our assessment, especially if it is taken into account that the first bank restructuring cost around EUR 850 m (DEM 1.6 bn), which means that the total fiscal impact amounted to between EUR 1.5 bn and EUR 2 bn. The bad shape of the Slovenian banking system is worsening the situation in the Slovenian economy, which is also being reflected in the calling of 40 After the approval of the articles of association and the establishment of the governing bodies, the Bank of Slovenia issued a decree implementing the decree on the completion of the restructuring process at the two banks on 22 July 1997. The completion of restructuring brought an end to the special status of the two banks, and put them on the same footing as other commercial banks, meaning that the banks have to follow the same principles of safe and sound banking operations as all other banks (Hafner, 2013). 3,000 2,500 8 2,000 7 1,500 6 1,000 5 4 500 3 0 2 0 guarantees provided on the basis of laws41 adopted to mitigate the financial crisis. On the basis of these laws the government issued around EUR 2.5 bn in guarantees (almost 90% of which were guarantees to banks) and received just over EUR 60 m in commissions. Between 2009 and 2012 EUR 47 m of guarantees were called, which is, according to our assessment, 15% of all guarantees provided to nonbanking subjects. 4.2 Importance of bank restructuring for the Slovenian economy The Slovenian economy is primarily financed through the banking system. This is a consequence of the nature of the Slovenian economy, and the prevalence of SMEs, which do not have access to the capital market or for which acquiring financing on the capital markets is not economically viable because of high costs. It is assessed that the banks will therefore remain one of the main sources of financing for the Slovenian economy. It is therefore urgent to restore the soundness of the banking system as soon as possible to provide for a more normal financing of the Slovenian economy, and to prevent the further spread of the adverse effects of the crisis through the banking system to the economy. Other segments of the financial sector are poorly developed, as a result of which bank financing is also a relatively important source of funding for large enterprises, for which financing via the capital market would be sensible, were the capital market not shallow and illiquid. The institutions of this segment are also relatively insignificant. The banking sector accounts for as much as 77.3% of the financial assets of the Slovenian financial system,42 while the financial assets of other financial intermediaries account for a lower proportion than in the euro area overall. The transfer of bad claims from the Slovenian banking system to a bad bank addresses two major problems faced by Slovenia: the large share of bad claims in the banking system and the over-leveraging of the Slovenian economy. It directly 41 Public Finance Act (ZJF-D; Official Gazette of the Republic of Slovenia, No. 109/2008), Republic of Slovenia Guarantee Scheme Act (ZJShemRS; Official Gazette of the Republic of Slovenia, Nos. 33/09 and 42/09), Act on the Natural Persons Guarantee Scheme of the Republic of Slovenia (Official Gazette of the Republic of Slovenia, No. 59/09). 42 Excluding the central bank, the euro area average (excluding Germany, Ireland and Slovakia) is 55%. reduces both the stock and the share of bad claims in the Slovenian banking sector, which have been rising since the second half of 2008. The transfer of claims to a bad bank would, should they be converted into equity, reduce the indebtedness of those firms whose debts were transferred to the bad bank. Firms with lower leverage would thus be under less liquidity pressure and could devote more energy to their core business, thus becoming more attractive to potential investors. Once the banks have been relieved of major risks, it will also be easier to determine the quantity of capital needed to ensure their capital adequacy in the longer term. This would facilitate a more normal functioning of the Slovenian banking system, which would then be able to finance those firms that are not over-leveraged and have business opportunities. In previous years the problems of the Slovenian banking system were dealt with solely by recapitalisations, most of which were intended only to satisfy the minimum capital adequacy or the requirements of the regulator. However, the minimum amount of capital did not allow banks to take up new risks, where economically viable lending could have contributed to an increase in the stock of higher-quality claims, reducing the problem of bad claims in relative terms. However, until the adoption of the Act Determining the Measures of the Republic of Slovenia to Strengthen Bank Stability (Official Gazette of the Republic of Slovenia, No. 105/12), little was done to improve the management of bad claims in the banking sector and to reduce the stock of bad claims. The impact of the law is likely to be discernible even in the second half of this year, when the situation in the banking system is expected to stop deteriorating and perhaps to start improving gradually. 5. Challenges Alongside other structural reforms, restoring the soundness of the banking system is the key to the recovery of the Slovenian economy. An effective and transparent restructuring of the banking system would contain risk migration between the Slovenian banking system and the public finances. A successful bank restructuring is essential to halting the deterioration in the Slovenian banking system and obviating the constant need for bank recapitalisations. After a one-off increase in general government expenditure, this will relieve the pressure on the public finances and on state-owned firms, which used to participate in recapitalisations in the past. A successful bank restructuring is also a prerequisite for easing the pressure from international financial markets, which would in turn improve access to funding. Once they have clean balance sheets and sufficient capital adequacy, the banks will be able to take up new risks. Better access to bank financing will improve the business conditions for firms with sound financial structure and good business opportunities. A rise in the number of creditworthy clients will also ease the downward pressure on the quality of the banks' assets. To improve the efficiency of the economy, it is necessary to reduce the government's ownership role, and to put in place an ownership structure that will facilitate corporate development and improve corporate governance. State ownership, which is still significant in the Slovenian economy, has proved to be less than optimal in our assessment. As a result of the ineffective governance of state-owned firms in the past, in most cases state ownership only places an extra burden on the public finances. Under the current circumstances, the best solution would be to find strategic private investors for firms for which there is actual demand at the appropriate price. In this way the government could also improve its credibility for further privatisation processes. To improve the financial structure of firms in Slovenia, it is also necessary to ensure the proper functioning of other segments of financial services, which primarily rely on longer-term funding. Large, more financially stable firms could thus also seek financing under more favourable conditions on other financial markets. Furthermore, the crowding out of SMEs from bank financing would also be reduced, and these firms could, to a certain extent, also take advantage of better access to long-term financing. Literature Alessi, L., Detken, C. (2011). Quasi real time early warning indicators for costly asset price boom/bust cycles: a role for global liquidity. European Journal of Political Economy, Vol. 27, No. 3. Bank of Slovenia (2013). Stres testi banke Slovenije (Bank of Slovenia Stress Tests). Available at http://www.bsi.si/ iskalniki/sporocila-za-javnost.asp?VsebinaId=15881&MapaId=137#15881. Bank of Slovenia (various issues). Monthly Bulletin. Ljubljana. Bank of Slovenia (various issues). International Economic Relations. Ljubljana. Bank of Slovenia, 2013. Macroeconomic Developments and Projections. Ljubljana. Bank of Slovenia (various issues). Financial Stability Review. Ljubljana. Bank of Slovenia (various issues). Stability of the Slovenian Banking system. Ljubljana. Bank of Slovenia, 2013. 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Annexes Definition of indicators used in the analysis of indebtedness and financial structure of Slovenian enterprises and the values of selected indicators Share of debt in total liabilities = ^ (Provisions and long-term accrued costs and deferred revenues (aop72) + Long- 1=1 term liabilities (aop75) + Short-term liabilities (aop85) + Short-term accrued costs (expenses) and deferred payments (aop95)) / ^ (Liabilities (aop55)), where i=1, 2,...n and n is the total number of enterprises covered by the sample. =1 Share of debt relative to capital = ^ (Provisions and long-term accrued costs and deferred revenues (aop72) + Long- =1 term liabilities (aop75) + Short-term liabilities (aop85) + Short-term accrued costs (expenses) and deferred payments (aop95)) / ^ (Equity capital (aop56)), where i=1, 2,...n and n is the total number of enterprises covered by the sample. =1 Share of debt relative to EBITDA = ^ (Provisions and long-term accrued costs and deferred revenues (aop72) + Long- =1 term liabilities (aop75) + Short-term liabilities (aop85) + Short-term accrued costs (expenses) and deferred payments (aop95)) / ^ (Operating profit (aop151) - Operating loss (aop152) + Depreciation (aop145)), where i=1, 2,...n and n is =1 the total number of enterprises covered by the sample. Net sales on the domestic market = ^ (aop110), where i=1, 2,...n and n is the total number of enterprises covered by =1 the sample. Financial liabilities to banks = ^ (Long-term financial liabilities to banks (aop78) + Short-term financial liabilities to =1 banks (aop89)), where i=1, 2,...n and n is the total number of enterprises covered by the sample. Accounts payable to suppliers = ^ (Long-term accounts payable to suppliers (aop82) + Short-term accounts payable i=i to suppliers (aop93)), where i=1, 2,...n and n is the total number of enterprises covered by the sample. Share of bank loans in total liabilities = y (Long-term financial liabilities to banks (aop78) + Short-term financial n 1=1 liabilities to banks (aop89)) / y (Liabilities (aop55)), where i=1, 2,...n and n is the total number of enterprises covered =1 by the sample. Share of accounts payable to suppliers in total liabilities = y (Long-term accounts payable to suppliers (aop82) + n 1=1 Short-term accounts payable to suppliers (aop93)) / y (Liabilities (aop55)), where i=1, 2,...n and n is the total number =1 of enterprises covered by the sample. Return on assets = y (Net profit for the period (aop186) - Net loss for the period (aop187)) / y (Liabilities (aop55)), =1 =1 where i=1, 2,...n and n is the total number of enterprises covered by the sample. Value added = y (Gross operating returns (aop126) - Costs of merchandise, material and services (aop128) - Other =1 operating expenses (aop148)), where i=1, 2,...n and n is the total number of enterprises covered by the sample. Share of financial expenses from financial liabilities relative to net sales = y (Financial expenses from financial n 1=1 liabilities (aop169)) / y (Net sales (aop110)), where i=1, 2,...n and n is the total number of enterprises covered by the =1 sample. Share of financial expenses attributable loans received from banks relative to net sales = y (Financial expenses n 1=1 attributable to loans received from banks (aop171)) /y (Net sales (aop110)), where i=1, 2,...n and n is the total number =1 of enterprises covered by the sample. Share of financial expenses attributable to loans received from companies in the group relative to net sales = y (Financial expenses attributable to loans received from companies in the group (aop170)) / y (Net sales (aop110)), =1 =1 where i=1, 2,...n and n is the total number of enterprises covered by the sample. Share of financial expenses attributable to issued bonds relative to net sales = y (Financial expenses attributable n 1=1 to issued bonds (aop172)) / y (Net sales (aop110)), where i=1, 2,...n and n is the total number of enterprises covered =1 by the sample. Share of financial expenses from other financial liabilities relative to net sales = y (Financial expenses from other n 1=1 financial liabilities (aop173)) / y (Net sales (aop110)), where i=1, 2,...n and n is the total number of enterprises covered =1 by the sample. Financial expenses attributable to loans received from banks = y (aop171), where i=1, 2,...n and n is the total =1 number of enterprises covered by the sample. Share of long-term financial liabilities to banks relative to total liabilities = y (Long-term financial liabilities to n 1=1 banks (aop78)) / y (Liabilities (aop55)); where i=1,2,...n and n is the total number of enterprises covered by the sample. =1 Share of short-term financial liabilities to banks relative to total liabilities = y (Short-term financial liabilities to n 1=1 banks (aop89)) / y (Liabilities (aop55)); where i=1,2,...n and n is the total number of enterprises covered by the sample. =1 Net sales on foreign markets = y (Net sales on the EU market (aop115) + Net sales outside the EU market (aop118)), =1 where i=1, 2,...n and n is total the number of enterprises covered by the sample. Table P1: Selected indicators by different activities of private sector enterprises, 2006-2011 Share of revenues (in %) Growth (in %) Financial expenses from loans Financial expenses from bank loans Financial expenses from bank loans Sales revenues Manufacturing 2006 1.3 1 12.1 2007 1.5 1.2 40.3 14.2 2008 2.2 1.7 45.3 1.1 2009 2.2 1.7 -23.4 -20.7 2010 2.1 1.5 0.6 11.1 2011 1.8 1.5 4.8 5.6 Construction 2006 1.2 1 15.1 2007 1.3 1.1 49.8 44.2 2008 1.9 1.5 62 12.5 2009 2.4 1.8 -3.6 -20.1 2010 2.8 2.2 4.6 -13.6 2011 2.7 2.4 -12.8 -19.2 Wholesale and retail trade 2006 1.1 0.8 6.9 2007 1.3 1 34.8 8.9 2008 1.8 1.3 52.7 12.3 2009 1.6 1.2 -23.8 -13.8 2010 1.7 1.2 -1.3 -2.3 2011 1.6 1.1 -5.4 1.6 Financial intermediation 2006 68.6 46.4 31.6 2007 100.9 78.2 130.9 37 2008 145.2 112.9 82.1 26.2 2009 85.7 62 -55.7 -19.3 2010 95.4 75.5 31.7 8.1 2011 78.8 58.4 -23.9 -1.6 Real estate 2006 3.7 2.3 7.8 2007 5.6 3.5 95.5 30.4 2008 7.1 4.7 56.8 15.8 2009 7.5 4.4 -15.8 -8.8 2010 6.2 4 -2.3 7.9 6.3 4.2 1.9 -4.6 Source: AJPES; calculations by IMAD. Table P2: Selected indicators by different activities of private sector enterprises, 2007-2011 C D E F G H I J K 2007 Sales revenues 12.1 14.2 4.5 44.2 8.9 31.3 14.5 37 30.4 Value added 4.9 12.2 2.8 26.1 10.4 18.2 13.5 68.9 27.3 ROA 2.2 4.1 1.7 3.4 3.9 1.3 4.8 2.8 3.1 Bank loans to total liabilities 16.5 24.6 10.2 27 30.3 28.2 22.6 75.4 39.9 Long-term bank loans to total liabilities 7.5 11.1 7.7 8.5 15.2 21.9 14.8 60.6 20.3 Short-term bank loans to total liabilities 9 13.5 2.5 18.5 15.1 6.3 7.8 14.8 19.6 2008 Sales revenues 13.1 1.1 8.7 12.5 12.3 9.3 3.6 26.2 15.8 Value added 1.3 1.2 0.5 18 8.7 5.4 1.7 4.2 16.5 ROA -1 2.3 1.4 2.3 1.5 -1.5 2.7 0.6 1.7 Bank loans to total liabilities 19.9 27.8 12.3 28.3 33.2 33 26.3 75.4 41.6 Long-term bank loans to total liabilities 9.1 11.9 9.4 7.1 14.4 23.5 15.9 59.5 20.2 Short-term bank loans to total liabilities 10.8 15.9 2.9 21.2 18.8 9.5 10.4 15.8 21.4 2009 Sales revenues -6.4 -20.7 12 -20.1 -13.8 -2.2 -14 -19.3 -8.8 Value added 2.7 -14.8 -3.1 -14.5 -3.9 -1.1 -12.8 -21.5 12.1 ROA 0.2 0.02 0.9 -0.2 1.5 -1.5 -1 -0.7 0.8 Bank loans to total liabilities 23.1 28.6 12.6 30.9 31 33.8 25.7 75.6 39.6 Long-term bank loans to total liabilities 12.4 13.6 9.6 9.9 13.3 23.7 17.7 54.8 19.9 Short-term bank loans to total liabilities 10.7 15 3 21 17.7 10.1 8 20.8 19.7 2010 Sales revenues 6.6 11.1 3.3 -13.6 -2.3 -2.7 5.6 8.1 7.9 Value added -2.6 5.4 9.2 -22.3 -5.4 -3.8 2.2 3.1 -7.5 ROA 0.7 1.3 1.7 -4.3 -0.3 -2.4 -5.7 -1.2 0.2 Bank loans to total liabilities 23 28.6 15.8 34.6 33 35.1 27.1 74.9 38.8 Long-term bank loans to total liabilities 12.8 14.2 11.8 11.4 14.6 24.9 17.8 55.9 22.2 Short-term bank loans to total liabilities 10.2 14.4 4 23.2 18.4 10.2 9.3 19 16.6 2011 Sales revenues 0.2 5.6 4.8 -19.2 1.6 5.3 -4.1 -1.6 -4.6 Value added -0.01 1.1 11.7 -13.7 -4 2.8 -8.5 2.4 -1.4 ROA -0.1 1.9 1.5 -3.3 1.2 -3.3 -0.6 -1.5 -0.4 Bank loans to total liabilities 24.5 27.9 18.2 35.6 33.6 36 25.9 74.4 37.9 Long-term bank loans to total liabilities 15.2 13.7 14.9 12.2 18.5 22.1 15.7 55.3 21.8 Short-term bank loans to total liabilities 9.3 13.5 3.3 23.4 15.1 13.9 10.2 19.1 16.1 Source: AJPES; calculations by IMAD. Note: SCA2002: A&B: Agriculture-fishing; C: Mining; D: Manufacturing; E: Electricity, gas, steam and air conditioning supply; F: Construction; G: Wholesale and retail trade, repair of motor vehicles and motorcycles; H: Accommodation and food service activities; I: Transportation and storage; J: Financial intermediation; K: Real estate activities, rental and leasing activities.