Slovenia is at a turning-point. Will it fulfil its potential of becoming the first central European state to reach the average level of living standards in the EU? Or will it stagnate – growing at the same slow rate as neighbouring Austria, and never edging much ahead of Greece or Portugal?
The outcome will depend on the speed of reform, which until now has been much slower than in the rest of central Europe. That’s because Slovenia, unlike the Czech Republic or Hungary, has so far not seen the need for radical change. GDP per capita was $9,362 in 1996, about double the Czech and Hungarian levels. That is largely a reflection of achievements in the 1980s when Slovenia was the most developed republic of Yugoslavia, itself the richest of the east European states. The Slovenian government often argues that fine-tuning rather than radical reform is all that’s required.
Recent macroeconomic data suggest that it is being complacent. After growth of 4.1% in 1995, in 1996 the economy expanded 3.1% while industrial production moved up only 1%. The annual growth rate fell again in the first quarter of this year to 2.2%.
Slovenian economists blame the slowdown on languishing growth in the largest export markets. Exports to the EU – 67% of total exports – stagnated in 1995 and fell 5% in the first four months of this year. But that raises a fundamental question: why is Slovenia incapable so soon after the fall of communism of expanding its share in export markets? The official line is that companies are reorganizing in the wake of privatization and that they will soon bounce back. “In manufacturing industry, a massive amount of restructuring is taking place,” says Igor Strmsnik, deputy director of the government’s Institute of Macroeconomic Analysis and Development. He predicts that growth for 1997 will be between 3% and 4%, rising to 4.5% in 1998.
Although other observers question the pace of restructuring, almost everyone agrees that a key determinant of the speed of industrial restructuring will be whether the banking system can cope with the massive demand for corporate lending expected in the next three years. Like their counterparts in Germany or Austria, Slovenian corporates turn first to the banks rather than the stock market when they are planning capital expenditure – and for the six years since Slovenian independence they have been disappointed by short maturities and tough terms. “Interest rates are so high that there is little incentive to invest,” says Joze Mencinger, professor of economics at the law faculty of Ljubljana University.
The state of the banking system encapsulates the dilemma facing Slovenia. Reform began in earnest in 1993 when the government launched a scheme to restructure and recapitalize Nova Ljubljanska banka (NLB), the country’s largest bank, and Nova Kreditna banka Maribor (Nova-KBM), the third-largest institution by assets. The rehabilitation programme formally ended in June, and the country could quickly create the banking system it requires were the government to select the right model for bank privatization. At the same time, there are pressures to halt reform at this stage or to give away shares in the banks – which would appease pressure groups but condemn the country to slow growth.
“Time is not the issue here,” says Alojz Jamnik, director of Slovenia’s bank rehabilitation agency. “What matters is that we set up a structure of shareholders that would ensure proper governance and step up profitability.” He is against giving shares away for free in return for vouchers – a measure that Slovenia’s ailing voucher privatization funds have been lobbying for – arguing instead that the banks need fresh capital. “Many argue that a strategic partner to strengthen the banks is the best solution, especially when their operations are to spread to the international financial markets.”
NLB and Nova-KBM are certainly in a much stronger position now than they were in 1993, when both had negative equity and a large proportion of their assets was non-performing, placing massive strains on liquidity. The banks transferred their bad assets to the rehabilitation agency which in return gave them government-guaranteed bonds. The agency became the sole owner of both banks and appointed new management with a brief of cutting costs and introducing new lending procedures to prevent bad loans re-emerging.
NLB’s figures show how successful rehabilitation has been. By June 1997, capital had risen to $266 million and the bank had a BIS capital-adequacy ratio of 19.2%. Total assets were $3.53 billion and only 7% of that was non-performing. “Given the complexity of the circumstances and the scale of the problem, rehabilitation has been a success,” says Marko Voljc, president of NLB. “However, it took longer than it could have done because of the government’s decision – which I believe was correct – not to allow us to monetize our foreign-currency surpluses, which would have meant sacrificing the anti-inflation policy.”
According to Voljc, NLB has been operating like any other Slovenian bank since October 1996, which was when it last drew on a central-bank liquidity line reserved for banks in rehabilitation. But one area of concern has been the relative slow growth in lending – loans rose 7% in real terms in 1996 – at a time when companies should be investing heavily. “Loan growth could be faster,” says Voljc. “But not much faster if we are to preserve the quality of the portfolio. Given the share of loans in Slovenian GDP, non-bank loans could grow about two and a half times faster than GDP. So if the economy grows at between 3.5% and 4%, we could increase assets by 10% to 12%.” NLB’s latest figures show loan growth of 7% in the first half of 1997, suggesting that the bank may be on target to meet Voljc’s target.
The future of NLB and Nova-KBM became clearer in mid-July when the rehabilitation agency ceased to exercise some of the functions of an owner and the government appointed supervisory boards. In turn, the new supervisory boards appointed managers of the two banks. Not much has changed at NLB, where Voljc stays on as CEO and the agency’s Jamnik joins the bank as a member of its three-man management team.
But the changes at Nova-KBM are indicative of a worrying trend in Slovenia: the politicization of industry. The bank now appears to be controlled by the Slovenian People’s Party. This is the second-largest party in the ruling coalition and, with an electorate dominated by farmers and other rural voters, it has shown little support for pro-market reforms.
There have been other setbacks during the rehabilitation of Nova-KBM. A third bank, Komercialna banka Nova Gorica from western Slovenia, took part in the rehabilitation scheme. In 1995 the agency decided to merge it into Nova-KBM – which is based in the eastern city of Maribor – in an attempt to create a super-regional bank that could rival NLB and SKB banka, the largest private bank. That scheme failed because of regional tensions, with Komercialna banka staff going on strike at one stage. “Six months ago we realized that the only solution was to re-establish an independent bank in Nova Gorica,” concedes Jamnik. There are still just under 30 banks in Slovenia – far too many for a country of just 2 million people – and few mergers have taken place.
Despite the slow pace of economic reform, Slovenian banks and the government itself have been able to raise funds internationally at increasingly cheap rates. The country is a net creditor, with foreign exchange reserves of $3,875 million in May 1997, $40 million more than the foreign debt of all Slovenian residents; sovereign foreign debt stands at $1.59 billion. Slovenia is also the highest-rated east European state, rated A3 by Moody’s and single A by Standard & Poor’s.
In May NLB raised Dm150 million ($85 million) in the syndicated loan market at just 22 basis points over Libor – the cheapest loan so far for a Slovenian borrower. But the most impressive performance has been by the government itself. Its inaugural $325 million five-year Eurobond trades below swap rates, the only liquid east European issue to have achieved this feat. In late May the country set a new pricing low for east European borrowers in the Deutschmark bond market, raising seven-year debt at 43bp over Bunds. “The transaction was very well accepted by the market,” says Branko Greganovic, head of the ministry of finance’s public-debt management department. “It was launched at the tightest spread ever achieved by a comparable credit and the transaction was increased from Dm300 million to Dm400 million soon after launch.”
In April Slovenia adopted a new foreign-debt management strategy. It aims to achieve a currency structure for its debt of 40% US dollars, 45% Deutschmarks or euro-bloc currencies and 15% yen. It also intends to lift the proportion of fixed-rate debt to two-thirds. About half of outstanding debt comprises two series of floating-rate notes issued when Slovenia assumed part of the Yugoslav commercial bank debt. The country may refinance the first series of bonds, paying 13/16% over Libor. The country is also considering launching its first samurai or yankee issues in 1998.
But it is in its approach to the stock market – and especially to foreign portfolio investment – that the Slovenian establishment displays attitudes that died out in the rest of Europe earlier this century. Many companies have attempted to delay the listing of their shares on the stock exchange, ostensibly because they fear hostile takeovers while economists such as Mencinger have argued that portfolio investment and a stock exchange per se are of little value to Slovenia at this stage of its development. “Slowly companies’ way of thinking is changing,” says Tomaz Rotar, deputy chief executive officer of the Ljubljana Stock Exchange. “They still prefer bank loans when they are raising new funds, but in the years to come there will be some IPOs.” So far, only two listed companies have raised new capital: SKB banka and real estate group BTC.
Public offerings were included in the privatization programme only as an after-thought and the 150 or so companies that were privatized this way did so only because their employees could not afford to buy the whole company, not because of any commitment to wider share ownership or having their shares publicly traded. These public offerings involved shares being sold in exchange for vouchers, so no new capital was raised.
After many delays, the first privatized company began trading on the Ljubljana Stock Exchange in January 1996. Foreign portfolio investors moved into the market in September of that year when Lek, a large pharmaceutical company, started trading. Interest grew in the last few months of 1996 and beginning of 1997 with the SBI, the market index, rising from just under 1200 to around 1650 in January alone.
Then the central bank intervened. On February 8, it introduced regulations requiring foreign portfolio investors to hold their shares through custody accounts at Slovenian banks, which in turn were required to hold foreign-exchange reserves against these accounts. Since Slovenian banks will pass on the cost of these reserves, the attraction of Slovenian equities to foreign investors was artificially reduced. In reaction, the market collapsed, with the index falling 25% in a couple of days.
Banka Slovenije, the central bank, introduced these measures because it was facing a massive inflow of capital that threatened to destabilize the exchange rate of the Slovenian tolar – and also to push up inflation. “Last year inflation was 8.8% and the tolar depreciated only 3.3% against the Deutschmark,” says Janko Tratnik, international director at Banka Slovenije. “That is killing our exports. Foreign-exchange reserves grew by 4% of GDP when we have a balanced current account.”
The central bank has tried to sterilize the inflows by issuing Deutschmark-denominated short-term bills. “But our capacity to sterilize is limited,” says Tratnik. “So with these new measures we are trying to slow down the rate of inflow. We are not closed to capital completely.”
Strategic investors were exempt from the central bank’s rules, provided they owned more than 50% of a company or had control through an agreement that gave them an effective veto on the shareholders’ assembly. In June, in a surprise move, Banka Slovenije diluted the regulations further. Henceforth, any foreign investor that agreed to hold its shares for at least seven years would still have to hold those shares in a domestic custody account, but there would be no need for reserves to be held against them.
Although the market rose after this step, some observers believe it will drive share trading offshore. While most portfolio investors would be unwilling to commit themselves to holding Slovenian equity for seven years, commercial banks might willingly do so and then issue global depository receipts which would be traded abroad. Domestic equity trading could dry up when it has barely started.
