The Slovenia Times

Recent issues show financial markets are relatively poor in predicting political developments



On Dec 14, 2018, S&P Global Ratings affirmed its 'A+/A-1' long- and short-term foreign and local currency sovereign credit ratings on Slovenia. The outlook remains positive. As the S&P Global claims: "The country's current account is in a substantial surplus, while net government debt is set to fall below 50% of GDP by 2020." What are your thoughts?

Country risk assessment provided by the rating agencies is an important indication of how a particular country is perceived in the global economy. It should, however, be clearly said that changes in the rating typically come with a time lag and are behind the actual economic and political situation in a country. Just to recall Slovenia's case. Though in the context of the recent crisis our economic performance started to deteriorate sharply and quickly already in 2009, Slovenia only experienced its first downgrading by the rating agencies two years later. So, the December 2018 affirmation of Slovenia's rating should be assessed in this context.

The rating rightly acknowledges significant positive developments in the country, especially high economic growth and the consequent decline of public debt as proportion of GDP. The other strongly positive development is that significant macroeconomic imbalances in the form of a large proportion of bad debts in the banking sector and large corporate-sector indebtedness have been largely eliminated. And finally, the growth drivers today are completely different than in the years prior to the 2009 crisis. At that time, economic growth was strongly driven by domestic consumption while today the growth is much more balanced and export based. This dramatic change is most clearly illustrated with the current account figures. While in 2007 Slovenia had a deficit of around 5% of GDP, now now run a surplus at an annual rate around 7% of GDP. Of course, high dependence of the country on the exports - it is logical for a small, highly open economy - is associated with certain risks as well. If the global economy cools down, which is actually already taking place, then this will quickly have negative implications on our export-based growth. Within this context, I am also not particularly happy with the recently proposed budget proposal. In my view, it is simply inappropriate or at least unwise that cyclically increased public finance revenues are by and large transformed into increased public expenditures with no clearly articulated structural reform agenda. In the current highly favourable international environment, public finance surplus should simply be higher than the one planned by the government. Similarly as before the 2008 crisis, we are again not using "good times" to strengthen the fiscal buffers for "bad times". It is more than obvious that the coalition composed of a rather large number of political parties is in fiscal terms a rather expensive governance structure.

What does the sale of the country's largest bank, Nova Ljubljanska Banka (NLB), mean for the Slovenian financial system and economy?

Slovenia's 2009-2013 crisis was a combination of banking and a sovereign crises. In 2013, our country was on the edge of a default and one of the main reasons were major weaknesses of the banking sector. The problem of this sector was addressed with a massive recapitalisation of major state-owned banks that was implemented under the state aid rules agreed with the European Commission. Under these agreements, Slovenia committed itself to restructure the near defaulted banks and then privatize them. The privatization of NLB should therefore be seen as a somewhat delayed implementation of the state aid commitment made in 2013. The method of NLB privatization that has been selected by the authorities reflects the realities of the banking industry in Europe these days, as well as the policy choices of the owner. In circumstances where selling to a strategic investor was not very realistic, the selected method of privatization seems to have been the most appropriate one. It allows the bank to remain an independent financial institution with a significant market share not only in Slovenia but in the region of South Eastern Europe as a whole. This is even more important at the time when some of the largest international banking groups have either reduced their presence in the region or plan to leave the region altogether. The privatization of the largest commercial bank in the country, however, poses a question to the authorities as to what strategy of financial sector development they will pursue in the country. Here I do not mean the banking sector only but the financial sector as a whole, including the insurance business and financial markets. Issues concerning the relationship between economic growth and financial sector development should also be addressed. One question within this context is, for example, the following. What kind of a role do the authorities envisage for the SID bank that will, in a not-so-distant future, remain the only important state owned bank in the country? This institution played a very important counter-cyclical role during the previous crisis. Should this role be continued or even strengthened?

Political uncertainty also raises questions about the shape of international trade, the outcome of Brexit and Italy's budget. Could this affect the euro and how?

If we first look at the global economy as a whole, it is these days being faced with a number of challenges. They range from geopolitical ones, including Donald Trump's economic and especially trade policy, over macroeconomic challenges caused by growing debts and large differences in policies run by major central banks, especially FED and ECB, to the challenges associated with digitalisation and climate changes.

Of course, all these global challenges affect the EU and the Eurozone in various ways. On the security side, Europe cannot rely exclusively on transatlantic partnership any longer. It will have to develop its own security and defence mechanism. The global economic and political governance is changing fast, and the status of the EU in the world is increasingly challenged not only by the US and China but also by EU's large neighbours, Russia and Turkey. The weakening of the EU in a global arena is clearly visible in the Balkans, where the vacuum created by the de-facto fading commitment of the EU for expansion in the region is increasingly filled out by the growing presence of other global powers. Among other political challenges of the EU in the forthcoming period, Brexit, migrant issues and political changes in EU institutions seem to be the most pressing. On the economic side, the EU is still faced with an incomplete institutional reform of the Eurozone. Unfortunately, due to the lack of political appetite for further reforms in this area, they will probably be addressed no earlier than the moment we are faced with a new crisis. Experience namely confirms that the EU is ready to make politically difficult decisions in circumstances when they are absolutely necessary.

What are the highlights from the global monetary perspective after the UK leaves the EU?

Financial markets have proved to be rather good in predicting macroeconomic as well as business developments. On the other hand, these markets have proved to be rather poor in forecasting political developments. Let us be reminded about two first-class political events in recent years where financial market predictions were completely wrong. One was the election of Donald Trump for President of the USA and the other one was the outcome of the Brexit referendum. As unpredictable political developments are becoming the "new normal", it is realistic to expect that they will be accompanied with more intensified economic fluctuations as well as with more unpredictable changes in the global business environment.

When we talk about implications of the planned departure of the UK from the EU on monetary policies of major central banks, it really depends on the conditions under which Brexit will actually happen (if it happens at all). In case of a "hard" Brexit, we can expect a significant weakening of the pound over the medium-term term, although a part of this has already been integrated in the current price of the UK currency. This kind of a Brexit will also constitute an additional concern for ECB that is already challenged with weakening growth in the EU and softening fiscal and public debt commitments of some larger members, especially Italy and France. As far as the US dollar is concerned, its exchange rate developments over the next year or two are expected to be largely determined by the US domestic agenda as well as with its trade and financial relations with its major economic partners, especially China, the EU and Japan. Overall, it is realistic to expect that in the forthcoming period exchange rates among major currencies will fluctuate more intensively than in the recent past with political developments rather than economic fundamentals being the main reason for this increased volatility.

Growth is slowing in the euro area, while the EU parliamentary elections will happen in May 2019. Is the EU sufficiently prepared to withstand another recession and is there any correlation with the upcoming elections?

It has already been mentioned that the EU will face numerous political challenges in 2019, from Brexit through the EU parliamentary election to the formation of the new Commission and appointment of the new ECB president. The EU has never faced so many institutional changes within one year. Of course, this may mean that at the end of this year, the EU may look quite different from today.

The EU faces all these institutional challenges in circumstances of solid economic growth and significantly reduced macroeconomic imbalances. In terms of its economic governance, as well, the EU is much better prepared for recession or even a new financial crisis than it was in 2008. For example, the financial sector, though not fully cured, is in a much better shape that it was a decade ago. Also, the euro zone's institutional structure today is much better than at that time. On the one hand, crisis prevention infrastructure has been strengthened via the so-called "Six Pack, "Two Pack", Fiscal Compact and the banking union. On the other hand, euro zone has created a completely new crisis resolution mechanism called the European Stability Mechanism. So yes, the EU and eurozone are better prepared for bad times than they were a decade ago, but their institutional structure is still a work in progress.


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