Slovenia, yet another "success" story of the Eurozone

The European authorities have engaged in a shameless PR campaign, presenting the Greek default as a resounding success. Prime Minister Luca Papademos said before the nation that the debt restructuring represents a "historic success", which for the first time results in a reduction of the public debt. The former official of the European Central Bank neglected to explain however, how the debt reduction actually works, when a "haircut" of 110 billion Euros is actually replaced with loans of 130 billion Euros.

Now the markets have turned their attention to Portugal, Spain and even Ireland, which was denied the request to postpone the payment of 3.1 billion Euros, which was coming to maturity at the end of this month.

For now, the banks have focused on the countries in the first line of European bankruptcies, and have been neglecting the countries in the second tier, where Slovenia is currently ranked.

In a hurry to leave the political instability of the former Yugoslavia behind, the Slovenians became EU citizens in 2004 and joined the Eurozone in 2007. New markets opened up for the Slovenian companies, the interest rates fell and a wave of foreign financing boosted the economy.

Between joining the EU and until 2008, the country's GDP increased 5%, compared to an average of 4% seen between 1993 and 2003. Unfortunately, the drawbacks of switching to the Euro were not noticed or were disregarded until the onset of the global financial crisis.

The economic growth was stimulated by the unprecedented advance of the private debt, which came to amount to 130% of the GDP at the end of 2011. In 2004 the leverage of the private sector was about 75%, according to Eurostat data.

Between 2004 and 2007, the weight of the public debt in the GDP fell from 27% to 23%, and then boomed, amid the fiscal stimulus measures, rising to almost 48%, in 2011. Since the adoption of the Euro in 2007, the public debt of Slovenia almost doubled, up to 16.8 billion Euros. The IMF estimates indicated a public debt of 42.3% of the GDP in 2011 and 48%, in 2014.

The foreign and the budget deficits have significantly increased after entering the Eurozone, and the average structural deficit (author's note: a variable which is very carefully tracked, according to the provisions of the new European fiscal treaty) over the last four years was 3.9%, according to data from the IMF, whereas in 2005 it was less than 1%.

Now, the European Commission has put Slovenia on the list of European countries which need to be carefully watched to determine whether they are "risky or harmful" for the entire Union. I wonder how the Slovenians are feeling about having somehow managed to become "harmful" to the EU in just five years?

In the IMF report, on the state of Slovenia's economy, of May 2011, it was estimated that the unemployment rate would reach 7.5%, in December 2011, and the economic growth in 2011 would be 2%. The official data from Ljubljana show an unemployment rate of 12.5%, whereas the economy contracted 0.2% (author's note: after the GDP fell 2.8% in Q4 2011). According to the latest government estimates, Slovenia's economy would contract 0.9% in 2012, and the unemployment rate would grow to 12.9%.

How has it come to this? That's simple, we are talking about the same explosive growth of the debt, which far exceeds the ability of the real economy to repay them. Whereas the GDP increased 31% in nominal terms, the total debt has increased almost 130%, since joining the EU.

Since it is difficult to attract deposits in a country with 2 million inhabitants, the banking system lent money from foreign sources. The average loan to deposit ratio reached a peak of 162.7%, in 2008, and even exceeded 250% in the case of banks with foreign shareholders.

The dependency on foreign financing remained extremely high in 2011 as well, as the loan/deposits ratio stood at 140% for the banking system and over 200% for the banks with foreign controlling shareholders.

As it was to be expected, lending has also targeted the residential real estate sector, which has seen an "impressive" speculative bubble.

The latest report on financial stability, published by the Slovenian Central Bank in December 2011, states that real estate prices have increased at a rapid pace until 2008, but have only decreased slightly since then, in spite of the large stock of unsold homes. Does that sound familiar?

Another thing in the report of the central bank it also states that "the downward pressure on real estate prices will increase over the next two years, in spite of the contraction of construction activity", because "many of the unsold homes are unattractive because of their features or location". Again, does that sound familiar?

Joining the big European family, (author's note: which proves increasingly dysfunctional) stimulated the optimism of companies, which caused them to "accumulate" loans for expansion.

Since joining the Eurozone, the total debts of companies have increased to almost 100% of the GDP, from about 65% in 2007, as these debts have reached almost 140% of their equity in Q2 2011.

Many of these loans have gone sour over the last few years, and that trend has become increasingly prevalent in 2011. Loans more than 90 days overdue have reached 11.4% of the total loan portfolio of the banking system, in September 2011, with a nominal value of 5.7 billion Euros. For non-financial companies, things are far more dire, as payments more than 90 days overdue have reached 18.6%, up from 2.3% at the end of 2010.

About 44% of the loans granted to the construction sector were more than 90 days overdue in September 2011, and for loans granted to the IT and telecom sector loan repayments more than 90 days overdue exceeded 28%.

In the 2011 report on the financial stability of the Slovenian banking system, the country's central bank states that "the portfolios of loans granted to non-financial companies are the worst in the case of big banks with local shareholders", and the negative trend will continue into 2012.

Slovenian companies now need 4 billion Euros in additional capital (author's note: about 11% of the GDP of Slovenia in 2011), in order to be successful in acquiring new loans, according to recent statements by the governor of the central bank.

The disastrous consequences of the irrational exuberance generated by cheap money are naturally being felt by the banking system as well.

Slovenian banks reported record losses in 2011, as the economy once again entered recession. The data of the central bank shows cumulated losses of 356 million Euros, as the banks allocated 1.1 billion Euros for provisions.

Nova Ljubljanska Banka and Nova KBM, the top two banks of the system, recently borrowed 1.7 billion Euros from the ECB, as part of their long-term refinancing operation. Unfortunately, those kinds of loans do nothing to improve the quality of the assets in the portfolios of the two state-owned banks. The financial situation of Nova Ljubljanska, the largest in Slovenia, is so dire, that the central bank even considered taking it over and managing it directly, according to a piece of news published by Bloomberg in February 2012.

The fall of the economy in 2009, when the GDP fell by over 8% compared to the previous year, caused a surge n increase in the social and political tension, as an austerity program needed to be urgently implemented.

The reform of the public pension system and the raise of the retirement age were of course among the priorities of the program, and a referendum held on that topic led to the fall of the government and to the holding of early elections. A coalition of five parties had a lot of trouble in creating a new government, in January 2012, of which the Pensioners' party is an important member. What is the probability of the supporters of that party voting in favor of the reform of the pension system and how will they receive the European commissioners, who will come in and demand the implementation of the fiscal pact?

Slovenia's economic outlook remains negative at least in the medium term, due to an unexpected recession in 2011 and the worsening of the economic outlook on a continental level.

The excessive dependence on the EU markets was the most noticeable in the case of Slovenia's top two exporters. Revoz, a subsidiary of the Renault group and the country's largest exporter just announced significant downsizing, amid dropping orders from the European markets, and Gorenje reported a significant deterioration of its earnings, due to shrinking demand and rising prices of the raw materials it uses.

What else is there left for Slovenia to do now, a country whose European dream turned so quickly into a nightmare?

In the event of a collapse of the Euro, it would be placed in a far more difficult position than the one it had when it set off to look for fortune in the Eurozone, saddled with a huge debt burden, amid an increase in borrowing costs.

Of course, the government will go with the option of siding with Europe, which will soon force it to require a financial agreement similar to the one that "rescued" the Greeks. Replacing private creditors with public ones will lead to an even tighter "grip" from the "bigger brothers" in the European Union, which will smother any chance for an improvement in the way things are for Slovenians.

Leaving the Eurozone and the restructuring of debts, prior to the "staging" of a rescue program by the international financial institutions is becoming an increasingly attractive option. But is it also feasible, when the reprisals of the European authorities linger threateningly over any dissidents?

There is still an option, but that choice depends on the window of opportunity opened by a new sovereign default in the Eurozone. This window is getting near, and Slovenia may be sucked in to a new lane, which would allow it to rebuild.