Despite the worldwide glare on Slovenia – saddled by high debt and distressed asset values – normal banking services in the country have yet to be disrupted, while the Cyprus bailout has failed to spark an outflow of retail deposits. “Slovenian locals kept their calm during the panic in Cyprus and there was no evidence of pressure on deposits, nor has there been any unusual withdrawals activity since then,” says Abbas Ameli-Renani, emerging markets analyst at RBS.
Slovenia’s government bonds have also suffered a strong sell-off on the back of the Cypriot crisis, especially after Moody's downgraded the sovereign by two notches to Ba1 with negative outlook on Tuesday, raising questions about the government's financing capacity.
The Cyprus crisis resulted in “some sections of the market – who were perhaps not as in tune with Slovenia’s fundamental story – drawing direct comparisons between the banking sector crises of Slovenia and Cyprus,” says Ameli-Renani.
Uncertainty about the government’s intentions on how to clean up the bad debt of the banking sector did not help either.
However, the real challenge facing Slovenia is a highly indebted and uncompetitive corporate sector, which is likely to limit growth in the medium and long term, says Marcus Svedberg, chief economist at East Capital.
Slovenian banks have high levels of non-performing loans (NPLs) and the country is caught in a negative feedback loop: a surge of bank-funded real estate construction came to an end as economic conditions deteriorated, undermining borrowers’ ability to repay loans, and therefore banks’ ability to lend.
There are around €7 billion of NPLs in Slovenia, or 20% of GDP, with €6 billion of that exposure on the top three state-owned banks.
The credit crunch in Slovenia has forced the large corporates active in the country to turn to the money markets, where short-term commercial paper (CP) has provided some temporary respite.
Corporates can raise money for less than a year’s duration this way and for now the market is reliable enough for debts to be rolled over at a reasonable rate. For example, Gorenje Group, a domestic appliance manufacturer, raised €30 million in eight months at a yield of 4.45%, says Ameli-Renani.
This looks broadly in line with the rates available in the bank market for equivalent durations.
Yet memories of 2008, when the CP market slammed shut, are fresh enough to ensure this is seen as a precarious strategy. And corporates cannot operate indefinitely without longer-term financing in place.
“The CP market is fairly small and is unlikely to be sufficient to boost corporate activity,” says Ameli-Renani. “It is providing breathing space but not much more.”
While the largest corporates will find the international bond markets receptive, smaller players will find that route closed to them.
There is little danger of Slovenia’s problems causing similar disruption to those of Cyprus in recent months. Slovenia is not a significant market for European exporters: on the contrary, 70% of its economy is comprised of exports.
Unlike the Czech Republic or Hungary, where there is foreign ownership of banks, Slovenia is dominated by three state-run banks.
“The evidence suggests that action will be needed by Slovenia within the next two to three months,” says Laurence Wormald, head of APT research at SunGard.
However, this is unlikely to look like the bailout designed for Cyprus, but arrangements to provide confidence in Slovenia’s banks. “A bail-in is likely to be less drastic than the one in Cyprus, since Slovenian banks are much less leveraged than those of Cyprus,” says Wormald.
If a bailout were needed, the numbers would be small: Europe’s commitment to Spanish banks ran to €100 billion, and Cyprus took €10 billion. A recapitalization of Slovenia’s banks is expected to cost €1 billion.
The pressure on Slovenia is for much-needed government reforms. For example, the eligibility criteria for welfare spending could be tightened to bring spending down, says the OECD, building on progress the state has made in means testing cash transfers after the introduction of a comprehensive electronic system.
Bad bank
The creation of a bad bank, expected within months, will also help, though political foot-dragging and months of delays might have undermined the plan’s chances of making a positive impact.
There is also pressure to privatize the banking industry, but the appetite to sell at the bottom of the market is low, with stock prices down around a quarter from the levels seen a few years ago.
However, there is no silver bullet. “Reforming the corporate sector will be highly complex,” says East Capital’s Svedberg. The economy must be reformed to make it easier for businesses to be created – and for businesses to die, which is never easy to sell politically, he says.
Part of Slovenia’s problem is the lack of urgency to deal with its problems: the government has most of the financing it needs for the remainder of the year, says Ameli-Renani. In April it raised €1.1 billion in an 18-month T-bill auction, well above its €500 million target, with a yield of 4.15% – higher than the 3.99% seen in a similar issue in December 2011.
“If it successfully borrows approximately $2 billion from international investors, as we expect it do so soon, the government may feel the weight of pressure for structural reforms off of its shoulders, pushing much-needed reform further into the future,” says Ameli-Renani.
In this sense, a bailout – though unlikely – might not be the worst outcome for Slovenia, if it provides cheap money and forces through changes that it might find politically impossible to push through on its own, says Svedberg.
Nevertheless, if the $2 billion issuance fails then a can of eurozone worms will once again be opened.