Press release - New Macroeconomic Projection for Slovenia and Financial Stability Review June 2017
The Governing Board of the Bank of Slovenia has discussed and approved the June 2017 Macroeconomic Projections for Slovenia, June 2017 andFinancial Stability Review*.
1. Macroeconomic Projections for Slovenia, June 2017
Macroeconomic conditions in Slovenia are improving for the fourth successive year. With the economy growing stronger at all levels and with favourable fiscal trends, the macroeconomic balance necessary for further development, investment and social well-being is re-establishing itself. The macroeconomic forecast is therefore significantly more optimistic and balanced this time around, but nevertheless subject to specific risks in the domestic and foreign environments.
This year and in the next two years we expect economic growth in Slovenia to be among the highest in the euro area (3.5% in 2017, 3.1% 2018, 3.0% 2019). With such a rate of growth, convergence processes can continue once again, approximately 10 years after being interrupted by the start of the crisis. Private investment and government investment are both growing, while the strengthening of domestic demand is becoming a pillar of economic growth. Numerous investment projects by both domestic and foreign investors are about to be launched, encouraged by the diminishing uncertainty in the business environment, favourable financing conditions, increased optimism in the export sector and the strengthening of private consumption. The last of these factors will be stimulated by favourable conditions in the labour market and diminishing uncertainty among consumers, and will be a key factor of economic growth alongside investment. With the high level of retained earnings at corporates and the relatively high level of household savings, the need for external financing of both investments and consumption will be less than in the pre-crisis period, the growth in loans will be more moderate and economic growth will be more sustainable.
With the improvement in conditions in the international environment, the growth in foreign demand and thus of the export sector continues. Export growth will thus continue to be high in the future and should reach a period average of 5.5%. Despite the continuation in export growth, the contribution of net trade to economic growth will be significantly lower than in past years, since increased domestic demand will be partially covered by higher imports. The merchandise trade surplus will narrow and as a consequence the current account surplus will also be smaller. The latter will nevertheless remain high, reflecting the external competitiveness of the economy, and act as a buffer in the event of unexpected shocks in the international environment.
Simultaneously with the economic recovery, conditions in the labour market are also improving. With favourable average employment growth of almost 1.5%, we also expect a gradual fall in the unemployment rate to the pre-crisis level of around 6% by the end of 2019. Recruitment will be more rapid in export-oriented sectors, construction and services. A gradual fall in the unemployment rate below the natural rate of unemployment and structural imbalances in the labour market will start to put pressure on wage growth during the forecast period.
Wage growth will strengthen throughout the forecast horizon. Since growth in wages will outstrip growth in productivity, growth in unit labour costs will also start to increase.
Inflation will start to gradually rise and will exceed 2% at the end of the forecast horizon. If the base effects in energy and food prices are set to have a significant impact on inflation this year, the growth in prices over the next two years will mainly be influenced by domestic factors. With continued economic growth above currently estimated potential growth, an output gap will also start to gradually open this year, while further upward pressures on prices will be caused by wage growth outstripping productivity. By the end of the forecast horizon, core inflation will have gradually increased to approximately 2.5%, while higher growth in prices will be evident above all in the case of services, while the growth in prices of other tradable goods will be lower and more limited.
The majority of uncertainty factors accompanying the present forecast could have a positive impact on both economic growth and inflation. The biggest risks to projected economic growth now come from the domestic environment, primarily on account of potential faster-than-expected growth in both private-sector and government investment. Particularly in the case of government investment, where major investment projects are involved, the effects on growth could be considerable. Optimism in the labour market and diminishing general uncertainty are strengthening private consumption, which given favourable financing conditions could also be considerably higher. From the point of view of the forecast, the risks of potentially faster growth of developing countries and Russia, which could additionally strengthen the growth of exports, are also not negligible. In the case of inflation forecasts, alongside risks from the international environment, risks from the domestic environment are also getting stronger. Uncertain movement in oil prices combined with significantly faster economic growth over a longer period could increase demand-side pressures and cause faster price growth. If wage growth is simultaneously higher than expected, the effect on inflation could be even greater.
Banks are operating in a favourable macroeconomic environment, which through stability and forecast further growth increases the confidence of business entities and households. Labour market optimism and a growth in disposable income are stimulating household demand for loans. The improved structure of corporate financing and a growth in earnings are increasing creditworthiness and having a positive effect on risks deriving from this segment of bank investments. The biggest challenges to bank performance continue to be the challenges of operating and achieving adequate profitability in a low interest rate environment, to which banks are also adapting by changing their business models. In general terms, the sensitivity of banks to systemic risks fell in 2016, which gives a good basis for a revival of lending activity this year.
Continuing economic growth and the outlook for the next few years are having a favourable impact on the financial situation of households and businesses. Combined with growing optimism, at the start of 2017 these factors contributed significantly to halting years of declining lending activity by banks. The perception of smaller risks associated with lending is reflected in less stringent credit standards and is additionally contributing to more favourable lending conditions, which are to the greatest extent characterised by low lending rates and a growing range of favourable fixed-rate loans.
Several factors led to further corporate deleveraging in 2016. The process of reducing bank debts, which has been going on for several years, extended almost to the end of 2016, while corporate borrowing in the rest of the world also came to a halt. For the second year in a row, corporates are financed to a greater extent by an inflow of equity, mainly foreign, which has improved the structure of their financing in the direction of more sustainable deleveraging. In the structure of total corporate financial liabilities, the share of equity reached 49%, which is already very close to the euro area average. The two processes – debt repayment and a growth in equity financing – have reduced corporate leverage to the euro area median, while corporate debt relative to GDP was not problematic even in the years of considerably higher indebtedness.
Corporate operating results in 2016, with greatly increased earnings that approached the pre-crisis level from 2007, additionally improved creditworthiness. The earnings of companies operating in the domestic market increased more than those of exporters, which is a consequence of the greater contribution of domestic demand to economic growth in comparison to foreign demand. Earnings grew in all principal economic sectors with the exception of construction. Further forecasts of growth in domestic demand could favourably influence the faster recovery of those companies that are more oriented towards the domestic market and represent the segment of the banks' portfolio that is otherwise more burdened by non-performing claims.
With the better financial position of the corporate sector and favourable economic forecasts, conditions are being established for a new credit cycle capable of supporting the trends that are beginning to be seen in investment. The growth in corporate loans from December 2016 could signify a turnaround in the lending activity of banks, while at the same time numerous supply-side and demand-side indicators show that the bases exist for positive expectations. The years of contraction of bank lending have, however, seen the establishment of a corporate financing model based, to a significantly greater extent than in the pre-crisis period, on internal resources. The growth in earnings and accumulated liquid assets represent, in many companies, a good basis for own financing of development. The strengthening of loan offerings with competitive conditions to this group of customers could also contribute significantly to improving the quality of banks' overall portfolio.
Regarding household lending, there is less uncertainty in the short term. The growth in housing loans and, to an even greater extent, consumer loans is supported by the improved income situation of households, increased consumption and a growing property market. Although growth rates for consumer loans have reached double figures and there is a simultaneous increase in housing loans, households continue to have significantly less debt than the euro area average. The growth of this part of the credit portfolio with a low credit risk has the effect of improving its overall quality. Owing to the past reluctance of households with regard to spending and investment, the level of indebtedness of this sector has been falling for several years. This gives banks a little more room to increase their exposure to this group of customers, although with an adequate credit risk assessment over the longer debt servicing period. Despite the growing share of fixed-rate loans, the greatest part of the stock of household debt is subject to variable interest rates, which affects risks on both sides – interest rate risk in the case of households and credit risk in the case of banks.
Once again last year, banks successfully reduced the stock and proportion of non-performing claims through active resolution. Since the bulk of banks' efforts to date have been focused on resolving non-performing claims in large enterprises, the claims remaining in banks' portfolios are those that require a different approach. Small and medium-sized enterprises, corporates in bankruptcy and non-residents are segments that still maintain significant shares in the structure of the non-performing segment of the portfolio. At the end of 2016, claims against corporates in bankruptcy still represented more than half of all claims against corporates more than 90 days in arrears. More than half of non-performing claims against non-residents are concentrated in four countries of the former Yugoslavia. In view of the low economic growth in these countries, autonomous improvement of these claims is limited.
Within the structure of bank investments, the proportion of investments in government or government-backed securities is falling. At maturity, these investments are partially substituted by bank and corporate bonds. The effect of this is to reduce the high risk of concentration in banks that was previously present. The stock and proportion of the most liquid assets on bank balance sheets are growing. At 12%, their proportion is several times greater than some years ago. Despite the low return on these investments, maintaining the adequate liquidity of banks is important from the point of view of reducing the risks deriving from maturity mismatch in assets and liabilities. This gap continues to widen, both because of the continuously increasing proportion of sight deposits in the structure of deposits and total assets, and because of the extension of maturity of investments. The widening maturity gap in bank assets and liabilities increases some risks in the banking system, where funding risk and liquidity risk in particular are of a potentially systemic nature. Notwithstanding the presence of these two risks in the Slovenian banking system, the regulatory safety mechanisms, whether established (deposit guarantee scheme, emergency liquidity assistance, liquidity ratios, emergency liquidity aid, etc.) or emerging (liquidity coverage ratio, net stable funding ratio, etc.) mean that the current situation is not problematic. Even so, a warning to banks to carefully monitor the development of these two risks, both on their own balance sheets and in the banking system as a whole, is appropriate.
Income risk remains one of the key risks in the banking system. Recent trends in the lending field are showing, after a long absence, the positive though still minimal contribution of increased lending to interest income. The growth in non-interest income in the last two years is above all a reflection of one-off factors and does not signify an increased focus of banks on other activities outside "core" banking. On the cost side, despite the expected further improvement of the credit portfolio, impairment and provisioning costs are unlikely to remain low, since these are to a large extent a reflection of the easing of earlier impairments. Improving cost-efficiency is also a longer-term process.
Adaptation of the business models of banks with a growth in fixed-rate loans and an extension of maturity, above all in the case of loans to households, will contribute to a growth in interest income through increased lending. With the simultaneous persistent shortening of the maturity of deposits, the interest sensitivity of banks continues to increase. The results of supervisory stress tests of interest rate risk (IRRBB) have shown that banks in Slovenia are relatively conservative when it comes to managing their interest-sensitive positions and that interest rate risk is under control.
The capital adequacy of banks remained favourable at the banking system level in 2016, and similar to a year earlier. Minor changes in capital adequacy were more the consequence of changes in capital requirements than of changes in capital, and there was a slight reduction in both last year. A growth in capital requirements is a consequence of the gradual revival of lending activity. In the future, the stability of the capital position will to a large extent also depend on the ability of banks to generate additional capital.
The property market is moving from the recovery phase to a growth phase. Residential property prices and the volume of transactions are growing more quickly than in previous quarters. With growing demand and existing supply, the gap between the two is widening. A lack of adequate supply could subdue the expected investment and construction cycle. For the time being, the business property market is not following trends in the housing market, and the number of transactions has not increased in 2016, while prices of offices and other commercial premises have fallen more sharply. Despite this, given favourable economic conditions we can also expect a gradual turn to a growth phase in the business property market.
The positive influence of the economic recovery is also apparent in other segments of the financial system. In the case of leasing companies, this is reflected in the growth in business, above all in the movable property sector. In the insurance sector there is a growth in gross written premiums, while the low interest rate environment is having a negative impact on current and future income from investments. The effect of the recovery of the European economy on foreign capital markets is also being transferred to the domestic market. Positive investor sentiment is reflected in renewed growth in investments in mutual funds, an increase in transactions concluded on the Ljubljana Stock Exchange and above-average growth of the domestic stock index. Low liquidity and the shallowness of the domestic capital market are, however, also leading to greater price fluctuations.
Publication:Macroeconomic Projections for Slovenia