Economic and financial developments, October 2018

The Governing Board of the Bank of Slovenia discussed and approved the October 2018 Economic and Financial Developments report.

Highlights:

• For the moment the medium-term forecasts of economic developments in the trading partners point to a continuation of the relatively favourable situation for Slovenian exports, although the risks of lower growth are increasing. The high oil prices are strengthening inflationary pressures from the international environment, with negative consequences for real growth in disposable income.
• Domestic economic growth remains high, and to a significant degree is a reflection of the competitive export sector. Government investment is also strengthening before this year’s local elections. A reversal in the direction of stronger private consumption is absent, despite the very buoyant labour market. The continuation of weak growth in corporate investment from the second quarter of this year could indicate increased caution on the part of firms because of the uncertain situation in the international environment.
• Growth in employment remains high, with recruitment of foreign workers now accounting for more than half of it. The situation remains favourable for growth in private consumption: the high employment growth means that real growth in the wage bill also remains high. It stood at 4.8% in August, down only slightly on the pre-crisis period of 2006 to 2008. From the perspective of cost competitiveness, wage growth is limited by the weak growth in productivity, which is indicative of the slow technological progress of the economy.
• Slovenia’s external position is significantly better than before the crisis. The 12-month current account surplus approached 8% of estimated GDP in August, while the net external debt has declined by almost EUR 2 billion in just one year.
• Headline inflation remains above 2%, while core inflation remains low, despite the strong domestic economic dynamics. Domestic unit labour costs have begun to rise, albeit without any notable impact yet on inflation developments.
• The general government balance is in surplus, and debt is expected to further reduce. The improvement in the fiscal position is largely attributable to favourable cyclical developments. From the perspective of the sustainability of public finances, the key is to avoid measures that would cause a deterioration in the structural fiscal position, as general government debt remains high.

The risks in the international environment are increasing because of trade disputes and sanctions, currency weaknesses in certain developing countries, and Italy’s fiscal difficulties. Nevertheless, international institutions are not yet sharply lowering their global GDP growth forecasts for the medium term. It is a similar case for the euro area, where growth is expected to be stable, at around 2%. The most recent weighted economic growth forecasts for Slovenia’s main trading partners also indicate solid growth in foreign demand for the products of Slovenia’s export sector. Inflationary pressures from the international environment increased, as oil prices rose sharply as a result of the US embargo against Iran.

In the structure of domestic economic growth, the anticipated reversal in the direction of stronger private consumption has not taken place, and the export orientation of the economy is continuing to increase. Growth in private consumption was unexpectedly weak in the second quarter, and suggests the continuation of the pattern seen over the first three quarters of last year, when a rapid improvement in the situation on the labour market was not tracked by increased growth in household consumption. Growth in investment in machinery and equipment also slowed sharply in the second quarter. Should these trends continue, it might already be indicative of the impact of the reduced confidence caused by the tense international situation on investment decisions by the export sector. Judging by the export dynamics, growth in foreign demand remained relatively high at least until August, and, in the wake of weaker growth in imports, net trade was again a significant factor in domestic economic growth.

Although in surveys firms are reporting major difficulties in recruiting, and unemployment is falling rapidly towards its pre-crisis lows, growth in employment remains high. The reason is the increasing employment of foreign workers, who again accounted for more than half of the year-on-year increase of 3% in the workforce in employment excluding farmers recorded in August. This is associated with a negative structural impact on growth in the average nominal gross wage, as foreign workers are mostly employed in sectors with below-average wages, while growth in employment in these sectors is above-average. Growth in average real wages has also been reduced this year by higher inflation. The situation remains favourable for growth in private consumption: growth in employment is still high, for which reason growth in the real wage bill also remains high. It stood at 4.8% in August, down only slightly on the pre-crisis period of 2006 to 2008.

The country’s external position is continuing to improve. The 12-month surplus approached 8% of estimated GDP in August. After declining in the first quarter, nominal growth in exports of merchandise and services strengthened again. Nominal growth in merchandise imports declined at the same time, despite an increase in growth in import prices. The net external debt has been declining since 2015, and fell by almost EUR 2 billion over the last year alone. The level of household saving, a fiscal policy that remains moderate for now, and growth in investment predominantly on the basis of firms’ internal resources suggest a continuation of economic growth that is largely based on exploiting the international climate. This structure of growth is reducing the economy’s dependence on financing on international financial markets, but at the same time is increasing the risks associated with the current highly uncertain situation in international trade.

Headline inflation remains above 2%, while core inflation remains low, despite the strong domestic economic dynamics. Headline inflation stood at 2.2% in September. Higher oil prices remain the stand-out external factor, while growth in services prices is highlighted among domestic factors. At the same time core inflation remains low, and comparable to the average in the euro area overall, despite Slovenia’s significantly stronger economic growth. The narrowest core inflation indicator stood at 1.1% in September, up just 0.2 percentage points on the beginning of the year. Domestic unit labour costs have begun to rise, albeit without any notable impact yet on inflation developments.

The fiscal position is continuing to improve, as a result of the favourable cyclical situation, a reduction in the interest burden, and more moderate growth in expenditure. The general government sector recorded a surplus in the amount of 0.6% of GDP over the 12 months to June, while the general government debt is forecast to decline to 70.3% of GDP by the end of the year. Borrowing terms remain favourable, and treasury bills have continued to be issued at negative interest rates. From the perspective of the sustainability of public finances, the key is to avoid measures that would cause a deterioration in the structural fiscal position, as general government debt remains significantly higher than before the crisis, and does not yet allow room for manoeuvre for a stronger counter-cyclical fiscal policy.

Growth in labour productivity is low, and is indicative of the deterioration in the quality of economic growth after the crisis. Economic growth in the current cycle is comparable to the 4% average annual growth recorded between 1993 and 2005, i.e. before the beginning of the excessive loan financing of growth. Labour productivity increases of around 4% accounted for virtually all of the economic growth in the pre-crisis period, while in the current cycle GDP growth is largely being driven by employment. Growth in labour productivity has averaged just 1.9% over the last two years, and averaged merely 1% in the first half of this year. The large supply of labour from the pool of unemployment created during the crisis has been a factor in the disproportionate growth in employment in recent years. This factor has now largely been exhausted, although GDP growth remains labour-extensive, as the economy is addressing its difficulties with a shortage of domestic labour by importing foreign workers. The continuation of labour-extensive growth is an indication of weak technological progress, and the limited reach of the generation of GDP per employee in today’s economic structure.