High growth in economic activity this year and next; uncertainty regarding the evolution of the epidemic remains high

In the context of the improving epidemiological picture, Banka Slovenije expects economic growth to reach 5.2% this year and to remain high next year (4.8%). GDP is thus expected to reach the pre-crisis level already at the beginning of next year. Economic growth will be driven by both domestic and foreign demand. Inflation will also rise and remain below the medium-term target of less than 2%, but will be close to that limit. Banka Slovenije also finds that uncertainty regarding the future evolution of the epidemic remains high. Thus, in addition to the core projection, we have also drawn up alternative scenarios with the help of a healthcare expert.

With the proportion of the population vaccinated growing steadily, the spread of infections is slowing, at least in Slovenia and its main trading partners. Banka Slovenije is expecting high growth in economic activity this year and next. That forecast is based on the assumption that the epidemiological conditions will not require another broader and more protracted lockdown. We are also assuming economic growth will continue to be supported by monetary and fiscal policy measures. We estimate that economic activity would have contracted by one-tenth last year in the absence of such measures.

Figure 1: Forecasts of economic growth in Slovenia and the euro area in the period 2021–2023

Source: SORS, Eurostat, Banka Slovenije forecasts and the macroeconomic forecasts of Eurosystem/ECB experts, June 2021

Economic growth will strengthen over the projection horizon on account of both domestic and foreign demand. We are expecting a recovery in household spending, and increased public-sector and government investment activity. This will be underpinned by investments co-financed by funding from the Next Generation EU recovery package. Growth will be driven by government spending over the entire projection horizon. Encouraging growth in exports is expected with the recovery in economic activity in trading partners.

Favourable developments on the labour market will strengthen household spending in the context of improving epidemiological conditions and the gradual diminishing of economic uncertainty. We are expecting the revival in economic activity to lead to additional hiring by corporates as early as this year. This will be reflected in an unemployment rate similar to last year’s rate, despite the expected lifting of job preservation measures. With the continued economic recovery in the coming years, we are expecting relatively favourable employment growth and a gradual drop in the unemployment rate, which is expected to fall to a historically low level at the end of the projection horizon. Wage pressures will increase towards the end of the projection horizon. Temporary emergency measures will have a significant impact on wage developments, particularly this year and next.

Growth in consumer prices will strengthen over the projection horizon, but will remain below the medium-term target, i.e. inflation of less than 2%, until the end of the aforementioned period, but will be close to that limit. In addition to external factors linked to growth in the prices of oil and other commodities on the global markets, domestic inflation factors will also strengthen. We are expecting a considerable rise in core inflation with the recovery in domestic demand, which is supported by targeted economic policy measures, and rising cost pressures in the context of favourable conditions on the labour market. Following last year’s drop in consumer prices, we are expecting inflation of 1.3% already this year, primarily as the result of last year’s temporary reduction in energy prices due to the outbreak of the epidemic and the resulting government measures. We are expecting growth in the prices of services and non-energy industrial goods over the remainder of the projection horizon, while rising food prices will drive up headline inflation.

Alternative scenarios

Health conditions continue to cause considerable uncertainty in the preparation of macroeconomic forecasts. The key factors in the continued evolution of the epidemic are the proportion of the population vaccinated and the outbreak of new strains of the virus, against which existing vaccinations might not be effective.

For this reason, Banka Slovenije also drafted alternative scenarios of economic trends with the help of an external expert, Assoc. Prof. Dr Janez Žibert from the Faculty of Health Sciences in Ljubljana who is also a member of the COVID-19 Tracker team. In the first, milder scenario, which is more favourable than the core forecast, GDP would reach the pre-crisis level already this year in the context of strengthening confidence and the more rapid adaptation of the economy to the new conditions. In the second, less favourable epidemiological scenario, we assumed a lower proportion of the population vaccinated in the autumn months that would be required to halt the spread of infections. The retightening of measures to contain the epidemic would slow the recovery in GDP, which would remain one percent below the core forecast in 2022 and 2023. In the third, more severe scenario, which assumes the outbreak of a new strain of the virus against which currently available vaccines and the immune protection of persons who have already recovered would be ineffective, a new larger wave of the epidemic would follow in the autumn. This would have to be contained through more protracted measures, which would further slow the recovery in economic activity, while the pre-crisis level of GDP would not be achieved until 2023.

Figure 2: GDP over the projection horizon, by scenario

Note: The dotted line represents the level of GDP in 2019.
Source: SORS, Banka Slovenije forecasts and estimates

Certain other risks are also increasingly evident. In addition to geopolitical tensions in the Middle East, risks caused by challenges in global supply chains primarily due to shortages of certain raw materials and semi-products are rising. If such developments are of a more protracted nature, this could be reflected in slower growth in economic activity and faster growth in prices. In the domestic environment, the risk of higher-than-forecast growth is linked to potentially higher household spending following the end of the epidemic, which would additionally spur GDP growth. This would also be facilitated by the historically high savings accumulated by households during the period of stringent containment measures.

Publication Macroeconomic Projections for Slovenia, June 2021 is available on the link.