Press release after the Meeting of Governing Board of the Bank of Slovenia on 6 January 2015
1. The Governing Board of the Bank of Slovenia discussed current supervisory matters.
2. The Governing Board of the Bank of Slovenia discussed and approved the January 2015 Economic and Financial Developments report.
Economic growth in Slovenia over the first three quarters of 2014 was significantly higher than the euro area average. Growth in exports strengthened, which in the wake of weaker growth in imports maintained the contribution made to GDP by net trade at a high level, and made a key contribution to the widening of the current account surplus to 5.7% of GDP. The first signs of increased investment in industrial production capacity began to appear, conditioned by rising capacity utilisation and improved access to foreign financing. Another factor in the significant change in economic dynamics was the reversal in fiscal policy, which acted to stimulate economic growth over the first three quarters of the year with the support of EU funds, as the positive contribution made by public investment was significantly larger than the negative contribution made by the decline in final government consumption. Public infrastructure investment had a beneficial impact on construction activity, despite the negative reversal in the third quarter, while weak growth in private consumption and increased corporate turnover on the domestic market promoted growth in the majority of private-sector services.
Economic growth is already being reflected more strongly on the labour market. Unemployment fell, primarily as a result of high transition to employment, which increased most sharply in private-sector services. Employment agencies were prominent in this process, having made the largest contribution to growth of almost 1% in total employment in the third quarter, which is fogging the actual picture of the sectoral breakdown of employment, particularly in industry and construction. Following labour market reforms, which partly tightened the conditions applying to temporary employment, the increase in employment via agencies was most likely the result of firms’ response to the demand for flexible forms of employment. Average wages are also gradually rising in the wake of employment growth, although growth lags behind growth in labour productivity. The fall in inflation towards zero brought an increase in the real wage bill, particularly in the third quarter, which is increasing consumer purchasing power.
The economic recovery in the narrower external environment remains weak, despite the ECB’s expansionary monetary policy. At the same time sanctions and plummeting oil prices are weakening the Russian economy. There were therefore further reductions in late 2014 in the economic growth forecasts for 2015 in the majority of the key export markets. They nevertheless remain slightly more favourable on average than the estimates for 2014, which, given the improvement in the competitiveness of Slovenia’s export sector, is providing the main basis for further growth in domestic economic activity.
The positive economic turnaround is not being reflected in domestic inflation. Inflation as measured by the HICP stood at zero in the final quarter of 2014, largely as a result of falling commodity prices, and averaged just 0.4% over 2014, the lowest figure to date. In addition to headline inflation, the core inflation indicators were also all below the euro area average. The differences primarily derive from a greater loss of purchasing power in the crisis and the cautious behaviour of domestic consumers, who have mostly not transferred the real increase in the wage bill into their final consumption. This is primarily being reflected in further decrease in prices of industrial goods. Lower prices of input commodities and the outpacing of wage growth by productivity growth also suggest the absence of price and cost pressures at firms.
There was a large general government deficit in 2014, as a result of the increased burden of interest payments and one-off factors related to bank recapitalisations and the repayment of old foreign currency deposits, although there was also a significant increase in general government revenues. According to Ministry of Finance estimates from the end of December, the deficit stood at 5.3% of GDP, while the primary deficit after the exclusion of one-off effects and interest payments was estimated at just 0.1% of GDP. The general government debt is estimated to have increased to 82.2% of GDP by the end of 2014, albeit partly as a result of the pre-financing of bond repayments in 2015. Sovereign borrowing terms improved significantly. The required yield on 10-year Slovenian government bonds stood at just 2.1% in December, down 3.1 percentage points on a year earlier.
Despite the rapid economic recovery in 2014 and the improved medium-term outlook, Slovenian economic policy continues to face a number of challenges. Among the most significant are the non-functioning of the credit channel, high unemployment, fiscal consolidation and the restructuring of the economy. These challenges can partly be addressed through responsible and prudent corporate ownership restructuring.
3. The Governing Board of the Bank of Slovenia discussed and approved the December 2014 Stability of the Slovenian Banking System report.
The bank recovery and resolution process which begun in 2013 contributed to a significant reduction in risk in the banking system. Credit risk remains high and very significant, although the resolution of non-performing claims is stabilising the situation. In the wake of the pronounced improvement in capital adequacy after the measures of December 2013, it should be noted that the maintenance and improvement of capital adequacy is primarily relying on a reduction in lending activity and adjustments to the risk structure of bank investments, and the corresponding decline in capital requirements. There needs to be a focus on the banks’ income risk, which is increasing in an environment of low interest rates, contracting balance sheets, aversion to the take-up of credit risk and increased corporate financing abroad. Refinancing risk and macroeconomic risk are declining for the banks.
The banks continued the process of balance sheet contraction last year, despite the improvement in the domestic macroeconomic situation. This was conditioned on the liability side of the balance sheet by a fifth consecutive year of net repayments of liabilities on the wholesale markets, albeit at a significantly slower pace than in 2013, and by the early repayment of liabilities to the Eurosystem. On the other side growth in loans to non-financial corporations remains negative, although there are signs of a gradual stabilisation. The reasons for last year’s contraction in corporate loans were more or less unchanged from 2013: the relatively high leverage in the corporate sector was very slow in being reduced, and limited creditworthy demand, and the banks remained reluctant to take up additional credit risk with tightened credit standards, despite the improvement in capital adequacy indicators.
The most recent survey figures (BLS) show that (estimated) corporate demand for loans increased in 2014 after a long period of decline, and that the banks’ credit standards are not being additionally tightened, which is increasing the likelihood that the contraction in loans to non-financial corporations will begin to slow in the upcoming period. The structure of bank funding remains unstable, and will be adjusted further in the year ahead. The improvement in the macroeconomic situation in 2014 helped ease corporate financial recovery, with the anticipated further revival of the business cycle. However this will only be reflected in the financial cycle gradually and with a lag, even though it is the increased credit growth that would have the most beneficial impact on bank performance and on an improvement in the quality of the credit portfolio.
Credit risk gradually stabilised in 2014. The proportion of non-performing claims declined by 2.5 percentage points in October to 13.2% as a result of the transfer of claims from Abanka to the BAMC, although the figure fluctuated downwards even without the effect of the transfer. Non-performing claims also declined in absolute terms last year in the corporate sector in particular, although the contraction in bank lending activity meant that this was not reflected in an improvement in the quality of the credit portfolio. A declining trend has been seen in accommodation and food service activities and in transportation since the beginning of 2014. The instability of non-performing claims and the upward fluctuations suggest that the risk of a further deterioration in the banks’ credit portfolio remains high. The quality of the credit portfolio of non-residents is notably low: it was not subject to resolution via transfer to the BAMC, and is dependent on economic recovery in the countries of the western Balkans in particular. The persistence of the financial crisis is increasing the likelihood of non-performing claims spreading to new sectors of the economy. In the wake of the resolution of non-performing claims primarily at large enterprises, the proportion of the banks’ non-performing claims accounted for by SMEs is increasing: last year it rose to 39% of total non-performing claims against corporates. This indicates the urgency of more active measures by the banks themselves to resolve non-performing claims by means of their sale, faster write-offs, etc., and greater risk segmentation of borrowers in the approval of new loans.
The deleveraging and restructuring of over-indebted firms is proceeding slowly. Activity in corporate restructuring and the adoption of measures to further reduce non-performing claims at banks could significantly contribute to the management of credit risk and an improvement in the quality of bank investments. December’s Bank of Slovenia guidelines for the creation of impairments and provisions for claims against corporates with which a master restructuring agreement has been concluded were adopted for the purpose of speeding up corporate restructuring and more actively including the banks in these processes.
Given the high realisation of credit risk, there is a high likelihood of the additional creation of impairments and provisions, and consequently a rise in income risk at the banks. Despite an improvement in performance, and growth in the interest margin, interest income has been adversely impacted by the contraction in loans, while the beneficial impact on the banks’ income of the fall in liability interest rates has now largely been exhausted. In an environment of low interest rates and a shift towards lower-risk, lower-yielding investments, the question is whether the banks will be able to generate sufficient income to cover operating costs and impairment costs. The banks’ greater focus on government bonds is additionally increasing income risk on account of potential sovereign downgradings or renewed loss of confidence on the international financial markets in the more vulnerable countries of the euro area. The retention of high spreads over average euro area interest rates is encouraging creditworthy customers to seek financing abroad, and could result in the loss of a source of bank income over the longer term.
Refinancing risk declined in 2014 as debt repayments to the rest of the world were intensified. Most banks, particularly those under majority domestic ownership, have already repaid the majority of their debt raised on the wholesale markets. The restoration of confidence in the domestic banks has seen household deposits returning to the banking system. This positive development was particularly notable at the large domestic banks, which in 2013 had seen the largest fall in savers’ confidence and decline in household deposits. The banks will remain exposed to the risk of less-stable funding structure as a result of the projected low rates of growth in household deposits in the next two years.
The strengthening of economic growth, largely as a result of the favourable dynamics in exports, and the improvement in the situation on the labour market have brought an improvement in the macroeconomic situation in Slovenia, while the banks are seeing a decline in macroeconomic risks. There nevertheless remains a risk of lower-than-forecast GDP growth, as a result of the uncertain economic recovery in certain euro area countries and the potential rise in geopolitical tensions in Ukraine and the Middle East. Domestic economic growth remains based on foreign demand, which could lose momentum, given the uncertainty of the economic recovery in key trading partners.