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Sunday, 17 December 2017

Seeking clarity amid the chaos

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Slovenia avoided the stigma of a Troika rescue, but the economic pressure of a state-imposed bailout has rocked the government.

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“If you visit, it doesn’t feel like an economy in free-fall,” said Marcus Svedberg, chief economist at East Capital. It is a comment that strikes at the heart of the former member of the Yugoslav Republic. The first to break away from the Communist state, Slovenia then spent the 1990s successfully reinventing itself as the Austria on the other side of the Alps.

Its capital Ljubljana has always felt distinctly European, and euro entry in 2007 was a foregone conclusion thanks to the fastest growth in the eurozone. But that is when the rot set in. The global debt crisis shone an unwelcome light on crony capitalism and the wild spending of its state-owned banks. Slovenia narrowly managed to avoid metamorphosing into a second Cyprus late last year.

Thanks to the Herculean efforts of Prime Minister Alenka Bratusek, the country was able to avoid the stigma of a Troika bailout. In December, the country pumped in €3.3bn of government funds to save its lenders.

But a huge amount of work still needs to be done. Thanks to the bailout of its own banks, the country’s debt rocketed to 71.7% of GDP at the end of last year, according to Eurostat, up from 23% in 2008.

The government intends to cut the budget deficit from an eye-watering 14.7% of GDP down to 4.2% of GDP this year. And while the subject of non-performing loans is a familiar one in Central Europe, in Slovenia they stand at a hefty €11bn. That is almost a third of the annual national output. Little wonder that Bostjan Jazbec, governor of the central bank, has described the problem in several recent interviews as “worrisome”.

It is true that there have been some improvements. In mid-March the Bank of Slovenia said that arrears of more than 90 days had fallen from 17.4% at the end of Q3 last year to 13.4% at the end of Q4. While a step in the right direction, the figures are something of a mirage. Fitch pointed out that Slovenian banks’ asset quality was still a risk despite the transfer of non-performing loans to a government-created “bad bank”.

“Impaired loans have not reduced substantially as stricter loan classification has led to new inflows, even though official NPLs have fallen,” it noted.

Privatisation issues

A front-line weapon in the government’s armoury to reduce debt is privatisation. The calls for privatisation might have been rapid, but work has been slow. Half the economy still remains in state hands. So far, only two of the 15 state-controlled companies that had been earmarked for privatisation have been sold.

A huge step was taken at the beginning of April with the announcement of the 75.6% sale of national telecoms Telekom Slovenije, the jewel in the country’s privatisation crown. A few weeks later, the sale of the country’s second-largest bank Nova KBM was also announced.

All of this is difficult, and yet Slovenia receives little other than positive sentiment. The sovereign has had few problems raising money in the international markets. Despite €24bn of debt outstanding, with almost a third due by 2016, Slovenia has already comfortably covered its needs for this year and has stolen a march on next year too.

In mid-February, it raised US$3.5bn through a dual-tranche offering of new five and 10-year notes. Admittedly, the initial premium was a generous 25bp–37.5bp, but the order book still reached a whopping US$18.5bn at its peak, and even when scaled back, books topped US$16bn. The US$1.5bn five-year was priced at US Treasuries plus 280bp while the US$2bn 10-year went at Treasuries plus 280bp.

This was followed in early April by the sale of €2bn of notes, split equally between three-year and seven-year tranches. The fact that the debt is denominated in euros was deliberate – a sign that the country is pulling away from emerging market rivals and back into the eurozone fold. Even though the premium was single-digit this time, books swelled again and this time reached more than €9.5bn. The October 2017 tranche went at mid-swaps plus 115bp while the €1bn April 2021s went at mid-swaps plus 173bp.

It is a sign of how positively the Balkan nation, rated Ba1/A–/BBB+, is now viewed that the 1.75% coupon on the 2017s is almost a full three percentage points tighter than 4.7% rate Slovenia had to pay for the €1.5bn 2016 paper it privately sold to Pimco in the middle of its debt storm in November. It had the knock-on effect, too, of pushing down the yield on the domestic 10-year issue to 3.576%, the lowest in 3-1/2 years.

The bonds performed well in secondary trading, not just after the break but throughout April. At the end of the month, the 2021s were trading at mid-swaps plus 153bp.

“A change in the market was felt on the back of the US deal [in February]. Investors are now increasingly positive on the progress the country has made with its economic reform agenda and banking recapitalisation plan,” said Fabianna del Canto, managing director in European syndicate at Barclays, which led both deals.

Mired in politics

But increasing economic stability has come at a political cost. The pressure felt by the need for government cutbacks to bring down the fiscal deficit has shaken Bratusek, who lost a party vote of confidence at the end of April.

The trigger for her fall was a contentious real estate tax that, as planned in November, would have raised €126m a year – equivalent to roughly 1.5% of state income. After complaints from opposition politicians that the tax of between 0.15% and 0.75% on property values had been rushed through, Slovenia’s constitutional court annulled the tax at the end of March. It declared it unconstitutional on the basis that the value of real estate was not defined clearly enough.

At the time, a regretful Bratusek told Slovenia’s news agency STA: “We have some solutions in mind but they will be much more painful for citizens.”

Many would argue that she was right. The government’s solution was a short-term rise in VAT – from 22% to 24% for eight months. That,, too bit the dust. Rival party the Civic List, one of the four that make up the ruling coalition, said a higher sales tax would just hurt the economy and that Bratusek should look for more savings in the budget.

Instead, the coalition said it planned to raise excise duties and continue with spending cuts as it hoped to bridge the fiscal gap.

But after she was forced to abandon the VAT plan, Bratusek called a vote of confidence from her own Positive Slovenia party. Ahead of the vote, she told congress that she could not remain the prime minister without the party’s support. “I can no longer be the prime minister if I do not have support within my own party,” she said.

But she did lose the vote at the end of April, in favour of Ljubljana mayor Zoran Jankovic. A contentious figure in Slovenian politics, Jankovic founded the Positive Slovenia party in 2011, two months before the last election. The following year he stepped aside in favour of Bratusek after he was accused of corruption and of a failure to declare private assets. No charges have been brought against him though.

The three other partners in the ruling coalition made it clear they would not work with a Jankovic-led Positive Slovenia.

“With the election of Jankovic the time of this government is over,” Igor Luksic, the president of the second-largest party, the centre-left Social Democrats, told the local business daily Finance after the non-confidence vote. It was a sentiment echoed by the two other parties in the coalition: the Civic List and Desus, the pensioners’ party.

Domestic markets took the news badly. The yield on the Slovenian 10-year jumped by 22bp to 3.91%, still a long way away from the high of 6.88% it reached in the depths of the banking crisis last year. But again, it is a sign of international faith that although the US dollar 2024 bonds immediately slipped 1.5 points to 101.50 on the news of Jankovic’s win, within 24 hours they were back up to 103.039.

“I have to say that it is surprising how cool the market has taken the government situation,” said a New York-based trader.

At the end of April, Bratusek said she would remain as prime minister only until elections could be called. “I stand by my words: that I cannot lead the government without support from my own party. Therefore, early elections in Slovenia are a reality,” she said, expressing a preference for June or July. Whether it can happen that quickly is another matter. Analysts do not expect to see a new government in place before in September or October at the earliest.

At the end of Q1, economists were bullish about Slovenia. The economy had been expected to pull out of recession in 2014 with GDP growth of 0.5%; a distinct green shoot of recovery after two years of decline. But political stalemate means that even though Slovenia is unlikely to need to go cap in hand to the international markets, the cuts and privatisations that are necessary to revive the economy are unlikely to happen.

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