Cross-posted from Credit Writedowns
“Slovenia becomes the new problem child of the EU”. This is the headline today in Handelsblatt, a leading German financial newspaper. Below is a translation of that article and a few comments:
Slovenia was long regarded as a model country. But now it is becoming a new problem case for the euro-zone. The government needs to cut vigorously to avoid Greece’s fate.
Jean-Claude Juncker, chairman of the Euro group, and Luxembourg’s Prime Minister, has called on the small country to take drastic cost-cutting efforts.The government in Ljubljana must not increase the national debt. Otherwise a fate similar to Greece’s could threaten Slovenia.
In 2007, Slovenia was the first Eastern European EU country to join the euro zone. The small country of two million inhabitants has long been regarded as economically sound. But since the financial crisis, the national debt has grown from year to year. According to the latest estimate by the EU Commission, the budget deficit for the year will have risen to 5.8 percent of gross domestic product (GDP). In 2010, the ratio stood at 5.6 percent. The public debt will account for 42.8 percent of GDP in December. A year earlier, it was 38 percent. Euro group chief Juncker criticized foremost that the Slovenian population rejected the revamping of the state pension system and an increase of the retirement age in a referendum earlier this month. "Slovenia must now get to grips with problems elsewhere. An agreement on pension reform would have been the easiest way," Juncker said, according to the Slovenian news agency STA. The government must now take "quick and brutal" decisions.
In the beginning of the month, the Slovenian central bank chief Marko Kranjec had already warned against a rejection of the pension reform. The country must definitely do something about the rapidly growing national debt. "If things continue at this place, our country will find itself in Greece, Portugal or Ireland’s position," the central bank head said.
Slovenia is certainly still a good bit below the EU average with its level of debt, which is about 80 percent of GDP. Investors, however, are worried about the extremely rapid growth of the Slovenian government debt in such a short time. In 2005, the rate was 27 per cent of GDP. This year it will exceed the 40 percent level.
Gunter Deuber, Eastern Europe specialist at Raiffeisen Banking Group in Vienna, warns of a growing loss of credibility for this small country. With its open economy, Slovenia has so far always been regarded as fairly reliable and solid. At present, potential problems have been overlooked due to the crisis in Greece. Slovenia has to be careful, however, as international investors could turn away soon. "Slovenia is trying to find its way," laments Deuber. The openness of the previous era has been lost somewhat. The country is now increasingly closing itself off from the outside.
I would say the tone of the article is somewhat overstated since there is clearly no comparison between Slovenia and Greece on debt-to-GDP metrics. However, Slovenia’s problems highlight the fundamental deflationary bias of the euro system and all fixed exchange rate systems more generally.
In the wake of a deep recession, private sector demand falls. Income falls with it, causing tax receipts to fall even as budgetary needs rise due to automatic stabilizers. This opens up a wide government deficit. In general, this is what you want fiscal policy to do; the public sector picks up the slack for the private sector in and coming out of recession.
However, the euro acts as a gold standard for national governments within the euro zone as EMU has fixed their (now abolished) national currencies to an external currency they do not create. The Slovenian government needs to ‘get’ euros like any other euro currency user. This makes it vulnerable to liquidity concerns. Slovenia does need to be concerned given heightened awareness of euro zone budgetary problems. This is the risk governments run in abdicating currency sovereignty. Monetary policy is abdicated and fiscal flexibility is reduced as was initially desired in setting up the euro zone. That will likely mean cuts in Slovenia, adding yet further to fiscal policy as a drag throughout the euro zone.
Source: Slowenien wird zum neuen Sorgenkind der EU – Handelsblatt