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Country Study, Slovenia: Winning the Transitional Economies Race

Country Study, Slovenia: Winning the Transitional Economies Race

Country Study

Slovenia:

Winning the Transitional Economies Race

Submitted by

Michael Milton Peter mpeter@indiana.edu

Robert Scott Taylor staylor@indiana.edu

Dmitri Maslitchenko dmitri@mailroom.com

Government Finance in Transition Economies

Professor John Mikesell

Fall 1996

The World Development Report: From Plan to Market (WDR) argues

that with consistent and sustained reforms, transition countries can

achieve successful long-term economic growth, but also warns that

many challenges and risks -- among them long-term stagnation and

rising poverty -- still lie ahead for some countries.

-World Bank News, June 27,1996-

INTRODUCTION

Five years ago a small republic of the former Yugoslavia, started on

its path of transition from an eastern block socialist government with a

planned economy to a democratic government with a free market economy.

Fortunately, the rocky road, described by the World Bank News in the quote

above, has not been long for Slovenia. Although Slovenia was the most

prosperous Republic before the dissolution of Yugoslavia, after the breakup

of Yugoslavia in 1991, Slovenia experienced high levels of inflation, a

drop in the GDP and a tripling of the unemployment levels[1]. These

problems did not stop Slovenia’s transition to an economic powerhouse in

the former Eastern Bloc. However, Slovenia had several advantages over

other Eastern Bloc countries which aided in such a successful transition.

This analysis will present both Slovenia’s historical and current

economic status by examining the political and economic background,

budgetary and monetary conditions, expenditure policies and assignment, tax

structure and administration, and social insurance.

Political and Economic Background

Passing through its transition period from a centrally planned

economy to a market economy, Slovenia has dealt with some successes and

some failures. However, Slovenia’s experiences and economic policies could

prove to be helpful for other economies in transition. There are many

reasons why the transition period for Slovenia has been successful. The

foundation for its quick transformation to a market economy lies within the

positioning of Slovenia in the history of Yugoslavia before and after

its dissolution.

After the end of World War II, Yugoslavia’s definition of socialism

changed. Ownership of the means of production was defined as ‘social’

rather than ‘state’ and firms were managed by workers councils. No central

planning existed after 1965 and Slovenia, as well as the other republics in

Yugoslavia, were given a high degree of autonomy. Also Tito, a former

leader of Yugoslavia, had deviated from the ‘command economy’ model of the

Soviet Institution. As a result, the Yugoslavian government policy had

an emphasis on a greater sense of autonomy, as far the economy was

concerned.[2] The Republic of Slovenia developed its economic base by

increasing the level of manufacturing in the republic as well as

establishing stronger ties with the Western European countries.[3]

Slovenia had always been oriented towards the west, however, due to its

northwestern location in Yugoslavia, its economic interaction with the

western countries led it to become market oriented faster than other

Eastern Europe countries.

While Slovenia was a part of Yugoslavia, it was by far the most

successful republic with a per capita income of almost double that of the

national average.[4] The Slovene economy could not be solely dependent on

the national market and therefore they actively traded with Italy, Austria,

Bulgaria and Hungary. In fact, “with only 8% of the population, little

Slovenia brought in 25-30% of Yugoslavia’s foreign exchange.”[5] Also,

Slovenia accounted for 20% of the country’s Gross Domestic Product.[6] As a

result of this high degree of decentralization and positive net outflows,

the aforementioned characteristics provided the economic basis to

secession. In May 1990, the people of Slovenia elected a government whose

economic policy, according to Mencinger, " was set by the premise that

prospects of transition to a market economy were worsening; the economic

policy of the federal government mistaken, the existing economic system

unsuitable, and the Federation facing political turmoil."[7] The

referendum on independence passed with 90 percent support. Since that

1990 vote, Slovenia has come a long way economically.

Slovenia declared its independence on June 25, 1991. The first year

for Slovenia was quite difficult. “Real GDP fell 15% during 1991-92, while

inflation jumped to 247% in 1991 and unemployment topped 8% - nearly three

times the 1989 level.”[8] The economy continued to plummet until 1993 when

it flatten and then head into the positive direction. By 1993 unemployment

was at 11% and many companies had lost almost 30% of their markets due to

the bitter conflict in Bosnia and the loss of faith in the region by

international trade partners.[9] However, “[a]t its current rates of

economic growth, [slovenia] it could pass EU members Greece and Portugal in

four to five years.”[10]

Current Economic Conditions

Gross Domestic Product

In order to appreciate the current economic conditions of the

country, it is necessary to examine some of the economic indicators in

relation to their past figures. The first indicator is Gross Domestic

Product. According to the EIU Country Report for the 2nd quarter of 1996,

the real GDP growth percentage is slowing down. In fact between 1994 and

1995 there was a -1.4% increase in GDP.[11] Even though there was a

negative change, the Chamber of Economy in Slovenia states that due to

“tremendous growth of new companies, particularly small businesses, and the

shift of foreign trade westward,” they project that slovenia is expecting

to experience a 5-6 percent increase in GDP in the period up to the year

2000.[12] In addition, “the GDP per capita is higher than those of Greece

and Portugal, double that of Hungary and the Czech Republic, and it has a

comparatively efficient manufacturing sector.”[13] Currently, mining and

manufacturing are contributing the largest percentage to the GDP (figures

from 1995 report 31%) with Trade, Hotels and Restaurants and Financial

Market Services at 14% each. Although, Slovenia continues to depend on

manufacturing and machinery production, other industries continue to grow

and keep a diverse base for Slovenia’s GDP. (See Appendix I) The country of

2 million people has a GDP of more than $18.5 billion.[14] The EIU

predicts that the real GDP percentage change form the previous year will be

3.0 and 4.0 in 1996 and 1997, respectively.[15] (See Appendix II)

Imports and Exports

Other important indicators are foreign imports and exports. In 1995

Slovenia had $20.8 billion in foreign trade, goods and services.

Slovenia’s international trade has been geared towards western Europe,

especially Italy and Germany.[16] (See Appendix III & IV) One advantage

that Slovenia has had in trading with the Western European countries, is

that Western Europe does not charge any duty on good entering their

countries from Slovenia, except some agriculture, steel and textile

products; in 1995 70% of all of Slovenia’s foreign trade went to the

EU.[17] Western Europe has maintained a high demand for machinery and

transport equipment, comprising 27% of Slovenia’s exports. (See Appendix V

&VI) This consistent link with the West also is evident in the political

philosophy of Slovenia.

Inflation

In 1991, when the Republic of Slovenia first started establishing

policy towards a market economy, the inflation rate reached a peak of

247.1%.[18] This was expected, since the economy was moving from a highly

state subsidized centrally planned economy to a free- market economy.

Fortunately, by 1995 the inflation rate had reached 9.5%.[19] One

important quality of this transition was that Slovenia managed to bring

inflation under control without any balance-of payment problems. Inflation

in 1996 thus far is at 10.7% a small increase form 1995, however, the

Chamber of Economy of Slovenia has a positive outlook for the next

year.[20] (See Appendix VII)

Privatization

In 1994, the Slovenian government took its first steps towards

privatization. At first the country observed the other Eastern Bloc

countries and learned from their failures. The companies or enterprises’

were allowed to choose between five privatization models, which were then

approved by the Agency for Privatization.[21] Most of the companies were

sold off to the workers and managers.

The citizens were given privatization coupons valued at 100,000 -

400,000 Tolars, depending on the age of the individual. The coupons could

be used to buy shares or invest the money into securities. Over 45%

percent of the coupons were invested into fund securities.[22] According

to Price Waterhouse, over 400 enterprises have been successfully privatized

and another 1000 will soon be at the same status. However, some companies,

such as public utilities, national telecom, and two commercial banks have

not gone through the process; the government states that these entities

will undergo special privatization processes.[23]

Political Situation

On the 25th of June, 1991, Slovenia declared the end of its

political ties with the former Yugoslavia. Although, the government of the

former Yugoslavia did not want the republic to secede, after a mild show of

military force, Yugoslavia gave Slovenia up. Since then, the National

Assembly has been the main legislative body of the Republic of Slovenia.

This national legislature consists of 90 members that are directly elected

by the people for four year terms. In addition, there is the Council of

State that is elected for five years. This council has 40 members, 22

representing local interests, 12 evenly divided between employers, and 6

representing non-economic activities.[24]

Slovenia is currently governed by two dominant parties who have

formed a government coalition, the Liberal Democracy of Slovenia (LDS) and

the Slovene Christian Democrats (SKD). The LDS stems from the youth

movement of the former communists while the SKD originates from a Christian

tradition dating back before the Second World War.[25] The differences in

these groups are the main reasons why there seldom is cooperation in making

government decisions. However, there are other parties with greater

opposition: the Social Democrat Party of Slovenia(SDSS), the Slovene

National Party (SNP) and the Slovene People’s Party (SLS).[26]

One aspect that has helped Slovenia remain stable politically is that

the ethnic make-up is not extremely diverse. Almost, 91% of the population

is Slovene and they are predominantly Roman Catholic.[27] (See Appendix

VIII ) This composition has allowed Slovenia to focus on economic revival

rather than religious ethnic conflict, quite unlike their neighbors to the

south in Bosnia-Herzogovina.

In November of 1996, Slovenia had elections and most of the

incumbents were re-elected. The LDS won the most seats (25) and the

Slovenian People’s Party, conservatives, won the second largest at 19.[28]

This could cause a conflict because, both the liberals and the

conservatives have gained a significant amount of power after this

election. In the coming months the coalitions that form with the parties

with fewer seats could be significant for the political climate of

Slovenia. The far right conservatives, United List of Social

Democrats(ZLSD- former communists), do not back Slovenia’s entrance into

NATO, claiming neutrality should be considered an option; the entrance into

the EU will be supported by the ZLSD.[29] However, economists warn that

Slovenia should not rely on its economic successes in the past but instead

should focus on increasing privatization and address the slowing industrial

production and rising unemployment.[30] The new government needs to

continue to work towards improving the economic state of the Republic if

they expect to become more like a Western European country.

Budgetary and Monetary Conditions

Slovenia began to stabilize its economy before it had gained its

complete independence because inflation was increasing drastically.

Although, Slovenia made a clean break to independence, there were some

costs involved. Slovenia had 33 percent of its exports going to

Yugoslavia, however, with its independence Slovenia had an instant 6

percent decrease in its GDP.[31] This economic shock was small in

comparison to the 38 percent decrease in industrial production Slovenia

faced because of its transitional state. Slovenia stabilized its economy

by October 1992. This was achieved through the introduction of a new

currency, the tolar, and the creation of an independent central bank, the

Bank of Slovenia.

The financial sector plays a key role in the transition process. In

1995, the financial and market services sector comprised 14% of the GDP,

the second largest contributor.[32] In addition, a strong financial sector

is necessary for resource allocation and mobilization, and a prerequisite

for any large-scale privatization scheme.

In 1991, there was a lack of financial regulation in Slovenia, which

produced many problems. Most banks were owned by the firms to whom they

lent. As a result, 30-40 percent of the loans on the books were non-

performing.[33] This combined with a monopolistic structure, lead to

exorbitant lending rates, preventing many viable enterprises from access to

capital. In addition, a healthy banking system requires recapitalization

and investment to improve service. This was not happening right away in

Slovenia. As a result, banks were audited in 1991 and in the autumn of that

year, the Bank Restructuring Agency was founded to deal with these problems

and to help restore competition. Now, most banks in Slovenia have been

privatized except two which remain state-owned.

Monetary Policy

Facing expansionary monetary policy, Slovenia needed some financial

discipline for the newly created enterprises and government, thus, they

created the Bank of Slovenia. The bank was created with the objectives to

stabilize prices and establish a balanced functioning of domestic and

international payments. The law that mandated the Bank of Slovenia,

allowed the bank to execute monetary policy, free from political control.

Another characteristic of the Bank of Slovenia that helped its success, was

that the bank would only give out short-term loans to the government to

cover cash flow problems. This restriction served to be effective in

preventing the accumulation of deficits. In 1994 the Bank of Slovenia

introduced a number of legislative acts which covered the following areas:

* accounting standards and financial statements

* methods of calculation of capital and capital adequacy

* criteria for the classification of balance sheet and off-

balance sheet items

* the levels of provisioning for potential losses

* the level of exposure to a single borrower

* capital investments and fixed assets reducing the capital

This legislation was adopted with the intent to ensure safer bank

operations that conform to the basic principles of liquidity, solvency and

profitability.[34]

In the early years of transition 1991-1992 the Bank of Slovenia

allowed several new banks to start up. Now, in 1996 Slovenia has the

highest concentration of banks in their region, with 31 banks and a

relatively small population of 2 million. The central bank was faced with

the problem of deterring speculators to avoid any kind of banking crisis.

The central bank decided to increase the amount in minimum capital

requirements for banks to $35 million. This move prevented any future mis-

happenings while also pushing banks towards consolidation.

Currency

In October 1991, the Tolar was introduced. As a means of inflation-

proofing, the law allowed contracts and wage agreements to be denominated

in foreign currency so no exchange was required. The deposits in the banks

were converted automatically on a one-to-one basis and 86 billion dinars of

personal cash were converted within a short period of time. The tolar’s

introduction came with ease as more than 80 percent of household monetary

savings were in foreign currency deposits.[35] The Tolar’s exchange rate

quickly stabilized due to a highly restrictive monetary policy which was

aimed at decreasing inflation, increasing stability and strengthening the

domestic currency.[36] Between 1993 and 1995 the Tolar was depreciated to

reflect a real exchange rate. (See Appendix IX) This monetary policy aided

in stabilizing the Tolar and making it fully convertible. On November 19,

1996, 1USD was equivalent to 137.69 Tolars.[37] In addition, the

stabilization allowed for foreign investors to conduct business in USD, DM

or Tolar.

Slovenia put tight controls on foreign currency movements in order to

maintain the stability of the tolar. Since the introduction of the Tolar,

total savings deposits have increased by over 494 billion Tolars. Savings

in 1995 accounted for 23.3 percent of GDP.

Also, Slovenia has a positive balance between the foreign debt and

exchange reserves. By August of 1996, foreign allocated debt had reached

$4.21 Billion and the exchange reserves were at $4.3 Billion. (See Appendix

X) This positive balance shows that the country’s economy continues to

stabilize.

Furthermore, Slovenia has managed to get credit ratings higher than

those of Greece and other countries with longer histories of being

democracies and having market economies.[38] As of May 1996, Slovenia had

the following Country Credit Ratings : [39]

Moody’s Investor’s Service A3

Standard’s & Poor’s A

IBCA A-

In addition, according to Institutional Investors, Slovenia ranks 47th

among 135 countries, with regards to potential areas for investment.[40]

Expenditure Policies and Assignments

In October 1995, the Parliament unanimously approved the 1996 draft

budget presented by Slovene Prime Minister Janez Drnovsek. Expenditures

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