Move over, Cyprus. Slovenia is the new tiny country you should worry about.

March 24, 2013

Slovenians offer us hugs, we give them financial crises. (Bor Slana-Reuters)

The Cyprus crisis, it appears, is soooo last week. The new country that's provoking concern is Slovenia. The small former Yugoslav republic—wedged between Italy, Austria, Hungary, and Croatia and best known for its exceptional skiers and Slavoj Žižek—had a pretty bad week, with long-term bond yields spiking to 5.4 percent Friday morning amid fears that the country would need a bailout. That's not crisis-level — Cyprus's yields are around 7 percent, for comparison — but it's certainly in the "Danger Zone."

How did Slovenia get here, and why?

When did Slovenia join the EU?


Slovenian President Borut Pahor (right), then prime minister, meets with German Chancellor Angela Merkel and other European leaders in 2011. (Geert Vanden Wijngaert / AP)

On Jan. 1, 2004. Almost as soon as it joined the EU, it joined the European Rate Mechanism (ERM), which required it to peg its currency, the tolar, to the euro. At the start of 2007 it went whole hog and just adopted the euro.

What was Slovenia's economy like before the crash?


It's a small open economy, reliant on exports. During most of the 2000s, it outperformed the euro zone on growth, as you can see above. But it had a correspondingly large amount of debt. Unlike most countries, which overdosed on housing debt, Slovenia had a problem with corporations financing operations through debt rather than equity. Large corporate loans financed much of the period's growth, most of them taken out by non-financial firms. An EU review found that in 2007 alone, private sector debt grew by 23.5 percent and non-financial private sector debt grew in excess of 40 percent. A lot of that debt went bad when the crisis hit in 2008.

How has it done since the crash?


The state of Slovenia today as represented by noted Slovenian Slavoj Žižek walking away from a flaming car. (Verso Books)

Not too hot. It both took a sharper dive during the initial downturn than the euro zone as a whole and has generally been underperforming relative to its monetary union partners during the recovery.

Why's it slacking?

Janez Janša, the former right-wing leader of Slovenia. (AP)
Janez Janša, the former right-wing leader of Slovenia. (AP)

An IMF report filed last Monday blames "a negative loop between financial distress, fiscal consolidation, and weak corporate balance sheets." The first and third components are related. Because corporations took out such large quantities of debts and now are having trouble repaying it, banks are suffering too. For example, the IMF report notes that at the three biggest banks in Slovenia, the share of loans that are "nonperforming" (that is, in default or near default) grew from 15.6 percent in 2011 to 20.5 percent in 2012. Nearly a third of the loans in question were to private companies.

Meanwhile, the country bought into the austerity fever spreading across the continent, with consolidation measures centered around spending cuts. Janez Janša, who was prime minister from 2012 to 2013, approved an austerity package including cuts to government employee wages and social benefits that he promised would cut the deficit to 3.5 percent in 2012. It hit that target, but only if you exclude bank recapitalization expenses, and revenues fell as the austerity measures battered incomes and reduce the tax base.

Why are people worrying now?


Slovenia Prime Minister Alenka Bratušek (Darko Bandic / AP)

The proximate cause is the election of a new center-left government, replacing the corruption-prone Janša. The new prime minister, Alenka Bratušek, has made it clear she cares more about helping the country grow than about reducing its debt load. That could spur credit rating cuts, and upon fears both of that and of the debt load increasing generally, bond yields spiked on Friday.

The IMF says that the country needs €3 billion ($3.8 billion) in bond funding this year, about a third of which could need to go to recapitalizing suffering banks. If bond yields stay high, raising that kind of money at a reasonable price could be difficult. That could mean the government has to look to the European Central Bank, or the Commission, or the IMF, or the Troika as a whole for a loan with below-market interest rates. In other words, a bailout.

Are they going to be all right?

Slovenian central bank governor Marko Kranjec. (Bor Slana / Reuters)
Slovenian central bank governor Marko Kranjec. (Bor Slana / Reuters)

Marko Kranjec, who serves on both the Slovenian central bank and the ECB, doesn't think a bailout will end up being necessary, and, to be sure, it's a less dire situation than in Cyprus. Cypriot bank deposits are about 800 percent of GDP, compared to about 125 percent in Slovenia. Government debt was only 52.7 percent last year and only set to rise to 69 percent by the end of 2014. Compared to countries with their own currencies like the United States, and certainly compared to countries actually in crisis like Greece, that's a pittance. If Slovenia had its own currency, it'd be a relatively easy problem to solve. But it doesn't have its own currency and so it finds itself on the brink.

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Ezra Klein · March 24, 2013