Slovenia Business Forecast Report Q4 2008

Difficult Times Ahead

Now that Slovenia's six-month stint as EU president has come to a close, the focus of political risk will be on the forthcoming general election. Due on September 21, the parliamentary vote is expected to be a close race between incumbent Social Democrat Party of Slovenia (SDS) and centre-left opposition Social Democrats (SD). Opinion polls suggest that no party will be able to form a majority government alone, thereby making coalition forming a key part of the election process. In our view, this also creates more risk and uncertainty, and could leave main parties heavily dependent on the votes of extremist or specialist partners. Broad EU and Eurozone support across all the main parties should keep the ongoing convergence process on track, though a weak government coalition would delay important reforms.

Faced with the possibility of an inconclusive election result, we have cut our short-term political risk ratings for Slovenia to 79.6, from a previous 86.7. This may seem like a steep adjustment, and on top of election uncertainty, we do see a greater threat from social unrest as the recent economic boom gives way to a difficult period with high inflation. That said, Slovenia still compares well to other states in emerging Europe. Its political institutions are well developed and relatively stable, and the democratic system firmly in place. This is reflected on the ongoing upward trend in the country's long-term political risk rating, which now stands at 85.3.

Since our last quarterly report, the global economic outlook has deteriorated, creating more downside risks for Slovenia's small and open economy. As such, we have downgraded some of our headline forecasts for this year. Inflation remains the key risk to stability, as it continues to hover around 7% y-o-y, well above the Eurozone average. Now that Slovenia has handed control of monetary policy to the European Central Bank, it has fewer tools at its disposal to defend against price increases. A key challenge for the government will be to prevent supply-shock inflation (caused by surging food and energy costs) becoming more permanent through excessive wage demands and higher future expectations. We have revised our current account forecasts over the short-term, as early data shows the external trade balance continues to deteriorate rapidly. In both cases, we expect conditions to stabilise by the end of the decade.

Slovenia's business climate better resembles that of a developed European state than one in transition. An excellent infrastructure, open markets, a skilled workforce, and stable political institutions all combine to make the country an attractive investment opportunity. Joining the single currency union at the start of 2007 and the Schengen free movement zone in 2008 underscores the progress made. Inward FDI doubled last year, and we expect it to continue growing at a robust rate over the next few years.