Slovenia Business Forecast Report Q1 2009

Uncertainty Spikes On Credit Crisis, New Government

Uncertainty has increased sharply since our last quarterly economic report. As a small and open economy Slovenia is highly vulnerable to the financial storm that is wreaking havoc across the global economy. But it is the speed at which the credit crisis has gripped the US and Europe that makes any emerging market outlook considerably cloudier than before. In addition, the country is about to adopt a new government, adding to investor's jitters. A new leftleaning administration will likely respond quickly to assist lowincome groups during the crisis, and we do not rule out direct state intervention in local markets. Given these unknowns we acknowledge a substantial degree of risk to our political and economic core forecasts, almost entirely to the downside. However, our fundamental view is that Slovenia will experience a relatively sharp slowdown, but not be the worst affected state in Europe, due to a relatively stable financial system and strong political institutions.

The new Social Democrat (SD)led government is scheduled to take over during November 2008. The centreleft coalition will include the LDS, Zares and DeSUS, though will still only enjoy a narrow majority in parliament. This will pose a risk to political stability in the shortterm, in our view, particularly as the support of specialist Pensioner's Party, DeSUS, may come with strings attached. The party could potentially become frustrated with a lack of progress in social projects during a time of crisis, especially as new Prime Minister Borut Pahor has pledged to keep public finances in check. Given this underlying threat, we recently cut Slovenia's shortterm political risk ratings to 79.6. While this is by no means a weak score in regional terms, it better accounts for the added uncertainty over the new government's stability and reform agenda.

Slovenia's economic growth actually accelerated in Q208 to a healthy 5.5% yearonyear (yoy). This, however, was before the external crisis began to have a strong impact on the regional banking system and the country's main export markets. Therefore, while we retain our 4.8% target for GDP growth in 2008, we have revised down our estimate for 2009 to 3.5%. This is based on an assumption that export growth will dwindle against a backdrop of eurozone stagnation, while domestic construction and manufacturing activity will also moderate sharply. We have also adjusted our yearend inflation forecast for end2009 to 3.1%. In both cases, we expect a higher figure in 2010, as the economy begins to recover. However, we also acknowledge the risks of further revisions to the downside.

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. However, powerful trade unions keep labour costs higher than the regional average, posing a key threat to business activity, particularly in an economic downturn.