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ECONOMIC ISSUES 2014FISCAL DEVELOPMENTS AND POLICYLjubljana, July 8 2014Lejla Faji IMAD(In cooperation with: M. Bedna, U. Brodar, G. Caprirolo, B. Ferk, M. Glaar, M. Hribernik, E. Zver) Last years stall in consolidation in Slovenia; headline deficit highest so far, without one-offs similar as in 2012 Source:SORS, one-offs MF.2Significant drop in bond spread, continuation of this is conditional on further improvement in areas of public finance consolidation, company indebtedness and structural reforms Source: Bloomberg.

Five years into the crisis:expenditure significantly above 2008 level, revenues caught up with that level in 2013Source: SORS, MF. Note: One offs: recapitalisation of banks and some state owned non-financial companies; in 2013 wage settlement in public sector and compensation to persons erased from the Permanent Population Register.

Expenditure in the period 20082013:only investment and subsidies lower, compensation of employees and intermediate consumption also higher despite the measures taken, capital transfers significantly higherSource: SORS.Revenues in period 2008 2013:tax revenues still significantly lowerSource: SORS.Path of fiscal consolidation in SP 2014:bringing the deficit below 3% in 2015, assuring fiscal surplus in 2018; however consolidation slower than in SP 2013Source: Stability programme update 2013, Stability programme update 2014.Consolidation slower, in spite of higher revenues, even higher expenditure projections in SP 2014, particularly in the year 2014Source: Stability programme update 2013, Stability programme update 2014.Revenues: shift from taxes to other sources of revenues(EU funds, various non-tax revenues, social security contributions, profits from state-owned companies)Source: Stability Programme update 2014.Revenue projections: main features Revenue projections are higher than in previous stability programme + a shift in composition of revenue projections

tax revenues projections lower

projections of other revenues significantly higher: EU Funds, non-tax revenues, profits from state owned companies, social contributions

The SHIFT is mainly a consequence of abandoning the real estate tax and the crisis tax, also slower economic reCovery in the medium term

High growth in revenues in 2014, due to discretionary measures, both in tax revenues and other revenuesRevenue projections: main risks Because of the shift to other revenue, consolidation is underpinned to a greater extent by these other revenues, which do not constitute a systemic fiscal source, which would address the fiscal challenges in the longer term

The question is sustainability of the projected level of other revenues after their high increase in 2014

In the medium term, revenue projections are subject to the risk of possible slower economic growth

A portion of the planned measures to increase revenue requires legislative changes, which can be delayed due to early elections

Crowding out in the period 20132018: interest payments crowd out other expenditureSource: Stability programme update 2014.Consolidation strategy relies heavily on reduction of wage bill, intermediate consumption and subsidiesSource: Stability programme update 2014.Expenditure projections: main features Expenditure (without one-offs) increases significantly in 2014, mainly due to interest payments and investment

by increasing investments In the short run, fiscal policy aims at increasing economic growth (partly EU funded), as in 2013

After 2014 increase, expenditure is reduced until 2018, when it reaches 2013 level

The only expenditureS growing in 2014-2018 period are social transfers and benefits (health and pension expenditure)

Lowering expenditure after 2016 relies on paying off part of the debt with privatisation proceeds, which reduces interest payments at the end of programming periodExpenditure projections: main risks Consolidation strategy strongly relies on reduction of wage bill, subsidies and intermediate consumption; This makes sense, but the approach is still too linear

Risks to wage bill: lacking measures to reduce wage bill, lacking solutions on how to offset the negative effects of a rigid wage system; on top of that: measures need to be agreed with social partners

Risks to subsidies: reducing subsidies relies on shift from non-refundable to refundable subsidies, this demands changes in legislation

Risks to Intermediate consumption: no permanent measures in sight

Risk to social transfers and benefits projections: transfers to individuals and household planned relatively low; freeze in social transfers beyond 2015 requires legislative changes

GIVEN THAT SOME REVENUE- AND EXPENDITURE-SIDE MEASURES HAVE NOT BEEN DEFINED, THERE IS A POSSIBILITY THAT INVESTMENT PROJECTIONS WILL NOT BE REALISED.

CUTTING INVESTMENT WOULD HELP MEET THE TARGETS, BUT IT WILL HAVE EFFECTS ON THE ECONOMIC GROWTH AS WELL.

3rd component of consolidation policy mix:Public debt to increase until 2015; in 2016 &2017 debt and interest payments are reduced; this strategy relies on the use of privatisation proceedsSource: Stability programme update 2014.Long term issues due to demographic changes:highest risks come from projected pension expenditure, however current health and long term policies also unsustainableTo sum up The chalenges of consolidation Slow economic recovery and limited scope to raise taxes means that fiscal consolidation will need to proceed by lowering expenditure

On the revenue side: possibilities for broadening the tax base, further measures to combat grey economy, taxation of wealth (reintroduction of real estate tax)

On the expenditure side: the challenge is to adopt measures with longer lasting effects, to cope with negative effects of austerity measures to prevent deterioration of quality in public services (possibility of assuring part of these services in the private sector)

Quite a few risks were highlighted , however we still believe that meeting of the targets in SP 2014 is possible, but it will demand swift action in adoption of measures planned and preparation of additional measures

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