Stabilisation over the next two years following this year’s contraction in the economy

Banka Slovenije is expecting a profound contraction in economic activity this year, but the situation should stabilise over the next two years. The baseline scenario forecasts a 6.5% decline in GDP this year, before growth resumes, reaching 4.9% and 3.6% over the next two years. A sharp downturn is expected on the labour market, before a gradual recovery over the next two years. These are the key findings from the Macroeconomic Projections for Slovenia presented today. Another highlight is that given the great uncertainty triggered by the Covid-19 epidemic, two alternative scenarios are presented alongside the baseline forecast.

The projections, which were drawn up as part of a joint process in conjunction with the other national central banks of the Eurosystem, took account of the anticipated stabilisation of the situation in the euro area and a relatively favourable forecast for growth in foreign demand. This will be significant for the export-oriented sectors of the Slovenian economy, which are strongly integrated into international trade and supply chains. By contrast, the domestic situation will depend to a considerable extent on the effectiveness of the government’s measures to stabilise the labour market, in particular the measures to partly subsidise reduced working hours and to co-finance furloughing. These measures could prevent a larger deterioration in the labour market.

The core projections forecast a contraction of 6.5% in the economy this year, followed by a stabilisation over the next two years with economic growth of 4.9% and 3.6%. Domestic fiscal policy measures are playing a significant role, and alongside the favourable financing conditions ensured by the ECB’s accommodative monetary policy are mitigating the contraction in the economy. Without them, the economic contraction would be around 3 percentage points larger.

The labour market is also expected to see a sharp downturn this year. After rising for six years, employment will fall by 1.9%, raising the unemployment rate to 6%. The emergency measures put in place will alleviate the epidemic’s impact on the labour market: they are forecast to make the fall in employment and the rise in the unemployment rate about a third smaller. The labour market is also expected to see a gradual improvement over the next two years.

A large fall in private consumption is forecast this year. Amid the uncertainty on the labour market, and the increased social distancing requirements, households will act more cautiously and will increase their level of precautionary saving. Consumption of non-essential and durable goods and services will decline in particular. Sales of cars in particular are expected to fall, but demand for services requiring direct physical contact will also decline.

The decline in orders and the interruptions to supply chains will have a huge impact on firms’ investment decisions. These will depend primarily on the level of deterioration in the liquidity position, which could be alleviated by the government guarantee scheme. Given the major decline in economic sentiment and the numerous uncertainties, firms will opt to defer investment to the following years, which this year will be reflected mainly in a large fall in investment in machinery and equipment. Moderate growth is expected to resume in the following years. The fall in demand in all the major trading partners will bring a sharp reduction in foreign trade this year, which will gradually strengthen over the following years in line with the assumed growth in foreign demand.

Consumer prices will stagnate this year. Inflation is mainly being driven down by energy prices. The pandemic has sharply reduced demand for oil, which has brought significant falls in oil prices. Deflation will be prevented mainly by food price inflation, driven by rises in global prices of food commodities and barriers to trade. Amid the uncertainty on the labour market, domestic demand will fall sharply, but deflationary pressures will also come from the external environment. The downward pressure on prices will only be partly alleviated by the positive price pressures associated with constraints on supply. In line with the economic recovery in Slovenia and around the world, inflation is expected to strengthen towards the end of the projection horizon, but will not reach its pre-epidemic level.

The government will record a fiscal deficit over the projection horizon. It will be particularly pronounced this year, when it is forecast to exceed 8% of GDP. The deficit will result from the decline in revenues caused by the altered economic circumstances and the significant decline in GDP, and from the measures taken to alleviate the consequences of the epidemic, which mainly entail higher general government expenditure. Given the temporary nature of the measures, the expectation is that the government fiscal position will improve slightly over the following years, but the deficit will remain relatively large over the projection horizon. The general government debt is forecast to rise to around 82% of GDP at the same time.

Alternative scenarios

The milder alternative scenario assumes the immediate lifting of all restrictive measures after the spread of infection has been curbed, without any temporary period of social distancing, which would be followed by the rapid recovery of various economic sectors in the second half of the year, with a significant part of the summer holiday season also being saved.  There would thus be a sharp increase in economic activity over the remainder of the year. In this event the economy would contract by less than 4% this year.

The more severe scenario reflects the consequences of a failure to curb the spread of the virus, and a potential second wave of the epidemic in the autumn. In this event GDP would decline by approximately 10% this year, and the remainder of the projection horizon would see the economy recover only very gradually.

Publication is available on the link.