Slovenia is no Cyprus. This was the message Alenka Bratušek, Slovenia’s new prime minister, sent global investors days after Cyprus agreed to an onerous bailout that forced it to shut a national bank and downsize its biggest lender.

But her reassurance did little to calm investors more concerned with remarks made by Jeroen Dijsselbloem, the Dutch finance minister heading the eurogroup, who suggested countries with an oversized banking sector – such as Slovenia’s – should “deal with it before you get in trouble”.

In the aftermath of the Cyprus bailout and Mr Dijsselbloem’s comments, Slovenia’s borrowing costs shot up. Yields on its 10-year bond hit fresh highs at 6.25 per cent, galloping towards the 7 per cent level regarded as unsustainable.

The spike in borrowing costs underscored investor worries that Slovenia’s distressed banking sector and fragile public finances could force it to be the next eurozone member in line to seek Brussels’ assistance for financial aid.

But is such panic justified? Most economists tend to agree with Ms Bratušek.

“Slovenia’s predicament is nowhere near as severe as Cyprus or other countries forced into the hands of the troika [of bailout lenders from the European Central Bank, International Monetary Fund and European Commission],” said Gavan Nolan, director of credit research at Markit.

However, he added: “The mishandling of the Cyprus situation and the subsequent shambolic communication from various European officials has fuelled contagion and Slovenia is under intense scrutiny as a result.”

Citigroup said that a comparison with Cyprus was unjustified, given the difference in size of the two countries’ banking sectors – the prime cause of the crisis on the small Mediterranean island. Cyprus’s financial system was about eight times the size of the country’s gross domestic product, while Slovenia’s is just 1.4 times larger than GDP.

“A ‘Cypriot template’ is unlikely to be applied on Slovenia, as its banking sector relative to GDP remains among the smallest in the euro area,” said Citigroup.

Nevertheless, investors’ concerns are not entirely misplaced. The first post-communist country to join the eurozone has over the past four years gone from being one of Europe’s most vibrant economies to one of its worst performing.

Slovenia’s GDP contracted 2.3 per cent in 2012 and is expected to decline a further 2 per cent in 2013, according to the IMF. Meanwhile, its budget deficit is ballooning towards 5 per cent of GDP.

“A negative loop between financial distress, fiscal consolidation and weak corporate balance sheets is prolonging the recession,” said the IMF in March following a visit to Slovenia.

Of greatest concern is the deteriorating state of Slovenia’s banking sector, which was deeply hit during the global financial crisis. Its bad debts have consistently risen, with non-performing loans moving above 20 per cent, according to international lenders.

The country’s three largest banks urgently require to be recapitalised to the tune of about €1bn, according to the IMF. Meanwhile, Slovenian banks have a hole in their combined balance sheets of about €4bn, according to Petra Lesjak, head of asset management for institutional investors at Ljubljana-based KD Funds.

“The banks still have liquidity, but it is streaming out of deposits that they are paying heftily for – about 4 per cent a year for 12-month deposits,” Ms Lesjak wrote in a column for BeyondBrics, the FT’s emerging markets blog.

The poor management of the country’s banks – many of which are state-owned – and the slowdown suffered by the construction sector have been blamed for fuelling the domestic crisis.

“Weak governance in public banks, and a credit boom financed externally and directed in significant part towards construction companies and management buyouts and corporate takeovers, are at the root of the problems,” said the IMF.

Slovenia’s political instability has also aggravated the current situation. Ms Bratušek has been in the job for barely a month after the failure of the previous conservative government to fix the country’s economic troubles.

Despite the economic and political uncertainty lying ahead, EU officials are said to be convinced that Slovenia could emerge from its current crisis without external help by simply applying the necessary structural reforms that the country badly needs: fiscal consolidation, cleaning of bank balance sheets and pension reform.

“It now has a government that seems ready to tackle the issues,” said Mr Nolan.

Get alerts on Eurozone economy when a new story is published

Copyright The Financial Times Limited 2019. All rights reserved.
Reuse this content (opens in new window)

Follow the topics in this article