Toxic Loans Risk Slovenian Bond Rally: East Europe Credit

Slovenia’s bond rally, the biggest among Europe’s former communist nations, risks faltering as a government budget dispute following the cleanup of toxic-bank loans threatens to unseat Prime Minister Alenka Bratusek.

Bratusek, the third premier since 2011, is trying to quell a challenge to her leadership and end a coalition quarrel that threatens to derail her deficit-cutting program after she spent almost 10 percent of economic output last year to clean up the nation’s banks, whose bad loans reached 11 billion euros ($15.2 billion). The government needs to boost revenue and overhaul state companies to sustain the fiscal improvement.

“The threat of early elections is real,” said Abbas Ameli-Renani, an emerging-market strategist at Royal Bank of Scotland Group Plc (RBS) in London. “That may bring the bond rally of recent months to a halt.”

The extra yield investors demand to hold Slovenia’s 10-year euro-denominated bonds rather than German bunds, Europe’s benchmark government security, rose to 214 basis points yesterday from 179 on April 4, the lowest in almost four years, according to data compiled by Bloomberg. While the yield on the security has fallen 143 basis points this year, the biggest drop among 19 European sovereigns after Cyprus, Greece and Portugal, it has climbed in four out of the past six days, reaching the highest since March 27 two days ago.

Avoiding Bailout

Slovenia avoided the fate of Greece, Ireland, Portugal and other euro-region nations that needed a financial bailout after Bratusek installed an austerity program that pushed yields down after reaching 7 percent.

Bratusek, in power for 13 months, said she can’t rule out snap elections as she seeks a vote of confidence as early as May after the Constitutional Court struck down a proposed property tax law on March 28.

Coalition partners are at odds over how to replace revenue spent on the bank cleanup. The budget deficit shot to 15 percent of gross domestic product last year after including 3.2 billion euros in bank-rescue costs.

The Adriatic nation covered its borrowing needs for this year before the political dispute escalated, having sold 2 billion euros of debt on April 1 and $3.5 billion in February, its fastest pace of raising debt on record. Slovenia, which adopted the euro in 2007, has about 24 billion euros of borrowing, according to data compiled by Bloomberg.

Financial Cushion

The recent sale, in which the government took advantage of falling yields after carrying out the bank recapitalization program, may act as a short-term cushion against a government stalemate, economists including Jaromir Sindel at Citibank AS in Prague said.

Slovenian bonds returned 8.3 percent this year in euro terms, exceeding the 4.5 percent for the Bloomberg Eurozone Sovereign Bond Index, which tracks securities of 14 out of 18 members of the bloc. By comparison, bonds in emerging Europe returned 3.31 percent, trailing broad emerging markets with 4.1 percent, according to Bloomberg Emerging Market index.

“Slovenia has a large financing reserve to cover borrowing needs for 2014, 2015 and partly for 2016,” he said by e-mail on April 11. “From this perspective, the sovereign risk seems to be limited unless we see a combination of a political crisis and a failure of privatization of state-owned banks.”

The bank cleanup prompted Moody’s Investors Service to change the outlook on Slovenia’s Ba1 rating on Jan. 24, the highest junk rating, to stable from negative. The government steps removed concerns about the cost of the recapitalization and have reduced the probability that the country will need outside aid, the ratings company said

Economic Turnaround

The government is also relying on accelerating economic growth to shore up public finances after the economy expanded 2.1 percent in the fourth quarter from a year earlier, after eight straight quarters of contraction.

Economists are now more upbeat about the recovery. GDP is set to grow 0.6 percent this year, 1.4 percent in 2015 and 1.7 percent in 2016, the central bank said April 8. As recently as October, policy makers expected the economy to shrink this year.

“Slovenia has the potential to outperform” the forecasts, Chris Marsh, an economist at Pharo Management in London, said in an e-mail on April 10. “That said, current political uncertainty warrants caution, and it is particularly important not to see any claw-back of progress made towards privatization or governance reforms.”

Asset Sales

The government wants to raise 4 billion euros from the sale of 15 state-owned companies, including stakes in banks, according to Finance Minister Uros Cufer. The administration also needs to boost revenue to meet the budget deficit target of 3.9 percent of GDP by year-end as estimated by the European Commission in a February forecast.

Bratusek will face a challenge to her leadership of the Positive Slovenia party on April 25 from Ljubljana Mayor Zoran Jankovic, the party’s founder. If she wins, a confidence vote in parliament is set to follow in May.

Prime Minister Borut Pahor was toppled in September 2011 after three years in office as tensions over austerity splintered the coalition. Janez Jansa, Bratusek’s predecessor, was ousted just over a year ago when two junior coalition parties left the ruling bloc.

“Political risks remain significant and at this moment it’s difficult to judge the outcome of the confidence vote,” Alen Kovac, the chief economist at Croatia’s unit of Erste & Steiermark Bank DD said in an e-mail yesterday. Investor wariness “could reduce the appetite for privatization and fiscal consolidation, which would in turn emphasize macroeconomic risks,” he said.

To contact the reporters on this story: Boris Cerni in Ljubljana at bcerni@bloomberg.net; Radoslav Tomek in Bratislava, Slovakia at rtomek@bloomberg.net

To contact the editors responsible for this story: James M. Gomez at jagomez@bloomberg.net

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