GDP growth is projected to slow from 5% in 2022 to 0.5% in 2023, reflecting higher inflation, weaker external demand and the negative impact on confidence from Russia’s war of aggression against Ukraine. Despite slowing activity, the labour market is expected to remain tight, fuelling stronger wage growth and contributing to inflationary pressures. Nonetheless, real wages will fall, damping private consumption. Growth will pick up to 2% in 2024 as inflation slowly recedes.

Fiscal policy will remain supportive in 2023, before tightening in 2024. Government measures aim to mitigate the effects of increasing energy prices on households. Fiscal support should be targeted on low-income households, preserve energy saving incentives and be financed by spending cuts, as the current expansionary fiscal stance risks intensifying inflationary pressures. Structural reforms to address labour shortages and raise potential growth should focus on reducing labour taxes, financed by higher environmental and property taxes.

Economic activity continued to grow in the first half of 2022 driven by strong private consumption. This came despite higher inflation, a worsening external environment and a deterioration of consumer and business sentiment due to the war in Ukraine. Growth continued into the summer, supported by the expansion of service activities. However, retail trade turnover (without volatile automotive fuel sales) registered weaker growth of 0.4% month-on-month in September, while industrial production growth turned negative. The labour market remains tight with an unemployment rate of 4.1% in September, and the job vacancy rate at a historic high. The tight labour market is also reflected in stronger wage growth, with nominal gross wages rising by 5.7% year-on-year in August. Such domestic price pressures have contributed to a rise in core inflation to 6.6% in September. Headline inflation reached 11.7% in July but has declined to 10.3% in October, helped by a cap on electricity and gas prices.

Direct trade with Russia and Ukraine was low at the onset of the war, although nearly all gas and 17% of oil and petroleum imports came from Russia. Since then, dependence on Russian gas and oil imports has been reduced through the diversification of suppliers. Also, gas storage targets were met earlier than expected. Nonetheless, higher international energy prices have a negative impact on the trade balance and contribute to inflationary pressures. Higher gas prices are also weighing on gas-intensive manufacturing (such as basic metals, chemicals, paper and paper products), which accounts for 4.5% of employment, more than almost anywhere else in Europe.

The government responded to the energy crisis with a fiscal package of 0.6% of GDP in 2022 and announced further spending of 2% of GDP for 2023. This includes direct subsidies to households and businesses and temporary tax cuts. The government also capped the price of electricity and gas in September for one year for households and small businesses. Temporary measures are assumed to be phased out in 2023. In addition, structural measures include higher pension benefits due to higher pension indexation and higher replacement rates. These measures are expected to increase the budget deficit to 5% of GDP in 2023, before the fiscal stance is tightened in 2024. The supportive fiscal stance adds to demand pressures. This comes at a time when euro area policy interest rates may be lower than needed to contain inflation and inflation expectations in Slovenia, as in other peer economies with strong growth and inflation.

Growth is projected to slow in 2023, reflecting high inflation and weaker foreign demand. Private consumption will be hit by the impact of high inflation on households’ disposable income. Weaker demand and higher interest rates will slow investment, although the inflow of EU funds should moderate the fall to some extent. The labour market will remain tight, contributing to stronger wage growth. This, together with high energy and food prices, will keep headline inflation elevated. Only in 2024 will growth pick up as foreign demand recovers and headline inflation slowly recedes, reflecting declining domestic demand pressures on the back of fiscal tightening. Downside risks depend on the continuation and intensity of the war in Ukraine and its impact on international energy markets and trade. Colder-than-usual winters could still force the government to ration supplies for heavy industrial users. On the upside, stronger labour force participation of older workers and migration could help reduce labour market shortages and wage pressures.

Faster fiscal consolidation is needed to reduce demand pressures. Support should be financed by cuts to other recurrent spending and be better targeted. This entails replacing energy price caps with temporary direct subsidies for low-income households that preserve energy saving incentives. Efforts to diversify gas supply, including the expansion of LNG capacity held in other countries and in coordination with the European Union, will help improve energy security. Such efforts should be implemented alongside structural reforms to raise potential growth and address labour shortages. This includes a growth-friendly tax reform with lower labour taxes, financed by higher environmental and property taxation.

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