New EU Member States from Central and Eastern Europe and Euro: Focus on Case of Slovenia

Abstract

First, this paper considers the impact of the global financial crisis on new EU Member States (NMS) from Central and Eastern Europe. In the case of Slovenia, the best performer among the NMS, the situation has been very serious.
Second, the mechanism of the crisis in Slovenia is examined in detail. Since the EU accession in May 2004, especially the adoption of the ERM II in June in the same year, in the financial area barriers between the Eurozone economy and the Slovenian economy practically disappeared. The sovereign risk premium decreased. Domestic banks borrowed a huge amount of funds at international wholesale financial markets and actively financed companies’ ambitious investments. Financial authorities in the country were not alert to cross-border movement of a huge amount of capital. Due to the Lehman shock, however, international financial markets became tight suddenly and demands in the Western markets sharply decreased. The direction of international financial flows reversed. The banking sector was obliged to dispose a huge amount of non-performing loans and recorded negative pre-tax profit for consecutive three years since 2010. One of the reasons why the Slovenian economy fell into such a serious crisis is that domestic banks increased their borrowings abroad too quickly within a short time from 2005 through 2008. In addition, there were the following circumstances: 1) the second wave of privatization of state-owned companies was implemented on the method of Management Buyout from 2006 and domestic banks gave loans to managers. Unfortunately, this was done immediately before the Lehman shock; 2) the weight of foreign-owned banks has been smaller in this country. In other NMS foreign-owned banks have been predominant in the banking sector, and their parent banks managed to support their affiliates in the global financial crisis. In contrast, in the case of Slovenia, the government has been required to inject fresh capitals into domestic banks to protect the banking system. The type of Slovenian crisis is different from that of the Greek crisis and the Cypriot crisis.
Finally, the paper considers the significance of euro for NMS from Central and Eastern Europe. The NMS, which have not adopted euro yet, will sooner or later advance toward the adoption of euro. After joining the Eurozone, these countries will be required to steer their economic policies cautiously on the basis of lessons from Slovenia’s failure.