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UPDATE 1-Deficit soaring but Slovenia can still avert bailout, EU says

Marja Novak and Martin Santa
Tuesday, 5 Nov 2013 | 9:11 AM ET

* Financial sector fix, continuing reforms only way out

* 2013 deficit at 5.8 pct/GDP, Growth return only in 2015

* Public debt to rise steadily, reach 74 pct of GDP in 2015

LJUBLJANA/BRUSSELS, Nov 5 (Reuters) - The European Commission said on Tuesday that Slovenia was set to see its budget deficit balloon next year but can still avoid an international bailout if it continues with structural reforms and fixes its banking sector.

The country is struggling under the weight of some 7.9 billion euros ($10.67 billion) of bad loans in the mostly state-owned banking sector but hopes tax increases, spending cuts and privatisations will raise enough funds to recapitalise banks.

In its latest economic forecasts, the Commission said the country's budget deficit is set to soar to 7.1 percent of economic output next year because of the cost of helping its lenders.

The deficit is forecast to be 5.8 percent this year, well above the 3 percent limit required of euro zone members.

But EU Economic and Monetary Affairs Commissioner Olli Rehn told a news conference in Brussels this did not means the small euro zone country would need others to step in.

"Slovenia is certainly not necessarily heading towards a (bailout) programme on the condition that it maintains ... recent determined action and effectively implements ... structural reforms," he said.

He also called for the rapid repair of Slovenia's banking sector, saying it was central to the country's recovery.

The International Monetary Fund, which oversees euro zone bailouts along with the Commission and the European Central Bank, said late last month that a recovery in Slovenia could be sustained by restructuring the indebted corporate sector and reducing the role of the state in the economy.

In Slovenia's favour, the country's fiscal accounts are less alarming after stripping out bank recapitalisation costs. Its deficit would be 4 percent of gross domestic product in 2013 and 3.6 percent next year, the Commission said.

CAPITAL NEEDS

Slovenia was the fastest growing euro zone member in 2007 but hit a brick wall when the global financial crisis erupted in 2008. It fell into a new recession in 2012 because of lower export demand, a credit crunch and a fall in domestic spending caused by budget cuts.

To avert becoming the sixth euro zone country needing some form of emergency financial aid, Slovenia plans to inject capital into the banks later this year, or in early 2014, after getting the results of banks' stress tests demanded by the Commission.

The government of the 35-billion-euro economy has earmarked 1.2 billion euros ($1.6 billion) for the recapitalisation of the main banks. There are still risks though, as analysts expect stress tests could show much higher capital needs.

The Commission said Slovenia's economy would contract by 2.7 percent this year and 1 percent in 2014, making it one of the poorest performers in the euro zone.

In May, the Commission forecast a 2 percent fall this year and a marginal decline of 0.1 percent in 2014.

The new GDP forecast is broadly in line with the projections by the government and the Bank of Slovenia, which expect the recession to last until late 2014.

"A tepid recovery of the economy is forecast to start only in the second half of 2014 and to continue in 2015, albeit at a very slow pace. The rebound would be driven by net exports, as global economic conditions improve," the Commission said.

The Commission projected Slovenia's public debt would steadily rise to 74.2 percent of GDP in 2015 from 63.2 percent of GDP this year.