By Michael Winfrey
LJUBLJANA (Reuters) - Slovenia, trying to avoid becoming the euro zone's next bailout victim, may have "significantly" misread the cost of fixing its troubled banks, the OECD said on Tuesday.
Following last month's messy rescue of Cyprus, the country of 2 million perched on Italy's northeast border is seeking funds to heal its state-owned financial sector.
But Slovenia is not in immediate need of rescue, said Yves Leterme, deputy secretary general for the OECD.
"The government of this country has been able to meet its financial needs without difficulties so far," Leterme said in Ljubljana while presenting an economic survey that assessed Slovenia's economic outlook as one of the worst in the OECD.
"It (borrowing) was at a relatively high cost (but) as far as we are concerned, there is no reason to anticipate an immediate need for a bailout."
In a sign of growing investor caution, Slovenia raised far less funding than planned and at higher costs at a treasury bill auction held after the Organisation for Economic Cooperation and Development presented its outlook.
The OECD, a 34-member club of wealthy states, said Slovenia should sell state-owned banks that were viable and allow those that were not viable to fail.
According to an assessment made last year, the local banks, mostly state-owned, are burdened with 7 billion euros (5.8 billion pounds), or a fifth of Slovenia's annual output, in bad loans.
The country risks lagging in its race to catch up with Western living standards, the Paris-based organisation said, citing uncertain costs to bail out its lenders, pressure on its exports from the euro zone crisis, and a rise in borrowing costs after Cyprus's bailout.
It predicted a second straight year of economic contraction, by 2.1 percent. It also noted public debt had more than doubled to 47 percent of gross domestic product since 2008 and said that could rise to 100 percent by 2025 with no new reforms.
"Against this difficult background and with a possible further deterioration in the international environment, Slovenia faces risks of a prolonged downturn and constrained access to financial markets," the OECD said.
It recommended Ljubljana should give the competition office more powers, gradually raise the pension age, wean wealthier citizens off family benefits, cut unemployment and other benefits and improve efficiency in education and healthcare.
TOUGHER STRESS TESTS
Analysts said Slovenia could still avoid a bailout, but that could not be taken for granted.
"Slovenia has assets that it can sell but the question is if there is political will to sell them. I guess Slovenia will be able to get through June and we should know by the end of the year ... whether a bailout can be avoided," said Matej Tomazin, head of the investment fund KD Skladi.
Slovenia is the only ex-communist European Union state that declined to privatise most of its banking sector.
The OECD said it now faces "a severe banking crisis, driven by excessive risk-taking, weak corporate governance of state-owned banks and insufficiently effective supervision tools."
The OECD said last year's estimate of the level of bad loans in the banking system was outdated and used methodology that was weak and non-transparent, so the real damage could be worse.
"Capital needs are uncertain and could in fact be significantly higher," it said.
It welcomed a plan to create a "bad bank" to take non-performing loans away from state banks but said "lack of transparency and potential political interference pose risks". It added that weak corporate governance and credit misallocation could potentially be attributed to corrupt behaviour.
It urged Ljubljana to stress test the banking sector again using more robust methodology and publishing the results, before recapitalising distressed but viable banks, preferably through share issues.
But it said market valuation showed equity in state banks had been "virtually wiped out", and banks that were non-viable should be wound down, with holders of subordinated debt and lower-ranked capital instruments absorbing losses.
Slovenia should then privatise the banks, the OECD said, criticising a plan being discussed by the left-of-centre government for the state to retain a blocking minority, saying it could lead to political interference and new problems.
It said failure to pursue reforms pledged when Ljubljana tapped the dollar debt market last year could "significantly raise borrowing costs", as could a higher than expected bill for recapitalising banks. All of this put pressure on the economy.
"Potential growth has fallen significantly since the outset of the crisis," the OECD said.
(Reporting by Michael Winfrey; Editing by Ruth Pitchford)
