DBRS Assigns A (high) Rating to Slovak Republic

DBRS, Inc. has today assigned long-term foreign and local currency issuer ratings of A (high) to the Slovak Republic. DBRS has also assigned short-term foreign and local currency issuer ratings of R-1 (middle). The trend on all ratings is Stable.

The A (high) ratings reflect Slovakia’s strong macroeconomic performance and deep integration with major Eurozone economies. Slovakia attracts high quality foreign investment and exhibits a strong commitment to fiscal targets and debt rules, and has a healthy banking sector. The ratings are constrained by a relatively low level of productivity, limited domestic savings, high unemployment and regional disparities. Slovakia also faces unfavorable demographics, with adverse consequences for pension, health and old age expenditures, and there is some uncertainty over the newly formed government coalition’s policy platform.

The Stable trend reflects DBRS’s assessment that risks to the ratings are broadly balanced. A reduction in the structural deficit combined with a steady decline in public debt could put upward pressure on the ratings. In addition, continued strong investment that enhances productivity combined with measures to address unemployment and regional disparities could be positive for the credit profile. On the other hand, the ratings could be lowered if the fiscal stance weakens significantly, leading to a deterioration in public debt dynamics. Similarly, following the March 2016 elections, a less disciplined policy framework or weaker economic performance could put downward pressure on the ratings.

Slovakia’s ratings are underpinned by its solid macro-economic performance with it being among the top growth performers in the EU during the last decade (2005-14) with growth averaging 3.8% led by both domestic and external demand. Slovakia’s drive to OECD membership in 2000, the EU accession in 2004, followed by the adoption of the Euro in 2009 were key factors behind the resilience in the economy. DBRS expects conditions are likely to remain favorable in the medium term at 3–3.5% reflecting sustained domestic demand supported by rising employment and real wages as well as a pick-up in exports due to new auto investments. While the domestic growth story is strong, risks to growth could emerge on the external front due to Slovakia’s growing role in global value chains and lower growth in its key trading partners and emerging markets.

Slovakia’s strong commitment to fiscal consolidation is evident from the near 5% reduction in the deficit since 2009 to 2.8% of GDP in 2013, enabling it to exit the EU’s Excessive Deficit Procedure (EDP). The government has targeted the 2016 deficit to fall to 1.9% from 2.74% in 2015. However, uncertainty on the new government’s spending package could result in the deficit remaining over 2% of GDP in 2016. Slovakia’s debt ratios have stabilized (52.5% of GDP in 2015) with the underlying debt dynamics pointing to a stable debt trajectory. Moreover, Slovakia’s fiscal commitment and measures to strengthen the credibility of public finances are reflected in its adoption of the Fiscal Responsibility Act in March 2012. Further, the composition of Slovakia’s public debt profile mitigates exchange rate and refinancing risks. Of Slovakia’s outstanding debt, 90% is denominated in Euros and the remaining 10% is in foreign currency and is being fully hedged. Refinancing risks are mitigated thanks to ECB’s expansionary policies and efforts to raise the maturity profile (7 years).

The banking sector in Slovakia has strong fundamentals as reflected in robust profit growth, adequate levels of capitalization and asset quality. The main banks are foreign subsidiaries, but their reliance on external funding is limited as they follow a traditional retail-oriented business model with stable domestic deposit-based funding. While private sector leverage growth led by housing in Slovakia is amongst the highest in the EU, low real interest rates, rising disposable income, and stable property prices are mitigating factors.

Despite its resilience, Slovakia faces several challenges. Similar to most European countries, sustainable fiscal consolidation would entail Slovakia addressing the long-term challenges on its fiscal position arising from its ageing population and pension and healthcare expenditure. Slovakia has tied the retirement age to life expectancy, but the population aged 65 and over is projected by the European Commission to increase from 20% to 72% of the working age population (20-64) between 2020 and 2060. Slovakia’s demographics are amongst the most unfavorable in the EU and this could have implications not only for debt dynamics but also medium term growth prospects.

Unemployment remains high at 11% and regional disparities persist with the Eastern and Southern regions continuing to lag. Structural unemployment remains a challenge with two-thirds of jobless being long-term unemployed. High levels of long-term unemployment could erode human capital, undermine growth, and exacerbate demographic challenges. Concentration risks are among the key challenges facing the economy. The auto sector (including component suppliers) plays a crucial role in Slovakia’s economy accounting for over 40% of Slovakia’s industrial production and 9% of employment highlighting the concentration and vulnerability to global fluctuations. Although this has helped to generate strong economic growth, it also tends to generate amplified swings in output tied to Germany’s economic cycle.

Slovakia’s external debt is high at 86.2% of GDP. This is mainly due to the high share of non-resident holdings of government debt (55%). However, despite the weakening net international investment position, external vulnerabilities are mitigated due to the high share of FDI and long maturities of foreign holdings of debt. While a pull-back by foreign investors could be disruptive to the domestic market, public sector liquidity concerns are mitigated by Slovakia’s stable institutional investor base and access to European support mechanisms.

Notes:
The main points discussed in the Rating Committee were (1) the resilience of the balance of payments section and (2) political developments post the elections.

All figures are in Euros unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website under Methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website under Rating Scales.

The sources of information used for this rating include Slovakia Ministry of Finance; ARDAL, National Bank of Slovakia; Eurostat, European Commission, IMF, Haver Analytics, DBRS. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

For further information on DBRS’ historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository see
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period while reviews are generally resolved within 90 days. DBRS’s trends and ratings are under constant surveillance.

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Lead Analyst: Rohini Malkani
Rating Committee Chair: ROGER LISTER
Initial Rating Date: April 22, 2016
Most Recent Rating Update: April 22, 2016

For additional information on this rating, please refer to the linking document under Related Research.