DBRS Confirms Slovak Republic at A (high), Stable Trend

DBRS, Inc. has confirmed the Slovak Republic’s Long-Term Foreign and Local Currency Issuer Ratings at A (high) and its Short-Term Foreign and Local Currency Issuer Ratings at 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, has a healthy banking sector and a solid fiscal framework. The ratings are constrained by relatively low productivity, regional disparities, and high long term unemployment. Slovakia also faces unfavorable demographics, with adverse consequences for pension, health and old age expenditures.

Slovakia’s ratings are underpinned by its solid macroeconomic performance. It has been among the top growth performers in the EU during the last decade. Growth has averaged 4.0%, led by both consumption and investment. Consumption has been supported by rising employment, real wages and favorable credit conditions. Slovakia is among the biggest beneficiary of EU funds transfers, which has benefited public sector investments, while private sector investments have been supported by accommodative ECB policies and improving lending conditions. Growth prospects are likely to remain favorable in the medium term at 3.2-3.9%, reflecting sustained domestic demand as well as higher exports due to new auto investments.

Slovakia’s commitment to the EU fiscal compact is evident from the 5% reduction in the deficit as a share of GDP, from 8% of GDP in 2008 to 2.8% in 2013, which enabled an exit from the Excessive Deficit Procedure in 2013. Driven by higher tax revenues, the fiscal deficit declined from 2.7% of GDP in 2015 to 1.7% in 2016. The government has targeted a deficit of 1.4% of GDP in 2017, with the aim of reaching its medium-term budgetary objective of a structural deficit of 0.5% of GDP in 2019. Slovakia’s debt ratios have stabilized (51.9% of GDP in 2016) with the underlying debt dynamics pointing to a stable debt trajectory. Near term fiscal risks are mitigated by the benign interest rate environment and favorable debt composition. The government is committed to balancing its budget and adhering to the Fiscal Responsibility Act, which specifies debt ceilings and measures to be implemented if ceilings are breached.

The banking sector in Slovakia, though still relatively small, has strong fundamentals as reflected in healthy profit growth, adequate levels of capitalization and robust asset quality. The main banks are foreign subsidiaries, but their reliance on external funding is limited. It is a traditional retail-oriented business model with stable domestic deposit-based funding.

Slovakia’s Eurozone membership is an integral component of its credit strength, both in terms of financial support and in preferential access for trade and financial markets. Financial conditions have improved across the economy because of the ECB’s asset purchase program, refinancing and other monetary operations. Investment into Slovakia is driven largely by European and other international firms seeking to take advantage of lower labor costs and proximity to Europe’s main population centers.

Despite, its resilience, Slovakia faces many challenges. Slovakia’s demographics coupled with low fertility are amongst the most adverse in Europe. As per the European Commission Ageing report, the ratio of people aged 65 and above relative to the working age population is expected to triple between 2013 and 2060. The EU projects that by 2060, there will be fewer than two workers for each pensioner, compared to five at present. While pension reforms are underway, given Slovakia’s demographics, sustainability of public finances remains a challenge and could have implications not only for debt dynamics, but also for medium term growth prospects.

Other challenges include regional disparities and labor market imperfections. While overall unemployment levels have seen a cyclical improvement from 14.2% of the workforce in 2013 to 9.7% (2016), regional disparities remain. The unemployment rate in Eastern Slovakia is 15%, significantly higher than in Bratislava and Western Slovakia, where the unemployment rates are 4.5% and 6.5%, respectively. This is largely attributed to limited labor mobility, lower levels of education and underdeveloped infrastructure in the Eastern and Southern parts of the economy.

While Slovakia has a healthy banking sector, growth in private sector leverage is among the highest in the EU. The double-digit rise in household loans is primarily due to low interest rates, labor market recovery and legislative changes, which impose limits on early mortgage repayment fees. Nonetheless, despite the rapid increase in housing loans, credit remains at relatively low levels, and repayment capacity is supported by low real interest rates and rising disposable income.

Lastly, while the domestic growth story is strong, given Slovakia’s growing participation in global value chains downside risks to the outlook stem from: (1) the European electoral cycle; (2) a disorderly Brexit scenario and (3) increased protectionism. In addition to trade and investment flows, Slovakia is also of the largest beneficiaries of EU transfers. Given Slovakia’s demographics, if Brexit does lead to a reduction in EU transfers to the region, it will be difficult for Slovakia to maintain trend growth.

RATING DRIVERS

The Stable trend reflects DBRS’s assessment that risks to the ratings are broadly balanced. Strong investment that enhances productivity, combined with measures to address regional disparities could be positive for the credit profile. In addition, a reduction in the structural deficit combined with a steady decline in public debt could put upward pressure on the ratings. On the other hand, the ratings could be lowered if growth prospects or the fiscal stance weakens significantly, leading to a deterioration in public debt dynamics.

Notes:

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. These can be found at http://www.dbrs.com/about/methodologies.

The sources of information used for this rating include Slovakia Ministry of Finance, ARDAL, National Bank of Slovakia, Eurostat, European Commission, International Monetary Fund, World Bank, Haver Analytics, and DBRS. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.
This rating was not initiated at the request of the rated entity.

The rated entity or its related entities did participate in the rating process. DBRS did not have access to the accounts and other relevant internal documents of the rated entity or its related entities.

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.

Lead Analyst: Rohini Malkani, Senior Vice President
Rating Committee Chair: Thomas Torgerson, Senior Vice President Sovereign Ratings
Initial Rating Date: 22 April 2016
Most Recent Rating Update: 21 October 2016

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