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, being among the top growth performers in the EU during the last decade. Growth has averaged 3.7%, led by both consumption and investment. Consumption has been supported by rising employment, higher real wages and favorable credit conditions. As regards public sector investments, Slovakia has benefited from being a recipient of EU funds transfers, 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, with the IMF projecting growth to range between 3.3% -3.9% (albeit lower than the National Bank of Slovakia’s forecast of 4%). Higher growth is a reflection of sustained domestic demand as well as higher automobile exports.

Slovakia’s commitment to the EU fiscal compact is evident in measures taken following the financial crisis, which resulted in a five percentage point reduction in the deficit, from a high of 8% of GDP in 2008 to 2.8% in 2013. Since then, the fiscal deficit has ranged between 1.7% - 2.7% of GDP, with the budget targeting a deficit of 1.4% in 2017. Slovakia’s debt ratios have stabilized (51.9% of GDP in 2016) with the underlying debt dynamics pointing to a declining debt trajectory. Near term fiscal risks are mitigated by the benign 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 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 EU membership is a key component of its credit strength, both in terms of financial support and in preferential access for trade and financial markets. Financial conditions have improved largely due to the ECB’s accommodative policies. Investment into Slovakia is driven 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 one of the most adverse in Europe. According to the latest Eurostat projections, from being the youngest economy in the EU at present, Slovakia will be the 8th oldest in 2060, with its old-age dependency ratio expected to increase from 19.7% in 2015 to 59.4% in 2060. 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% in 2016, regional disparities remain. This is largely attributed to limited labor mobility, lower levels of education and underdeveloped infrastructure in the eastern and southern parts of the economy.

Further, while Slovakia has a healthy banking sector, the rise in private sector leverage in Slovakia is amongst the highest in the EU over the last 10 years, with the stock of household debt amongst the highest in Eastern Europe. Given the interlinkage of the Slovak banking sector to the property market, the increase in loan growth is a concern. Nonetheless, repayment capacity is supported by low real interest rates and rising disposable income.

Lastly, while the domestic growth story is strong, risks could emerge on the external front due to Slovakia’s high sector concentration in global value chains. In addition to trade and investment flows, Slovakia is also one 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 its 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 weaken 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, Haver Analytics, International Monetary Fund, World Bank, UNDP 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, Global Sovereign Ratings
Rating Committee Chair: Thomas R. Torgerson, Senior Vice President, Global Sovereign Ratings
Initial Rating Date: 22 April 2016
Last Rating Date: 21 April 2017

Information regarding DBRS ratings, including definitions, policies and methodologies, is available on www.dbrs.com.