DBRS Morningstar Upgrades Republic of Slovenia to A (high), Stable Trend

DBRS Ratings GmbH (DBRS Morningstar) upgraded the Republic of Slovenia’s Long-Term Foreign and Local Currency – Issuer Ratings to A (high). At the same time, DBRS Morningstar upgraded the Republic of Slovenia’s Short-Term Foreign and Local Currency – Issuer Ratings to R-1 (middle). The trend on all ratings has changed from Positive to Stable.

KEY RATING CONSIDERATIONS

The ratings upgrade reflects DBRS Morningstar’s view that Slovenia’s credit quality across several analytical building blocks has improved. Impressive economic growth in recent years helped repair fiscal accounts and accelerated the downward trajectory in the debt-to-GDP ratio. DBRS Morningstar expects fiscal surpluses in the coming years and general government debt to decline to under 62% of GDP in 2020. If completed, that debt consolidation would constitute a remarkable reduction of over 20 percentage points of GDP since 2015. Current assumptions point to a debt ratio below the 60% Maastricht threshold by 2021. Improvement in “Debt and Liquidity” and “Economic Structure and Performance” building blocks are the key factors considered for the ratings upgrade.

Slovenia’s credit strengths stem from its wealthy and high value-added economy compared to A category regional peers, its effective debt management and judicious fiscal framework, and its membership of European institutions. However, the ratings are principally constrained by the small and open nature of the Slovenian economy that makes it vulnerable to external shocks, and the country’s still high stock of public sector debt. Notwithstanding the noteworthy reduction in the public debt ratio, government debt remains above regional peers and long-run debt reduction could be challenged by rising age-related spending. Unfavourable demographic trends are expected to place structural pressure over the long-term on public expenditures in the absence of healthcare and pension reform.

RATING DRIVERS

Ratings could be upgraded if the government’s debt ratio further declines in a meaningful way due to sustained economic growth, prudent fiscal management, and the passage of policy measures that address rising age-related spending. The strengthening of medium-term growth prospects without evidence of large macroeconomic imbalances would also be credit positive.

The ratings could face downward pressure if the improving trend on debt dynamics reverses due to a shock to Slovenia’s small and open economy that causes significant economic underperformance, material fiscal slippage, or substantial realization of contingent liabilities.
RATING RATIONALE

Slovenia’s Strong Performance on Debt and Fiscal Metrics Supports the Ratings Upgrade

Slovenia has been among the fastest euro area countries to reduce its debt to GDP ratio. Since 2015, when it reached a peak of 82.6%, the debt ratio declined by 12.2 percentage points to 70.4% in 2018 and is expected to decrease further to 66.3% in 2019. Current forecasts point to continued aggressive debt reduction, falling below the 60% of GDP threshold by 2021. The reduction is primarily due to improved fiscal and economic conditions and a strong funding profile. Proactive debt management and the favourable environment in the international bond markets have led to a decline in interest costs to 1.6% in 2019 from 2.9% of GDP in 2014. The average debt maturity extended to 9 years in 2019 from 5.7 in 2014. Nevertheless, the public debt burden is high when compared to regional peers of similar economic size. The high debt stock limits shock absorption capacity and redirects public funds towards debt servicing.

Fiscal consolidation in recent years has been significant due to favourable economic conditions, strong revenue growth, and a steady decline in interest expenditure. Following a deficit result of 5.5% of GDP in 2014, a fiscal surplus of 0.8% is expected in 2019. For 2020, the Ministry of Finance projects a slight improvement in the fiscal surplus to 0.9% of GDP. Main downside risks to public finances stem from a weaker revenue intake in the event of an economic downturn and high expenditure growth, predominantly in wages and social benefits. Given Slovenia’s weak demographic outlook, age-related costs are expected to increase and will likely weigh on Slovenia’s long-term fiscal performance. Additional progress on healthcare and pension reform would support the long-term sustainability of public finances.

Domestic Conditions Support Slovenia’s Robust Economic Growth Performance

Supported by sturdy domestic demand and strong export growth, Slovenia’s recent economic performance has been strong. Following growth of 4.8% in 2017 and 4.1% in 2018, real GDP growth is expected to ease to 2.6% in 2019, due to the less favourable external environment. Private consumption will remain the main driver of growth in the context of sustained wage and employment gains and growing household disposable income. On the back of improved private sector balance sheets, favourable financing conditions and the delivery of European Union (EU) structural funds, investment is projected to remain strong. The contribution of net exports to GDP growth will likely turn negative due to weaker foreign demand. European Commission (EC) expects growth to average 2.7% in 2019-2020, still heathy compared to European peers and in line with measures of Slovenia’s growth potential.

Since 2011, Slovenia’s external sector has strengthened significantly with its current account position shifting from a deficit of 5.3% in 2008 to a surplus of 5.7% in 2018. Slovenia is integrated into the regional supply chain and manufactures a diverse range of high value-added component parts. Furthermore, improved cost competitiveness and a strong pick-up in external demand in recent years contributed to a steady rise in trade volumes. Even though export growth has recently expanded at a slower pace due to the slowdown among Slovenia’s main trading partners, the EC expects the current account surplus to decline gradually, but remain above 5% in 2020-2021. DBRS Morningstar expects such a strong external savings position to continue to narrow the net international investment position (IIP). Latest data show IIP improved to -17.8% of GDP as of September 2019, from -44.0% in 2012.

Improved Financial Sector Indicators and Progress on Privatisations

The completed sales of Nova Ljubljanska Banka (NLB) and Abanka are important achievements. The government relinquished 65% of NLB, Slovenia’s largest bank, following an IPO in late 2018 and another 10% in June 2019. It then completed the sale of Abanka, the third largest bank, in February 2020 to previously privatised bank Nova KBM (NKBM). DBRS Morningstar views that the divestment of these banks is an important step in the government’s efforts to reduce the historically high direct involvement of the state in the economy and reduces the government’s exposure to potential calls for capital to support these banks. For further details, see DBRS Morningstar’s commentary “Bank Divestment in Slovenia is an Important Achievement.”

The banking sector has worked through its crisis-legacies and is broadly in repair. In the context of strong economic performance, credit growth has resumed in the non-financial private sector. Loans to households have been particularly strong. Recent Bank of Slovenia stress tests conclude that the banking system is stable. Banking sector resilience is evident by improved capital and funding positions and the improvement in asset quality. Non-performing loans (NPL), mostly legacy loans concentrated in the real estate and construction sectors, are on a declining trend. The NPL ratio, measured as claims with arrears over 90 days to total claims, declined from 18.1% in November 2013 to 1.3% as of November 2019.

Despite the strong recent performance of financial sector indicators, the Bank of Slovenia’s Financial Stability Report points to key remaining challenges in the banking sector, including the less favourable environment for banks to generate net interest income and risk arising from the real estate market. DBRS Morningstar makes a negative qualitative assessment to account for financial risks in the “Monetary Policy and Financial Stability” building block.

Despite the Political Volatility, Slovenia has Stable Policy-Making Institutions

On 27 January 2020 Prime Minister (PM) Marjan Sarec announced his resignation, after failing to secure parliamentary support for healthcare legislation. The five party coalition government, in November 2019 lost the support of the opposition Left Party over disagreements about the 2020 Budget, making it difficult for the government to ensure support for its agenda. Snap elections will take place, most likely in April, if the opposition fails to secure a new majority.

Despite the political volatility, Slovenia has strong institutions. The country benefits from its membership of both the EU and Euro area, which functions as a stability anchor for macroeconomic policy. Slovenia also benefits from a healthy inflow of EU structural fund investments directed towards productive areas. The country’s credible policy framework is underpinned by its strong performance on the World Bank’s Governance Indicators when compared with its peers, particularly the Rule of Law and Government Effectiveness. The main policy challenge facing the next few governments will be how it manages the fiscal and economic consequences of its aging population.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/357241.

EURO AREA RISK CATEGORY: LOW

Notes:
All figures are in euros (EUR) unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal methodology is the Global Methodology for Rating Sovereign Governments, which can be found on the DBRS Morningstar website www.dbrs.com at http://www.dbrs.com/about/methodologies. The principal rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.

The sources of information used for this rating include the Ministry of Finance, Bank of Slovenia, Institute of Macroeconomic Analysis and Development, European Commission, Statistical Office of the European Communities, Republic of Slovenia Statistical Office, OECD, IMF, World Bank, Bank for International Settlements, UNDP, Haver Analytics. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.

This rating included participation by the rated entity or any related third party. DBRS Morningstar had no access to relevant internal documents for the rated entity or a related third party.

DBRS Morningstar does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings GmbH are subject to EU and US regulations only.

Lead Analyst: Jason Graffam, Vice President, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Credit Ratings, Global Financial Institutions & Sovereign Ratings
Initial Rating Date: November 17, 2017
Last Rating Date: August 30, 2019

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