Morningstar DBRS Changes Trend on Republic of Slovenia to Positive, Confirms Ratings at A (high)

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

KEY CREDIT RATING CONSIDERATIONS
The Positive trend reflects Morningstar DBRS's view that the implementation of structural reforms, including the pension reform will strengthen fiscal sustainability. The government projects fiscal net borrowing to fall to 1.9% of GDP in 2026 from 2.6% in 2023, while GDP growth is set to pick up to 2.4% in 2025, from the projected 1.5% this year. Against this background, the public debt-to-GDP ratio will remain on a downward trajectory and is forecast to fall from 68.4% in 2023 to 64.2% in 2026, below the pre-covid level. Moreover, external vulnerabilities have also improved with the country a net creditor since 2023. However, Slovenia's economic performance would not be immune from the potential escalation in trade and geopolitical tensions as well as any imposition of U.S. tariffs on European Union (EU) exports. Slovenia's exposure to the U.S. is very contained but the economy is integrated in the EU supply chains and some indirect impact is possible. That said, the economy has demonstrated strong resilience over the past few years despite multiple shocks, and benefits from a very strong labour market and a competitive industrial base. Moreover, EU resources, aided by the NextGenerationEU (NGEU) and cohesion funds, will represent an important supportive factor for the Slovenian economy.

Slovenia's credit strengths reflect its wealthy and high value-added economy, its effective debt management strategy, and strong debt profile. Moreover, the country benefits from a credible policy framework, its Euro area and EU membership, and the EU resources at its disposal. Nevertheless, the credit ratings are constrained by the country's comparatively high stock of public sector debt in the context of unfavourable demographic trends and rising age-related costs. Furthermore, Slovenia's small and open economy makes it vulnerable to external shocks.

CREDIT RATING DRIVERS

The credit ratings could be upgraded if the public debt ratio remains on a downward trend due to effective implementation of policy measures that strengthen growth prospects or that address rising age-related public spending. The trends on the Long-Term credit ratings could be returned to Stable if structural reforms, for example the pension reform, are materially diluted relative to current expectations.

The credit ratings could be downgraded if there is a lasting deterioration in government debt dynamics, because of prolonged economic underperformance or weaker fiscal outcomes.

CREDIT RATING RATIONALE

GDP Growth is Set to Pick Up but Geopolitical Tensions are Intensifying

Slovenia is a small open economy, which, by benefitting from EU integration, has seen its income gap with the EU average narrowing over the years. At around EUR 34,900, Slovenia's GDP per capita on standard purchasing power was about 91% of the EU average last year, up from around 81% in 2015. Over the past few years, multiple shocks, including the pandemic, the energy and cost of living shocks have not dampened the country's economic fundamentals materially, with its potential GDP growth rate remaining at 2.5%, a similar growth rate as seen before the pandemic, according to the European Commission (EC).

Despite the catastrophic floods in August 2023, which caused material damage to properties and infrastructure, GDP expanded by more than expected in 2023, with the Statistical Office of the Republic of Slovenia (SURS) revising GDP growth from 1.6% to 2.1% in 2023. Slovenia's GDP growth is expected to rebound in the upcoming two years after slowing down in 2024. Weaker foreign demand and stagnant business investment, particularly in the construction sector, are weighing on the country's economic performance this year. According to the Institute of Macroeconomic analysis (IMAD), real GDP should expand by 1.5% in 2024, supported by strong public consumption, flood-related reconstruction investment, and moderate growth in private consumption. In the upcoming two years, the country's economic performance will likely accelerate, with GDP expected to rise more than 2.4% on average, according to IMAD. Growth is projected to be underpinned by further gains in household real income in the context of a lower savings rate and supportive wage growth. Moreover, the recovery in external demand and investment will also be supportive factors. However, risks remain tilted to downside as geopolitical tensions are intensifying along with a possible deterioration in external competitiveness of the Slovenian export sectors due to strong wage growth and high energy costs.

The multiple shocks have not undermined the resilience of the Slovenian economy, though. The country continues to benefit from a very strong labour market, with employment rate close to record levels and the unemployment rate at a historical low, as well as the large amount of EU funds to support spending on reforms and investments. However, a shortage of labour, as also in other EU countries, remains an important factor to monitor as it could affect the country's competitiveness through stronger wage growth and subsequently higher unit labour costs. The Harmonised Index for Consumer Prices (HICP) growth declined materially from the peak of 11.7% in July 2022 to 1.6% as of November 2024. However, the phase out of the energy support measures, as well the base effect, could contribute to a rise in inflation in coming months. That said, the country will continue to benefit from a large amount of EU resources, and this could be an important mitigating factor in case external headwinds intensify. The Recovery and Resilience Facility (RRF) makes available EUR 2.7 billion (around 4% of 2024 GDP) in grants and loans. So far, total disbursements amounted to around EUR 1.1 billion, corresponding to about 41% of the total allocation. Slovenia will also benefit from EUR 3.2 billion (about 4.8% of GDP in 2024) in EU cohesion funds and Common Agricultural Policy funds amounting to EUR 1.8 billion (2.7% of GDP) for the 2021-2027 period. Successful execution and absorption of these funds, in tandem with effective implementation of the structural reforms associated with the RRF, could increase Slovenia's economic productivity which would bode well for its GDP potential.

Phasing Out Previous Shock-related support and the Impact of New Reforms Will Bode Well for Slovenian Public Accounts

Slovenia benefits from a credible fiscal policy framework, which has typically resulted in moderate budgetary deficits. Slovenia will align its domestic framework to the new EU fiscal governance, which is not expected to alter the country's conservative fiscal track record.

Despite the impact of the floods, Slovenia's fiscal accounts are expected to continue to improve in the coming years. This will reflect the phase out of the energy support, the contributions from the long-term care reform, as well as the impact of the pension and the healthcare reform. Moreover, the flood-related construction will be financed mainly through temporary increases in corporate income tax and a levy on banks, as well as with temporary use of net and available profit of the Slovenian Sovereign Holding. In addition, Morningstar DBRS does not rule out some underperformance in investment execution as registered last year, when the deficit came in at 2.6% of GDP instead of the 4.5% initially projected. According to the EC, the deficit will likely fall to 2.4% of GDP this year before continuing to ease to 2.1% of GDP in 2025 supported by the new long-term care contribution, amounting to 0.4% of GDP as well as higher revenues from CO2 auctions.

Morningstar DBRS views positively the impact of the upcoming pensions reform. The government has adopted a proposal to revise the pension system along with some measures on the labour market which aim to foster employment in the older age cohort. By increasing the statutory age, changing the calculation method as well as lowering the share of wage growth in the formula for the indexation, pension expenditures as a share of GDP should stabilise at around 10% of GDP until 2045, instead of rising to almost 13% as indicated in the EC 2024 Ageing Report. This would bode well for public finance placing the pension system on a more sustainable path. Moreover, Slovenia, after making progress with the long-term care reform and the public sector wage bill, will likely implement the healthcare reform, which is expected to improve spending efficiency. In the medium-term fiscal structural plan, the government projects the deficit to reach 1.9% of GDP in 2026 before declining to 1.6% in 2027. Risks to the fiscal outlook over the medium term will depend on the scale of spending ultimately allocated for reconstruction, the country's economic performance and the impact of the structural reforms.

Slovenia's Debt-to-GDP Ratio Expected to Remain on a Downward Trajectory while Debt Affordability Remains Strong

Following the impact of the pandemic, public sector debt has rapidly declined from the 2020 peak of 80.2% of GDP. Strong nominal growth and moderate primary deficits along with contained interest costs led the public debt-to-GDP ratio to fall to 68.4% last year, only 2.4 percentage points higher than in 2019. In Morningstar DBRS' view, public debt as a share of GDP is set to continue to decline, benefitting from lower cash reserves, positive nominal GDP growth-interest costs differential, and gradual fiscal consolidation. The IMF projects the debt-to-GDP ratio to fall to 64.0% in 2027. Other key debt management metrics are also strong. Over the past ten years, the treasury has implemented liability management operations reducing funding needs, extending public debt maturity to 9.2 years as of September 2024 from 5.7 years in 2013 in tandem with a fall in the interest costs. The implicit interest rate projected at 1.8% in 2024, is significantly lower than 4.4% in 2014. Moreover, almost all public debt is in euros and at fixed rates. This mitigates currency risk and the impact from the rise in interest rates, contributing to strong debt affordability. The sizeable amount of cash reserves, estimated at 12.4% of GDP as of September 2024, along with a judicious debt strategy, lend support to a positive adjustment in the "Debt and Liquidity" building block qualitative assessment.

Risks to Financial Stability are Contained; Slovenia's Banking System has Remained Resilient

Slovenia's banking system has showed resilience in the current weaker macroeconomic environment with banks remaining liquid, improving profitability, and enjoying sound capitalisation. Asset quality has remained relatively stable with non-performing exposures (NPEs) in the portfolios of both non-financial corporations and households standing at 1.7% as of September 2024. The real estate market is cooling, and risks appear moderate. After reaching a peak of 17% growth in the first quarter of 2022 compared with a year earlier, the Slovenian real estate market is cooling down, with annual price growth of 6.7% in the second quarter of 2024. While the Bank of Slovenia identifies some overvaluation in the real estate market relative to price fundamentals, risks linked to high real estate price growth are mitigated by the moderate level of private sector indebtedness. Private sector debt amounted to around 59% of GDP in 2023, significantly lower than the euro area average estimated at 128% of GDP.

Slovenia's Current Account Returned to Surplus; U.S. tariffs Pose Risk to Slovenia's Export Performance

The country's credit ratings benefit from a sound external position because of a dynamic export-oriented sector and an improved net international investment position (NIIP). Nevertheless, the slowdown in European demand and geo-politics pose downside risks as Slovenia is highly integrated in European supply chains. Although the direct exposure to the U.S. is contained, higher tariffs on exports of machinery, electrical equipment, and cars in Europe could weigh on Slovenia's competitiveness. After a deficit of 1.1% of GDP in 2022, the current account shifted to a surplus of 4.5% in 2023 because of energy and other commodity import prices moderating along with lower imports in volumes. The EC expects the annual surplus to narrow to 2.8% of GDP in the 2024-26 period on average, as the trade balance is set to turn into deficit with imports accelerating more than exports, related to higher domestic demand. From a stock perspective, years of strong external savings have led to an improvement in the country's NIIP from a net debtor of 44.0% of GDP in December 2012 to a net creditor of 5.5% as of June 2024.

Slovenia has Stable Policymaking Institutions

Slovenia has a stable political system and strong institutions as reflected in the robust performance on the World Bank's Worldwide Governance Indicators when compared with its peers. Moreover, EU and euro area memberships anchor macroeconomic policymaking and the country's credible policy framework, which reduces regulatory uncertainty. The government, comprising the green-liberal Freedom Movement (GS) party, the Social Democrats, and the Left, is implementing an agenda focusing on accelerating the green and digital transitions, the post-flood reconstruction works, while enhancing preparedness for climate events, as well as passing important structural reforms. Frictions among coalition partners are unlikely to destabilise the government, which benefits from a wide majority. This bodes well for policy implementation.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
ESG Considerations had a significant effect on the credit analysis.

Social (S) Factors
The following Social factors had a significant effect on the credit analysis: The Human Capital and Human Rights factor affect the credit ratings. Slovenia's per capita GDP was relatively low at USD 32,673 in 2023 compared with its euro area peers. Nonetheless, Morningstar DBRS notes the improvement in Slovenia's per capita GDP over the past decades. This factor has been taken into account within the "Economic Structure and Performance" building block.

There were no Environmental and Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (13 August 2024) https://dbrs.morningstar.com/research/437781.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments at https://dbrs.morningstar.com/research/444263.

EURO AREA RISK CATEGORY: LOW

Morningstar DBRS notes that this Press Release was amended on [date] to update the title of the ESG methodology.

Notes:
All figures are in euros 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 (15 July 2024) https://dbrs.morningstar.com/research/436000. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://dbrs.morningstar.com/research/437781 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

The sources of information used for these credit ratings include Ministry of Finance (Draft Budgetary Plan 2025 - October 2024, Investor Presentation - October 2024), Bank of Slovenia (Financial Stability Review -October 2024, Review of Macroeconomic Developments - October 2024) Institute of Macroeconomic Analysis and Development (Autumn 2024 Forecast of Economic Trends - September 2024, Slovenian Economic Mirror No. 6 - October 2024) EC (European Economic Forecast Autumn 2024 - November 2024, Opinion on the Slovenian DBP - November 2024, Integrated National Energy and Climate Plan of the Republic of Slovenia, 2024 Ageing report - April 2024), Statistical Office of the European Communities, Republic of Slovenia Statistical Office, OECD, IMF (Article IV - May 2024, WEO - October 2024, World Bank, IFS, Bank for International Settlements, European Central Bank, Social Progress Imperative, Haver Analytics and Macrobond. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings to be of satisfactory quality.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, these are unsolicited credit ratings. These credit ratings were not initiated at the request of the issuer.

With Rated Entity or Related Third Party Participation: YES
With Access to Internal Documents: YES
With Access to Management: NO

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

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and credit ratings are under regular surveillance.

For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key credit rating assumptions can be found at: https://dbrs.morningstar.com/research/444262.

These credit ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Carlo Capuano, Senior Vice President, Sector Lead, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director, Global Sovereign Ratings
Initial Rating Date: 17 November 2017
Last Rating Date: 7 June 2024

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