Scope Ratings AG today confirms the Slovak Republic’s long-term local-currency issuer rating at A+, following the release of its revised sovereign rating methodology, and converts its status from subscription to public. The agency also assigns a long-term foreign-currency issuer rating of A+, along with a short-term issuer rating of S-1+ in both local and foreign currency. The sovereign’s senior unsecured debt in both local and foreign currency was also rated at A+. All Outlooks are Stable.

Rating drivers

The A+ rating is underpinned by Slovakia’s euro area membership within a large common market, a strong reserve currency, an independent European Central Bank (ECB) effectively acting as a lender of last resort, and an economic governance and macroprudential framework that support credible macroeconomic policies. Scope believes that these are important developments that reflect better protection of the euro area from adverse shocks, underpinning sovereign creditworthiness of member states.

The rating also benefits from Slovakia’s strong macroeconomic performance – one of the strongest in the EU. Slovakia's GDP growth, which has picked up since 2014 with the support of a high absorption of EU funds during the 2007-2013 programming period, remained strong in 2016 at 3.3%. The main driver of this growth has been private consumption buoyed by favourable labour market developments and a rise in household disposable income. Supportive financial conditions backed by the ECB's accommodative stance have also contributed through boosting credit growth. Scope expects Slovakia's economy to continue strong growth in 2017 and 2018, by 3.3% and 3.7% respectively, due to strong private consumption alongside continued investment in the automotive industry.

Labour market conditions have steadily improved, with unemployment falling under 10% in 2016, representing a 4.5 percentage point improvement from 2013. Scope expects the unemployment rate to decline further in the near term, reaching 7.4% in 2018. However, a segregated labour market, relatively weak labour mobility and skilled labour shortages (particularly in manufacturing) pose material challenges. Regional disparities between the Bratislava region and eastern/central regions, where employment rates and per-capita incomes are much lower, remain a key challenge.

As a small, open economy that is concentrated in the automotive industry, Slovakia is reliant on external demand and vulnerable to external shocks. Slovakia’s current account balance moved into deficit for the first time since 2012 last year, at -0.7% of GDP. This was partly driven by a widening of the primary income deficit owing to a worsening of the investment income balance (to around EUR 0.5bn). Scope expects the recent decline in the real effective exchange rate to support the price competitiveness of domestic producers, bolstering overall export growth in the medium term. Slovakia's external debt is mainly in local currency, with only around 14% denominated in foreign currency, bolstering resilience to external shocks.

Slovakia has progressed on its fiscal consolidation. The headline budget deficit fell to 1.7% of GDP in 2016, a 1 pp improvement over the previous year. The improvement was mostly driven by a reduction in expenditure, reflecting the drop in capital spending at the end of the EU programming period alongside lower interest expenses. On the revenue side, labour market improvements have helped to increase personal income tax and social contribution collections alongside raising corporate tax revenues. Scope expects the headline deficit to further decrease, supported by budget consolidation including the more effective use of public finances to improve spending efficiency in transport, healthcare and IT.

Slovakia benefits from a moderate public debt burden, which as a share of GDP in 2016 stood at around 52%, well under the Maastricht criterion. Scope expects this ratio to steadily decrease over the medium term, to around 45% by 2022, supported by robust economic growth and favourable financing costs. The present level of public debt is slightly above a national threshold of 50% of GDP (set by the Fiscal Responsibility Act (FRA)), but within a ‘tolerance’ band of up to 55%. Authorities are considering revisions to the FRA that include a shift of debt ceilings from a gross to a net debt basis and allowances for higher infrastructure spending to facilitate reductions in regional disparities. These revisions will provide fiscal space, more flexible debt management and some modernisation to the fiscal stance in the face of adverse demographic trends.

Long-term challenges to debt sustainability remain due to demographics. According to the European Commission’s 2015 Ageing Report, the old-age dependency ratio is projected to increase by approximately 47% between 2013 and 2060, the fastest such increase in the EU. Since 2012, however, the government has undertaken significant reforms to the pension system, including indexing pensions to consumer prices and linking the retirement age to life expectancy.

Slovakia benefits from a healthy and well-capitalised banking sector. The share of non-performing loans in total loans has declined since 2014, standing at 4.4% as of 2016, lower than the Visegrád Group average. According to the National Bank of Slovakia (NBS), bank reserve holdings at the central bank were 2.7 times higher than the reserve requirement in 2016. While the banking sector remains stable, profit growth has declined, partly driven by the extension of a special levy on banks alongside weak net interest income due to the low interest rate environment. The steady increase in highly leveraged mortgage loans (with around 90% loan-to-value ratios for new borrowers), supported by low mortgage rates for households, is a potential concern. To tackle the risk of credit market overheating from household credit, the NBS issued several macroprudential policy measures. Most importantly, it raised the counter-cyclical capital buffer to 0.5%, effective 1 August 2017.

Though risks to political stability in Slovakia remain low, some intra-coalition disputes and regional elections scheduled in November could weaken the current multi-party coalition, potentially leading to new elections. Scope expects the present government to continue similar policies to those of the previous government. The government’s agenda includes plans to improve public administration, modernise justice and tax collection systems, address issues in the efficiency of healthcare provision, and implement pension reforms. Nevertheless, administrative and regulatory barriers to business and public procurement, alongside government transparency, remain challenges.

Core Variable Scorecard (CVS) and Qualitative Scorecard (QS)

Scope’s Core Variable Scorecard (CVS), which is based on relative rankings of key sovereign credit fundamentals, signals an indicative “A” (“a”) rating range for the Slovak Republic. This indicative rating range can be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the size of relative credit strengths or weaknesses versus peers based on analysts’ qualitative analysis.

For Slovakia, the QS signals relative credit strengths for the following analytical categories: i) growth potential of the economy; ii) market access and funding sources. Relative credit weaknesses are not indicated.

Combined relative credit strengths and weaknesses generate an upward adjustment and signal an A+ sovereign rating for Slovakia.

The results have been discussed and confirmed by a rating committee.

For further details, please see the Appendix 2 of the rating report.

Outlook and rating-change drivers

The Stable Outlook reflects Scope’s view that the challenges faced by Slovakia remain broadly balanced.

The ratings could be upgraded if i) the implementation of structural reforms leads to a material reduction in structural challenges; and/or ii) pension reforms are implemented in full, leading to improvements in debt sustainability.

The ratings could be downgraded upon i) a reversal of political commitment to reforms and the debt brake rule; ii) a loosening of fiscal policy that leads to a higher-than-expected debt ratio; and/or iii) weaker-than-expected economic performance due to adverse external shocks or low productivity growth.

For the detailed research report, please click HERE.

Rating committee

The main points discussed during the rating committee were: i) the Slovak Republic’s growth potential, ii) macroeconomic stability and imbalances, iii) fiscal performance, iv) public debt sustainability, v) debt brake mechanism, vi) market access and funding sources, vii) recent political developments, viii) peers consideration.

Methodology

The methodology applicable for this rating and/or rating outlook, ‘Public Finance Sovereign Ratings’, is available at www.scoperatings.com.

The historical default rates used by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/governance-and-policies/regulatory/esma-registration. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default and definitions of rating notations can be found in Scope’s public credit rating methodologies at www.scoperatings.com.
The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months. A rating change is, however, not automatically ensured.

Regulatory disclosures

This credit rating and/or rating outlook is issued by Scope Ratings AG.

Rating prepared by John Francis Opie, Lead Analyst
Person responsible for approval of the rating: Dr Giacomo Barisone, Managing Director

The ratings/outlook were first assigned by Scope as a subscription rating in January 2003. The subscription ratings/outlooks were last updated on 05.05.2017.
The senior unsecured debt ratings as well as the short-term issuer ratings were assigned by Scope for the first time.

Deviation of the publication of sovereign ratings or related rating outlooks from the calendar shall only be possible when necessary for the credit rating agency to comply with its obligations under Article 8(2), Article 10(1) and Article 11(1) and shall be accompanied by a detailed explanation of the reasons for the deviation from the announced calendar.

Solicitation, key sources and quality of information
The rating was initiated by Scope and was not requested by the rated entity or its agents. The rated entity and/or its agents did not participate in the ratings process. Scope had no access to accounts, management and/or other relevant internal documents for the rated entity or related third party.

The following material sources of information were used to prepare the credit rating: public domain and third parties. Key sources of information for the rating include: National Bank of Slovakia, Statistical Office of the Slovak Republic, European Commission, Eurostat, ECB, IMF, WB and Haver Analytics.

Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.

Prior to publication, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds upon which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Conditions of use / exclusion of liability
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