Scope Ratings GmbH has today upgraded Slovenia’s long-term issuer and senior unsecured local- and foreign-currency ratings to A from A-, with a Stable Outlook. The short-term issuer rating has been affirmed at S-1 in both local and foreign currency with a Stable Outlook.

Rating drivers

The one-notch upgrade of Slovenia’s long-term ratings to A from A- is underpinned by the following two drivers: i) sustained public debt reduction and a prudent fiscal framework, including a gradual reduction of contingent liabilities from the financial sector; and ii) structural improvements in potential growth through gradual reforms of the labour market, the financial sector and the pension system, resulting in a potential growth rate of around 3%. The factors driving the rating action relate to changes in Scope’s assessment under the ‘Public Finance Risk’ and ‘Domestic Economic Risk’ categories of its sovereign methodology.

The first driver of the rating upgrade to A reflects Slovenia’s material reduction in public debt with a double-digit decrease from 82.6% of GDP to 70.1% within three years (2015-2018). This was achieved by a combination of primary fiscal surpluses (averaging 0.4% of GDP) and a strong economic recovery (average real growth of 3.5%) between 2014-2018. In 2019, authorities are expected to come closer to reaching the Maastricht rule of 60% by lowering debt to around 66% of GDP. The government’s cash position is projected at EUR 4.7bn (9.6% of GDP) over 2019, thus constituting a solid buffer against refinancing needs of EUR 2.14bn at the beginning of the year. Slovenia also benefits from a favourable debt profile: more than 30% of the debt portfolio has a maturity beyond 10 years, while the average nominal yield on outstanding amounts was lowered from 4% to 2.6% between 2015 and Q1 2019.

Slovenia’s fiscal framework has been strengthened with a fiscal rule law, in place since July 2015, including the establishment of an independent fiscal council (in operation since March 2017). The fiscal rule allows for a maximum structural deficit of 0.5% of GDP during years with a negative output gap while a structurally balanced budget is to be achieved otherwise. In February 2018, parliament adopted amendments to the Public Finance Act including final provisions for fiscal planning in accordance with the Fiscal Rule Act. It is Scope’s view that this fiscal framework contributes to the country’s prudent fiscal management.

Scope expects the fiscal consolidation process to continue over the medium term at a somewhat slower pace with a higher contribution stemming from primary surpluses (averaging 2% of GDP over 2019 to 2020). At the same time, moderating economic activity will lead to a closing of the positive output gap (with growth potential at 2.8% between 2019-21), preventing a faster consolidation process. Although Slovenia is at risk of deviating from the adjustment required to meet its medium-term budgetary objective in 2019, the European Commission expects authorities to have made sufficient progress towards compliance with the debt reduction target in 2018 and that the debt reduction benchmark will also be met in 2019.

Finally, Slovenia has taken further steps to reduce the size of contingent liabilities stemming from the banking sector. In 2018, the government sold an almost 60% stake of formerly state-owned NLB after a successful IPO and it plans to sell another 10% share by the end of the year. In addition, the privatisation process of Abanka, the country’s third largest bank, is on track with a public offering of shares expected to be concluded this year. Scope also notes that the authorities have begun to withdraw their engagement from 33 SOEs (650 entities including regional and local levels). As a first step, the government has launched tenders for thirteen SOEs to initiate the privatisation process.

The second driver of the upgrade reflects Slovenia’s strong economic recovery, which has led to a tripling of potential growth from 0.9% in 2015 to a projected 3% as of 2019. Most of the recovery was led by strong growth in employment, while, more recently, rising investment contributed to raising potential output. Moreover, recently enacted pension and labour market reforms have positively contributed to a lagged impact on the country’s economy activity.

In response to rising pressure from demographic challenges (with up to 6 perc. points higher fiscal expenditures projected by 2070), the government published a white paper in 2016. The paper recommended increasing the retirement age to 67, to be automatically adjusted with demographic changes, and greater restrictions on early retirement. Legislation is expected to be adopted by 2020, allowing for gradual implementation during a transitionary period. Draft bills have also been prepared by Slovenian authorities on health care and long-term care. Although the reforms have not been implemented yet, Scope expects parliament to adopt amended versions of the proposals within this parliamentary term.

The country’s Stable Outlook reflects the risks of negative spillovers from the external and financial sectors balanced against a favourable growth outlook and improving public finances. Slovenia is a small, open economy, which makes it particularly vulnerable to external shocks. In Scope’s view, the measures taken by Slovenia in the aftermath of the financial crisis are appropriate to counterbalance these risks, such as current trade tensions and slowing economic growth among major trading partners. In this context, Scope notes Slovenia’s strong external competitiveness, with a 20% increase in its world export market share (at a modest 0.23% in 2018) since 2010. Slovenia’s strong integration in global value chains has led to continuous current account surpluses averaging 4.6% of GDP between 2011 and 2018 and contributed to a substantial reduction in its net international investment position, from -47.2% of GDP in 2010 to -26.7% by the end of 2018, the lowest among Central and Eastern European emerging economies. Concurrently, external debt decreased from a peak of 125.7% of GDP in 2014 to 92.0% by end-2018.

Scope assesses the risks related to the financial sector as limited. The recent surge in credit growth and house prices (in 2018, the deflated house price index increased by 12.4% YoY) is mitigated by low private household and non-financial sector debt. At 77.7% of GDP, Slovenia has the second-lowest level of private debt in the euro area in 2018. Under this context, Scope also highlights previous Slovenian governments’ successful restructurings of the Slovenian banking sector after the global financial crisis and improved macroprudential supervision. This resulted in a decline in the loan-to-deposit ratio from 161.5% in 2008 to 77.9% at the end of September 2018, a capital adequacy ratio of 20.6% of risk-weighted assets and a CET1 ratio at 20.2% as of end-June 2018. Non-performing loans, measured as claims in arrears of over 90 days, were reduced from 18.1% of total loans at the end of November 2013 to 2.3% at the end of 2018.

Slovenia’s political environment also supports a Stable Outlook. Although the centre-left minority government led by Prime Minister Marjan Šarec holds only 43 out of 90 seats in parliament, Scope expects the current government to carry out its policy agenda. In March 2019, the government secured a majority of votes in parliament to approve the budget plan, which foresees a substantial increase in public sector wages of 4% and a general fiscal surplus of 0.55% of GDP. The approval of the budget confirms Scope’s view regarding the government’s ability to continue reform-oriented fiscal policies that are increasingly expansionary but nonetheless remain prudent overall.

Despite credit-positive developments, Slovenia’s ratings remain constrained by: i) a high public debt level; ii) the strong presence of state-owned enterprises, which affects productivity growth and contingent liabilities; and iii) an ageing population, which constrains fiscal flexibility.

Despite rapid debt reduction in the past, levels of public debt remain high and require continued consolidation efforts. Compared to that of its regional euro area peers, Slovenia’s fiscal flexibility remains constrained by relatively high interest payments in 2018 (2% of GDP), 1pp above those of select regional euro-area peers with substantially lower debt levels (of 39.1% of GDP).

A second risk to Slovenia’s credit ratings relates to its exposure to state-owned enterprises. SOEs account for 20% of non-financial-sector employment and make Slovenia’s government the largest asset manager and corporate debtor in the country. This has two important implications for credit risk. First, the presence of SOEs could crowd out private investment and thereby constrain productivity growth. Second, the high debt of Slovenian SOEs weighs on the government’s balance sheet, even if this debt is partly backed by assets. In 2018, outstanding guarantees by the government accounted for 12.7% of GDP while contingent liabilities of government-controlled entities ranked amongst the highest (at 53.8% of GDP in 2017) in the European Union (the EU’s average was 37.9% of GDP). These risks are, however, mitigated by the improving financial performance of SOEs since 2017 and the recent initiation of privatisation processes.

Finally, medium- to long-term risks for debt sustainability may arise from the ageing population. According to the 2018 Ageing Report of the European Commission, Slovenia faces the highest increase in pension and health care expenditure as a percentage of GDP in the euro area. Between 2016 and 2040, cumulative pension and health care expenditures are projected to increase by 4.2pp, compared to the euro area average of 1.9pp. These dynamics highlight the importance of further reforms to the pension and health care sectors to ensure Slovenia’s debt sustainability.

Factoring of Environment, Social and Governance (ESG)

Scope considers sustainability issues during the rating process as reflected in its sovereign methodology. Governance factors are explicitly captured in Scope’s assessment of ‘institutional and political risk’ under its methodology, on which Slovenia scores highly on a composite index of six World Bank Worldwide Governance Indicators.

Social factors are reflected in Slovenia’s relatively high GDP per capita (USD 26,234 in 2018), low rates of unemployment (5.3% in 2018), but a high old-age dependency ratio with more than 40% of the population aged 65 or older relative to the working-age population. In addition, Scope observes that the elevated, albeit declining, levels of low-skilled and low-income jobs may weigh negatively on productivity levels and the tax base in the long run. At the same time, Slovenia has the lowest income inequality in the euro area with the ratio of incomes of the richest 20% of households only 3.4 times that of the incomes of the poorest 20% of households (compared to an average ratio of 5.1 in the euro area as a whole). Finally, environmental factors are considered during the rating process, but had no material impact on Slovenia’s credit ratings.

Scope performs a qualitative assessment of the extent to which policy actions are achieving the Paris accord’s climate change goals. In 2009, the Slovenian government established the Government Office of Climate Change, which drafted the Climate Change Act and prepared Slovenia’s long-term low-carbon strategy. However, the act and the strategy are still in the process of being adopted. With 5.8 tons of CO2 emissions per person in 2017, Slovenia ranks slightly below the euro area average of 6.67 tons per person.

Core Variable Scorecard (CVS) and qualitative scorecard (QS)

Scope’s Core Variable Scorecard (CVS), which is based on the relative rankings of key sovereign credit fundamentals, signals an indicative ‘A’ (‘a’) rating range for the Republic of Slovenia . 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 qualitative analysis.

For the Republic of Slovenia, the following relative credit strengths have been identified: i) the fiscal policy framework; ii) external debt sustainability. Relative credit weaknesses are: i) vulnerability to short-term external shocks. The combined relative credit strengths and weaknesses generate zero adjustments and indicate a sovereign rating of A for the Republic of Slovenia. A rating committee has discussed and confirmed these results.

Outlook and rating-change drivers

The Stable Outlook reflects Scope’s view that risks to the ratings are overall balanced over the next 12 to 18 months.

The ratings/outlooks could be upgraded in the event of: i) a material reduction in public debt; ii) further steps towards the privatisation of SOEs; and/or iii) a successful implementation of pension and health care sector reforms.

Conversely, the ratings/outlooks could be downgraded in the event of: i) a reversal in fiscal policies; ii) a negative growth shock; and/or iii) a materialisation of contingent liabilities.

Rating Committee
The main points discussed by the rating committee were: i) Slovenia’s growth potential; ii) fiscal consolidation; iii) public debt sustainability; iv) external debt sustainability and vulnerability to external shocks; v) banking sector performance; and vi) peers’ considerations.

Methodology
The methodology applicable for this rating and/or rating outlook, ‘Public Finance Sovereign Ratings’, is available on www.scoperatings.com. Historical default rates of the entities rated by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. 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 as well as definitions of rating notations can be found in Scope’s public credit rating methodologies on 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.

Solicitation, key sources and quality of information
The rating was not requested by the rated entity or its agents. The rated entity and/or its agents did not participate in the rating process. Scope had no access to accounts, management and/or other relevant internal documents for the rated entity or related third party. The following substantially material sources of information were used to prepare the credit rating: public domain and third parties. Key sources of information for the rating include: Slovenian Ministry of Finance, Bank of Slovenia, European Commission, Eurostat, IMF, ECB, OECD, 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 the issuance of the rating or outlook action, 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.

Regulatory disclosures
This credit rating and/or rating outlook is issued by Scope Ratings GmbH.
Rating prepared by Bernhard Bartels, Associate Director
Person responsible for approval of the rating: Dr Giacomo Barisone, Managing Director, Public Finance
The ratings /outlook were first released by Scope in January 2003. The ratings/outlooks were last released on 17.08.2018.

Potential conflicts
Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings.

Conditions of use / exclusion of liability
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