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Rating action

Scope Ratings GmbH (Scope) has today affirmed Slovakia’s long-term issuer and senior unsecured debt ratings at A+ in local and foreign currency and revised the Outlooks to Stable from Negative. The short-term issuer ratings have been affirmed at S-1+ in both local and foreign currency and their Outlooks have been revised to Stable.

Summary and Outlook

The revision of the Outlooks on Slovakia’s ratings to Stable reflects Scope’s expectation that general government debt-to-GDP levels will stabilise and gradually decline over the medium run. This is due to gradually declining fiscal deficits and continuing, though slightly weakened, growth momentum, underpinned by authorities’ reaffirmed commitments to credible national fiscal rules. Scope expects the government to make progress with fiscal consolidation, underpinned by reforms to the fiscal framework, which will help to rebuild fiscal buffers.

The Outlook change reflects updated Scope assessments of Slovakia under the ‘public finance risk’ category of its sovereign methodology.

The affirmation of Slovakia’s A+ long-term ratings considers institutional strengths, underpinned by memberships of the EU and euro area. The latter confers advantages via a strong reserve currency and access to ECB asset purchases and refinancing operations that have supported Slovakia’s debt financing rates at favourable levels. The A+ rating recognises still-moderate levels of public debt and a competitive export-oriented industrial base, anchored by stable foreign direct investment inflow and access to substantive EU structural and recovery fund inflows.

However, Slovakia’s credit ratings remain constrained by outstanding short- and longer-term credit challenges associated with: i) uncertainty over an uneven economic recovery from the pandemic crisis, reflecting the economy’s high exposure to international value chains and current renewed lockdown restrictions; ii) debt sustainability challenges due to initial high structural fiscal deficits entering the Covid-19 crisis, compounded by adverse demographic projections long term; and iii) the Slovak economy’s high reliance on its automotive industry, exposing it to structural changes in the sector.

The Stable Outlook represents Scope’s opinion that risks to the sovereign ratings are balanced over the forthcoming 12-18 months.

The ratings/Outlooks could be downgraded if, individually or collectively: i) Scope observed materially higher debt ratios than currently expected due, for example, to reversals of recovery and/or greater-than-anticipated fiscal loosening; ii) a net external debtor position widened materially due, for example, to sustained weak external demand; and/or iii) there were a structural shock affecting the automotive industry, undermining growth and public finance outlooks.

Conversely, the ratings/Outlooks could be upgraded if, individually or collectively: i) the government’s medium-run fiscal consolidation increased Scope’s confidence that the general government debt ratio will decline substantively more than currently anticipated; ii) there was sustained, stronger-than-anticipated economic growth in the period ahead absent a substantial increase in macroeconomic imbalances; and/or iii) the implementation of reforms improved longer-run growth potential, including by means of structural adaptations to ongoing change in the car industry.

Rating rationale

The revised Outlook reflects Scope’s view that authorities’ credible medium-term fiscal consolidation agenda and implementation of reforms will help stabilise Slovakia’s public finances over the next two years. The improved projection as regards public finances is helped by recovery in tax revenue and gradual unwinding of fiscal support. As a result, Scope expects Slovakia’s general government deficit will narrow to 4.4% of GDP in 2022 and 3.2% of GDP in 2023, from an estimated 7.5% in 2021.

The government’s fiscal efforts are facilitated by envisaged reforms to the fiscal framework, including introduction of multi-annual expenditure ceilings and an amendment to the national debt brake rule¹, the latter seeing transition from a gross debt indicator to a net debt indicator. The proposed amendments to constitutional fiscal rules, moreover, foresee prudent corrective measures should a certain debt threshold be exceeded and require stricter consolidation during economic expansionary phases. In Scope’s view, this would help reduce pro-cyclicality of Slovakia’s fiscal policies and enable more efficient liquidity management, anchoring still-moderate levels of government debt compared with that of sovereign peers.

Scope projects general government gross debt to peak around 62% of GDP in 2021. Going forward, the gross debt ratio is seen stabilising and gradually falling to 60% by 2023, returning under the EU’s debt limit. Similarly, net debt is projected to stabilise around 55% of GDP this year and gradually decline to 53% of GDP by 2023. Slovakia benefits from favourable financing conditions and a supportive government debt profile. The ECB holds nearly half of outstanding Slovak government securities, which has resulted in an all-time-low weighted average yield of 0.14% for new issuances in the month of September². The average maturity of the Slovak debt portfolio is comparatively high at 8.5 years. Almost all debt carries a fixed coupon and is denominated in euro.

The Slovak government, in line with commitments under its Recovery and Resiliency Plan, is proposing to re-link the retirement age to average life expectancy. A retirement age cap was introduced in 2019, and this has adversely affected a longer-term outlook as regards the pension system, damaging fiscal fundamentals. The new proposal could improve financial sustainability of the pension system if it is implemented prudently and adopted without adding legislation with an offsetting negative impact on government finances³.

However, Scope notes that the public finance outlook still faces significant challenges. As a result of periods of pre-crisis, pro-cyclical fiscal policy and anticipated increase in ageing-related costs moving ahead, Slovakia’s medium- to long-run fiscal sustainability challenges are now among the most substantial of the EU. Slovakia has the EU’s sixth largest fiscal gap of 3.2% of GDP over the medium run and second largest fiscal gap of 7.7% of GDP over the long run⁴. This shows that further fiscal adjustments will be required to sustain debt around or under 60% of GDP over time.

Despite possibility of increasing political instability, Scope expects the coalition government to remain committed to its approach to sustainable public finances. Unresolved tension within the governing coalition dented the government’s standing under polling and has led to resignation of the prime minister and formation of a new government in April, albeit composed of the same four coalition parties. Given that the coalition government still holds a constitutional majority in parliament, a substantial change in policy making is unlikely at this stage. Scope notes that intra-coalition disputes will remain a factor, potentially creating further challenges for implementation of far-reaching reform.

Slovakia’s sovereign ratings also reflect the following key rating drivers.

Slovakia’s A+ rating is anchored by historically strong macroeconomic fundamentals and a competitive, export-oriented industrial base. Scope expects a medium-run economic recovery to be supported by resumed inflow of foreign direct investment to Slovakia’s automotive industry. As an example, the Volkswagen Group is planning to invest EUR 1bn (around 1% of 2020 GDP) in the economy over the next five years. Scope expects Slovakia’s economy to recover to pre-pandemic levels by H1 2022 and anticipates real growth of 3.7% this year, 5.3% in 2022 and 4.5% in 2023, accounting for ongoing components shortages in the car industry.

As a small, open economy specialising in the automotive sector, Slovakia is reliant upon external demand and vulnerable to external shocks. Its exposure to international value chains is among the highest in the EU, with foreign inputs and domestically produced inputs used in third countries’ exports amounting to around 64% of aggregate exports.

Scope notes that Slovakia’s medium-term growth outlook is exposed to structural changes taking place in the car industry, including a potential reorganisation of supply chains due to rising demand for electric automobiles and changing regulatory frameworks. The industry accounts for 13% of GDP and half of industrial production of Slovakia⁵.

Slovakia’s net international investment position remains in significant deficit, running at 61% of GDP as of Q2 2021. However, 40% of Slovakia’s gross external liabilities relate to inward foreign direct investment. This curbs the risk of external balance sheets deteriorating markedly during periods of global stress and enhances long-term sustainability of the external position. Scope expects the current account deficit to remain moderate over the coming years, factoring in projected recovery in exports but also growth in imports related to foreign direct investment inflow. The growing inflow of EU funds and FDI inflow more than finance current account deficits and ought to help reduce net external indebtedness in the coming years.

The front-loading of EU monies starting from 2022, following the European Commission’s recent endorsement of Slovakia’s Recovery and Resilience Plan (EUR 6.3bn in grants⁶ or 6.8% of 2020 GDP), along with allocations under the new 2021-27 EU budget (EUR 12.8bn, equivalent to 14% of 2020 GDP, under the EU Cohesion Policy, plus another EUR 4.9bn or 5.3% of 2020 GDP under the Common Agricultural Policy⁷) support medium-term public investment and economic growth. Scope notes, however, that a track record of weak EU fund absorption (only around 50% absorption rate over the 2014-20 EU multi-annual period as of September 2021, one of the lowest among central and eastern European EU member states) remains a growth bottleneck.

In Scope’s view, Slovakia’s banking sector presents a limited contingent liability for the sovereign balance sheet. The sector is mostly foreign-owned, and is well capitalised and profitable. Its system-wide tier 1 capital ratio of 18.9% of risk-weighted assets and return on equity of 9.5% as of Q2 2021 are above EU weighted averages of 17.1% and 7.4% respectively. Non-performing loans were close to 2% of total loans as of the same quarter. These buffers help absorb a potential short-run increase in non-performing loans as loan moratoria made available to households and firms hit by crisis expire.

At the same time, Scope notes risks associated with rising household indebtedness and declines in household disposable income due to the crisis. This has made Slovak households and banks more vulnerable to any abrupt tightening of financing conditions. Household debt increased to 82% of net disposable income in 2020, from 76% in 2019. These are among the highest debt levels in central and eastern Europe, driven by strong growth in housing prices and associated mortgage lending.

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, provides a first indicative rating of ‘a’ for Slovakia. Slovakia receives a one-notch positive adjustment to this indicative rating based on the reserve currency adjustment under Scope’s methodology. As such, the ‘a+’ indicative rating can be adjusted under the Qualitative Scorecard (QS) by up to three notches depending on the size of qualitative credit strengths or weaknesses relative to a peer group of countries.

Scope has identified the following QS relative credit strength for Slovakia: i) debt profile and market access. By contrast, the following QS relative credit weakness has been identified: i) current account resilience.

The QS generates no adjustment and indicates A+ long-term ratings for Slovakia.

A rating committee has discussed and confirmed these results.

Factoring of Environment, Social and Governance (ESG)

Scope explicitly factors in ESG sustainability issues during the ratings process via the sovereign methodology’s stand-alone ESG sovereign risk pillar, with a 20% weighting under the quantitative model (CVS) and in the qualitative overlay (QS). Under governance-related factors, Slovakia’s performance is weaker than that of other euro area member states in central and eastern Europe, as assessed via the World Bank’s Worldwide Governance Indicators. Nevertheless, the economy’s EU and euro area memberships support credible macroeconomic policy making and a stable governance framework. Scope views positively government plans to undertake judicial and anti-corruption reform, two areas in which Slovakia has made limited progress thus far.

Slovakia’s performance across key social dimensions is mixed. Socially related credit factors are reflected in steadily increasing old-age dependency ratios, high regional inequality (among the highest in the OECD), unemployment rates (6.3% as of September) near EU averages, and below-EU-average poverty ratios and risk of social exclusion.

Environment-related risks in Slovakia remain material. Energy intensity is higher than an EU average. While increasing, the share of renewables in total energy production was a moderate 26% in 2020, below an EU average of 38%. Enhancing the Slovak car industry’s capacity to transition to alternative electric models will prove important for the nation’s future production and export prospects. The current long-term EU budget presents a unique opportunity for Slovakia to increase renewables production and pave the way for transition to a lower-carbon economic model in the long term.

Rating committee
The main points discussed by the rating committee were: i) Slovakia’s growth outlook; ii) debt and fiscal trajectories; iii) external sector developments and car industry; iv) labour market and demographics; v) financial sector developments; vi) fiscal and reform programme; vii) peers.

Rating driver references
1. Ministry of Finance, Stability Programme of the Slovak Republic
2. Debt and Liquidity Management Agency (ARDAL), Investor Presentation
3. Slovak Council for Budget Responsibility
4. European Commission, Debt Sustainability Monitor
5. Slovak Investment and Trade Development Agency (SARIO)
6. European Commission
7. European Commission

Methodology
The methodology used for these Credit Ratings and/or Outlooks (Rating Methodology: Sovereign Ratings, 8 October 2021) is available on https://www.scoperatings.com/#!methodology/list.
Scope Ratings GmbH and Scope Ratings UK Limited apply the same methodologies/models and key rating assumptions for their credit rating services, while Scope Hamburg GmbH’s methodologies/models and key rating assumptions are different from those of Scope Ratings GmbH and Scope Ratings UK Limited.
Information on the meaning of each Credit Rating category, including definitions of default, recoveries, Outlooks and Under Review, can be viewed in ‘Rating Definitions – Credit Ratings, Ancillary and Other Services’, published on https://www.scoperatings.com/#!governance-and-policies/rating-scale. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. 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 Ratings’ definitions of default and Credit Rating notations can be found at https://www.scoperatings.com/#governance-and-policies/rating-scale. Guidance and information on how environmental, social or governance factors (ESG factors) are incorporated into the Credit Rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.
The Outlook indicates the most likely direction of the Credit Ratings if the Credit Ratings were to change within the next 12 to 18 months. 

Solicitation, key sources and quality of information
The Credit Ratings were not requested by the Rated Entity or its Related Third Parties. The Credit Rating process was conducted:
With Rated Entity or Related Third Party Participation YES
With Access to Internal Documents                              NO
With Access to Management                                        NO
The following substantially material sources of information were used to prepare the Credit Ratings: public domain.
Scope Ratings considers the quality of information available to Scope Ratings on the Rated Entity or instrument to be satisfactory. The information and data supporting these Credit Ratings originate from sources Scope Ratings considers to be reliable and accurate. Scope Ratings does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the Credit Rating action, the Rated Entity was given the opportunity to review the Credit Ratings and/or Outlooks and the principal grounds on which the Credit Ratings and/or Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and/or Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and/or Outlooks are UK-endorsed.
Lead analyst: Levon Kameryan, Senior Analyst
Person responsible for approval of the Credit Ratings: Dr Giacomo Barisone, Managing Director
The Credit Ratings/Outlooks were first released by Scope Ratings in January 2003. The Credit Ratings/Outlooks were last updated on 1 May 2020.

Potential conflicts
See www.scoperatings.com under Governance & Policies/EU Regulation/Disclosures for a list of potential conflicts of interest related to the issuance of Credit Ratings.

Conditions of use / exclusion of liability
© 2021 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Ratings UK Limited, Scope Analysis GmbH, Scope Investor Services GmbH, and Scope ESG Analysis GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions 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. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstraße 5 D-10785 Berlin.