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Rating action

Scope Ratings GmbH (Scope) has today affirmed the Republic of Slovenia’s long-term local- and foreign-currency issuer and senior unsecured debt ratings at A and affirmed the short-term issuer ratings at S-1 in local and foreign currency. All Outlooks are Stable.

Summary and Outlook

Slovenia’s A/Stable ratings are driven by the country’s i) wealthy and resilient economy, supported by a robust external performance; ii) favourable market access and debt profile; and iii) prudent fiscal policy, supporting a gradual reduction of primary deficits.

Rating challenges include i) the limited diversification of energy supply amid geopolitical uncertainties weighing on the economic outlook; ii) a moderately high public debt burden; iii) labour market rigidities curbing GDP growth; and iv) adverse demographic trends with a rapidly ageing population that will place long-term structural pressures on fiscal sustainability through rising pension and healthcare expenditures.

The Stable Outlooks reflect Scope’s opinion that risks to the credit ratings over the next 12 to 18 months are broadly balanced.

The ratings/Outlooks could be upgraded if, individually or collectively, Slovenia’s: i) medium-term growth prospects notably improved, supported by structural reforms addressing long-term challenges including labour market rigidities and the adverse effects of an ageing population; and/or ii) the fiscal outlook improved, with public debt on a firm downward trajectory.

Conversely, the ratings/Outlooks could be downgraded if, individually or collectively, Slovenia’s: i) medium-term growth prospects notably deteriorated due to, for example, substantial and sustained energy supply disruptions; ii) fiscal outlook weakened due to protracted fiscal deterioration and/or; iii) political fragmentation and policy uncertainty curtail the implementation of needed reforms and/or result in lower EU transfers and/or foreign direct investments.

Rating rationale

The first driver underpinning the affirmation of Slovenia’s A/Stable ratings is its wealthy (GDP per capita stood at EUR 24,678 in 2021) and resilient economy, supported by the country’s robust external performance. Slovenia’s economy has recovered strongly from the Covid-19 impact, growing by 8.1% in 2021 and is expected to grow 5.6% in 2022, driven by robust private consumption and investment. The country’s GDP level thus already exceeds its pre-Covid output since Q3 2021 as the 2020 growth decline of -4.2% was lower than most of its peers.

Still, looking ahead Scope expects a slowdown in H2-2022 and 2023 given the adverse impact of Russia’s war in Ukraine, increasing consumer and producer prices, tighter financial conditions, and lower external demand. While private consumption has so far been supported by high employment, increases in salaries, accumulated savings from the previous periods and social transfers, persistent inflation (7.6% in 2022) and lower real wages should curb consumption during the rest of the year and in 2023. Investment growth, which was still strong in the first quarter, is also forecast to decelerate in the second half of the year due to the increasing uncertainty, lower expected foreign demand, higher financing costs and prices of investment goods and construction materials. Nonetheless, public investment continues to be supported by the implementation of the national recovery plan amid 2022 legislative elections. Overall, Scope expects growth to slow down to around 2.5% in 2023, markedly above the estimates of the European Commission of 1%¹.

This more benign forecast also reflects Scope’s expectation of a sustained external performance. The country had continuous current account surpluses in the years before the Covid-19 crisis, averaging 4.6% between 2012 and 2019. The surpluses were underpinned by strong external demand and growth in manufacturing, services and tourism. Slovenia’s export-driven economy is well integrated with European trading partners; its biggest export market shares are Germany (18%), Italy (11%), Croatia (8%), Austria (7%) and France (5%). Slovenia’s global export market share also increased significantly by 20.2% over 2016-20.

Foreign demand recovered strongly last year despite supply chain bottlenecks, helping to maintain the current account at 3.3% of GDP in 2021, although still below pre-Covid levels. Even so, renewed pressures on energy and import prices, prolonged supply chain disruptions and the economic slowdown among EU trading partners are likely to pose challenges for Slovenia’s small, open economy in H2-2022 and 2023. While these issues will likely reduce the current account surplus in the short term, the foreign direct investment inflows sustained over the past three years, at an average of 3.1% of GDP, should help preserve the country’s external resilience.

The second driver supporting Slovenia’s A/Stable ratings reflects its strong market access and favourable debt profile. Borrowing conditions remained favourable in 2021 thanks to the ECB’s accommodative monetary policy. Since the launch of the Pandemic Emergency Purchase Programme in March 2020, the ECB has purchased around EUR 6.5bn of Slovenian public debt on the secondary market by end-July 2022, accounting for almost all of the country’s nominal debt increase since the end of 2019, in addition to net cumulative purchases of EUR 2.9bn under the Asset Purchase Programme over the same period. This helped keep the 10-year Slovenian government bond yields at a low 0.1% on average last year, almost unchanged from 2020. The benchmark government bond yield has remained anchored but has increased since the Russia-Ukraine war to around 1.5% to 2.0% - still, a very favourable cost of debt compared to historic levels and non-euro area peers.

Sound debt management has helped to lengthen the average debt maturity to 10 years, reduce the share of debt held by non-resident investors from 80% in 2014 to 57% in 2021 and build high cash reserves, currently at around EUR 8bn (15% of GDP). These measures provide substantial buffers against both market volatility and higher interest rates, reinforced by the Bank of Slovenia’s significant holdings of government debt securities (around 32% of the total) and the introduction of the ECB’s Transmission Protection Instrument.

The third driver supporting Slovenia’s A/Stable ratings is its effective and prudent fiscal policies. In the two years before the pandemic crisis, sustained fiscal discipline led to budget surpluses and declining debt levels. This provided the government with fiscal space to implement large-scale support when the pandemic hit, at more than 10% of GDP over 2020-22. These measures were effective at preserving the economy, but also reversed the improving debt trajectory, with fiscal deficits reaching 7.8% of GDP in 2020 and 5.2% in 2021.

Yet, the decrease in last year’s general government deficit was better than projected in the 2022 Draft Budgetary Plan, by EUR 1bn. This reflected stronger-than-expected economic growth as well as buoyant tax revenues, which grew 14.2% from the 2020 level and exceeded the 2019 pre-crisis level by 5.5% in 2021. The commitment to prudent fiscal policies was also shown during the pandemic, when the Fiscal Council warned to contain fiscal trends not directly related to the mitigation of Covid-19 impacts to preserve the sustainability of the fiscal balance in the medium term. As a result, the 2021 deficit excluding Covid-related measures amounted to only 0.7% of GDP, despite higher expenditure for investments and social benefits².

Scope expects the fiscal deficit to gradually decline from 5.2% of GDP in 2021 to 5.0% in 2022 and 4.5% in 2023 and to converge towards 3.3% by 2027 – slightly above the Maastricht criteria. This conservative fiscal trajectory reflects Scope’s assessment of the adoption of fiscal measures for higher energy prices, the planned reform of personal income tax and the current uncertainty around the coalition’s additional fiscal and business-friendly measures over the coming legislative period. This, together with growth converging towards 2.5% over the medium-term and slightly higher inflation in 2022-23, will result in public debt to decrease from 74.7% of GDP in 2021 to 68.9% in 2023, and further down to 68.1% by 2027, once Covid related measures are fully withdrawn and the energy crisis is addressed. Even so, Slovenia’s debt dynamic is expected to underperform peers such as Estonia – with the lowest debt to GDP ratio in the CEE-11 – or Slovakia – where public debt should hover around 50-55% of GDP by 2027. Still, Scope notes positively the expected gradual decline in the primary deficit and the associated reduction of public debt.

Despite these credit strengths, Slovenia’s ratings are challenged by several credit weaknesses:

First, the limited diversification of energy supply is posing serious risks amid the heightened geopolitical uncertainty due to the prolonged Russia-Ukraine war. Natural gas, while representing only 11.3% of the energy mix, is mostly imported from Russia – 81% of total gas imports as of 2020. Slovenia also has no gas storage capacity. A major disruption in Russian gas supply during the winter could threaten Slovenia’s economic outlook as it could slow supply chains and production in major sectors dependent on natural gas, such as automotive, which contributes 10% of GDP. Reducing the dependency on Russian gas will also be challenging in the next years, given that the transition towards a coal phase out by 2033 could lead to higher reliance on fossil fuels in the short-term. Against this backdrop, Scope expects greater efforts to increase energy supply diversification, prioritising investment in renewable energy, alongside initiatives to improve the network and storage infrastructure (42% of the Recovery and Resilience Plan is earmarked for climate transition). In that respect, projects aimed at improving the energy infrastructure and strengthening cooperation with neighbouring countries will be crucial. The bilateral agreement with Italy signed in July to increase gas imports from Africa as well as additional agreements for shared gas supply with Croatia and Austria, which are under negotiation, will help to cushion the impact of supply disruptions and gas rationing.

Second, the resumption of fiscal consolidation after the pandemic crisis may be challenged by the growing structural pressures on the budget over the medium-term. The budget deficit is likely to stay high due to additional costs for long-term care, projected at up to 0.8% of GDP, in combination with lower revenues due to the approved cuts on personal income tax that will reduce tax revenues by up to 1.3% of GDP. The Slovenian Fiscal Council estimates that the new tax reform will cause public debt to rise by 4-14pp of GDP in the medium term – although the overall impact could be lowered by the reform of the personal income tax planned by the new government. Moreover, an ageing population and declining number of births will result in a shrinking working age population over the next decades and a projected median age of the population of about 50 years by 2050. These factors will lead to Slovenia having the second biggest increase in public pension expenditure among the 27 EU member states, projected to reach 16% of GDP by 2070.

However, reforms addressing ageing-related spending pressures, on which disbursements from the EU Recovery and Resilience Facility (totalling EUR 2.2bn or about 4% of GDP) are contingent on, could mitigate some of these structural spending pressures. Scope also notes positively that this year’s electoral victory of the three-party coalition led by Prime Minister Robert Golob reinforces the prospect of structural reforms, as the coalition aims to align policy and fiscal rules with the country’s development agenda. This includes a reform to strengthen the first pension pillar and increase pension savings, whose effective implementation will be fundamental for long-term budget sustainability in view of the expected increase in pension and healthcare spending³.

Third, persisting structural rigidities in the labour market are hindering sustained GDP growth. Employment and activity rates are low among the older segment of the population, at 53% of those aged 55-64 against the euro area’s 61%. In addition, the share of temporary contracts among young people aged 15-29 is 39%, above a euro-area average of 36%. These issues have been exacerbated by short-term dynamics that have led to low mobility, increased minimum wage and high labour taxes. Further, labour shortages could weigh on production, particularly in the construction, information and communication sectors. Lastly, the planned green and digital transformations will require massive public investment to address skill mismatches and improve the country’s appeal to high-skilled foreign workers. That said, labour market conditions have been improving with the recovering economy and the implementation of reforms targeting labour market flexibility and lower labour costs. Unemployment fell to 4% in June 2022, in line with pre-pandemic levels and well below the euro area average of 6.6%. However, keeping the reform momentum on the labour market, with the implementation of all the measures outlined in the National Recovery Plan is key to preserve the recent improvements and address structural challenges.

Finally, the rapid rise in real estate prices poses risks for domestic financial stability. Since 2015, the rise in house prices, at 50%, has outpaced the improvement in economic fundamentals, with real GDP up by just under 30%. The Covid-19 crisis did not dampen this trend, with house prices higher by 12.9% in Q3 2021 YoY against the euro area’s 9.2%. Labour shortages and rising costs are also limiting new construction, contributing to overvaluation in the housing market. The Bank of Slovenia therefore reported the highest composite indicator of relative overvaluation in over a decade, at 13%. However, as stated by the European Systemic Risk Board, the adopted macroprudential policies – such as limits on debt-service-to-income and loan-to-value ratios for households – have been sufficient to improve lending standards on new housing loans and mitigate risks. Large maturity gaps in banks’ balance sheets between assets and liability also constitute another source of vulnerability^4,5.

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

In line with Scope’s methodology, movements between indicative ratings are not immediate but rather executed after analyst review of CVS results. The rating committee approved an implied indicative rating of ‘aa-’, after accounting for a one-notch positive adjustment for the euro’s reserve currency status. This indicative rating can be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the size of relative credit strengths or weaknesses versus the indicative sovereign peer group based on qualitative analysis.

For Slovenia, the QS signals relative credit weaknesses against indicative sovereign peers for the following qualitative analytical categories: i) macro-economic stability and sustainability; ii) resilience to short-term shocks; iii) financial imbalances; iv) environmental risks; and v) institutional and political risks.

Combined relative credit strengths and weaknesses generate a two-notch downside adjustment via the QS and signal an ‘A’ sovereign rating for Slovenia.

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

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 20% weights under the methodology’s quantitative model (CVS) and qualitative scorecard (QS).

Under governance-related factors captured in Scope’s CVS, Slovenia scores well on a composite index of six World Bank Worldwide Governance Indicators. Furthermore, Scope’s QS evaluation on ‘institutional and political risks’ factors in the structural reform agenda, which still has to test effective policy making and requires agreement of the new ruling coalition.

For social risk factors captured under the CVS, Slovenia presents an elevated old-age dependency ratio of 32.1 as of 2021, slightly below the euro area 33.2. The complementary QS for ‘social risks’ is assessed as ‘neutral’ given the presence of a productive and well-educated workforce and one of the lowest income inequality levels in Europe in nominal terms, despite challenges posed by weak demographics.

On the environmental risk sub-category, Slovenia scores below average on the CVS for carbon emission intensity against euro area peers but performs well for natural disaster vulnerability and the ecological footprint of its consumption relative to available biocapacity. The complementary QS assessment for ‘environmental risks’ is evaluated at ‘weak’, given the challenges faced by the country in the transition towards a decarbonised energy mix. Reducing the reliance on coal sources, diversifying the energy mix amid uncertainties around energy supply, and prioritising investments in renewable sources constitute challenges.

Rating committee
The main points discussed by the rating committee were: i) domestic economic risk, including uncertainties around energy supply; ii) public finance risk; iii) external economic risk; iv) financial stability risk; v) ESG-related risks, including the new government; and vi) peers.

Rating driver references
1 EU Commission – 2022 European Semester Country Report
2 Fiscal Council – Assessment of compliance of the general government budgets with fiscal rules in 2022
3 European Commission – Recovery and Resilience Plans Slovenia
4 Bank Slovenije - Financial Stability Review, May 2022
5 ESRB – Vulnerabilities in the residential real estate of the EEA countries

Methodology
The methodology used for these Credit Ratings and/or Outlooks, (Rating Methodology: Sovereign Ratings, 8 October 2021), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
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-governance/definitions-and-scales. Historical default rates of the entities rated by Scope Ratings can be viewed in the Credit Rating performance report at https://scoperatings.com/governance-and-policies/regulatory/eu-regulation. 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-governance/definitions-and-scales. 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://scoperatings.com/governance-and-policies/rating-governance/methodologies. 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 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  NO
With Access to Internal Documents                               NO
With Access to Management                                          NO
The following material sources of information were used to prepare the Credit Rating: public domain.
Scope considers the quality of information available to Scope 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 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 rating 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: Thomas Gillet, Associate Director
Person responsible for approval of the Credit Rating: Alvise Lennkh-Yunus, Executive Director
The Credit Ratings/Outlooks were first assigned by Scope in January 2003. The Credit Ratings/Outlooks were last updated on 11 February 2022.

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
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