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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 with Negative Outlooks. The short-term issuer ratings have been affirmed at S-1+ in both local and foreign currency with Negative Outlooks.

Summary and Outlook

The affirmation of Slovakia’s A+ long-term ratings with Negative Outlooks reflects risks related to an uncertain policy framework, the ongoing diversification of the country’s energy supply away from Russian fossil fuels, and fragile external demand from European trading partners. These risks are key drivers of the rating trajectory and could negatively impact credit fundamentals in the near- to medium-term.

Slovakia’s fiscal outlook is vulnerable to potential delays in the reduction of deficits despite its robust fiscal framework. In Scope's opinion, weaker commitment to budgetary consolidation or a prolonged period of political uncertainty is more likely following September’s legislative elections that highlighted high political fragmentation. This could hinder policymaking, weigh on public debt dynamics, and exert downward pressure on the ratings. Furthermore, ensuring energy security through alternative supply agreements and the upgrade of domestic infrastructure will take time, despite the material progress made to diversify the energy supply since 2022. In the meantime, domestic economic activity will remain exposed to higher geopolitical risks and commodity price volatility. Finally, challenging economic prospects among European trading partners could weigh on the GDP growth outlook as Slovakia has a small, open economy with high exposure to external demand and global value chains.

At the same time, the affirmation of Slovakia’s A+ long-term ratings acknowledges multiple credit strengths: i) institutional strengths, underpinned by membership in the European Union and euro area, conferring advantages via access to substantive EU structural and recovery funds, a strong reserve currency, access to the European Central Bank’s asset purchases and refinancing operations, as well as the European fiscal framework; and ii) moderate levels of general government debt and a competitive, export-oriented industrial base, anchored by robust foreign direct investment inflows.

The Negative Outlook represents Scope’s view that risks to the ratings are tilted to the downside over the next 12 to 18 months.

The ratings could be downgraded if, individually or collectively: i) fiscal consolidation was delayed due, for example, to weaker commitment to budgetary consolidation or a prolonged period of political uncertainty, leading to a rise in public debt-to-GDP ratio; ii) a shift in policy priorities weakened the reform agenda and undermined prospects of timely disbursement of EU funds; and/or iii) the GDP growth outlook deteriorated due, for example, to weaker external demand and/or disorderly energy supply diversification.

Conversely, the Outlooks could be revised to Stable if, individually or collectively: i) the trajectory of the public debt-to-GDP ratio was more favourable than anticipated based on a timely and sustained reduction in the fiscal deficit; and/or ii) GDP growth prospects were stronger than anticipated due, for example, to robust economic growth among European trading partners, a strong reform momentum and/or a swift diversification of energy supplies.

Rating rationale

The first driver of the maintenance of Negative Outlooks on Slovakia’s A+ ratings reflects an uncertain policy framework after the recent legislative elections.

The fiscal deficit is projected to widen from 2.0% of GDP in 2022 to 5.8% of GDP in 2023, or 0.3pps more than Scope’s previous estimate (5.5%). This figure is worse than the deficits recorded in 2020 (5.4%) and 2021 (5.4%) and one of the highest in the euro area and the Central and Eastern Europe (CEE) region. The revision reflects a more gradual phase-out of government support measures to offset the cost-of-living crisis as well as the delayed impact of inflation (8.9% year on year in August) on public expenditures. The deficit is projected to moderate to 4.8% of GDP in 2024 and 4.4% in 2025, each down 0.3pps compared to previous estimates (4.5% and 4.1%, respectively). This change captures the more expansionary fiscal stance that is likely to emerge under a scenario of a government coalition led by the Slovak Social Democracy (Smer SD) party. The projection assumes that the upcoming government would use the two-year exemption under the national debt brake to reinforce social benefits and public investment after the approval of its manifesto and a vote of confidence by the parliament¹. It also encompasses the risk of further political upheaval, including political deadlock, that would delay the reduction of the fiscal deficit. According to the Council for Budget Responsibility (CBR), the fiscal deficit is projected to remain above 5.5% of GDP over the next three years without a change in fiscal policy. At the same time, the revised forecasts also anticipate moderate fiscal consolidation based on structural adjustment required under the domestic budgetary framework (i.e., a balanced budget from 2024 onwards), statements from the Smer SD leadership on fiscal consolidation and the likely reactivation of the EU fiscal framework in 2024.

The downward revision of the fiscal deficit by 0.8pps of GDP on a cumulative basis between 2023 and 2028 will weigh on the trajectory of general government debt. The debt figure is projected to rise from 57.8% of GDP in 2022 to 62.6% of GDP in 2028. That is roughly equal to Scope’s previous estimate once the 2022 figure is corrected (58.8% of GDP forecast against a 57.8% of GDP outturn). The rising debt trajectory reflects slower-than-expected fiscal consolidation and a slightly lower GDP growth forecast for 2024 (2.0%, down 0.4pps) and 2025 (2.5%, down 0.4pps) as uncertainty surrounding the policy framework could weigh on internal demand and the disbursement of EU funds under the Recovery and Resilience Plan (RRP) (EUR 1.6bn in 2023, EUR 2.4bn in 2024 and EUR 1.8bn in 2025). That uncertainty could also weigh on funding conditions and net interest payments, which are projected to rise from 2.4% of revenues in 2023 to 3.2% in 2028. The spread against Germany has widened from 40bps on average in January 2022 to 123bps in September 2023 since the Russia-Ukraine crisis and under pre-election conditions. In the long run, adverse demographic trends are a risk to the debt trajectory given an ageing population. In a no policy-change scenario, public debt would exceed 100% by 2040¹ according to the government.

However, risks are partially mitigated by the reform of the first and second pillars of the pension system in 2023, which will help reduce long-term age-sensitive spending.

The second driver of the Negative Outlook reflects the ongoing diversification of Slovakia’s energy supply away from Russian fossil fuels.

Slovakia remains vulnerable to supply disruptions as Russian fossil fuels still account for a significant but declining share of energy imports, at 51% in Q1 2023², down from 76% in Q1 2021. Moreover, this structural vulnerability is expected to persist as long as Slovakia moves forward with reshuffling its infrastructure, including liquefied natural gas terminals, regasification units and potential investment in its nuclear industry^3,4. Although the drawdown of EU funds could support Slovakia’s transition away from Russian fossil fuels, upgrading domestic infrastructure is a multi-year process that is not expected to make material progress or be complete in the near-term. Similarly, strengthening interconnection networks (electricity grid, pipelines) with neighbouring countries and investing in renewables will require time to durably bolster energy security. During this transition period, Slovakia remains exposed to: i) a full-scale embargo of and/or a sudden halt in Russian exports; ii) infrastructural and logistical bottlenecks; and/or iii) upward pressure on commodity prices amid geopolitical tensions. However, the government has made significant progress in securing alternative energy supplies through agreements with energy majors that will provide nuclear fuel⁵ and liquefied natural gas^6,7. This is complemented by gas storage facilities that are 97% full as of end-September 2023, or more than 70% of annual consumption, and the rise in nuclear generation capacity through the expansion of the Mochovce power plant. Near-term risks are also mitigated by crude oil imports from Russia through the southern branch of the Druzhba pipeline based on a temporary exemption from the EU.

The third driver of the Negative Outlook reflects fragile external demand from European trading partners.

Having a small, open economy, Slovakia benefits from a competitive export-oriented industrial base anchored by robust foreign direct investment inflows. However, the country is reliant upon external demand and vulnerable to external shocks, with one of the highest exposures to international value chains in the EU. Global monetary policy tightening challenges the growth outlook of trading partners across the EU, which absorb 78% of Slovakia’s exports. Among them is Germany (rated AAA/Stable), for which a real GDP contraction of 0.4% is projected in 2023. Slovakia’s GDP growth is expected to decline to 1.4% in 2023, which is in line with Scope’s previous estimate after robust growth in Q2 2023 (up 1.5% year on year). Moreover, domestic demand is expected to be impacted by high HICP inflation, projected at 10% in 2023 and 5.5% in 2024, among the highest in the euro area and the CEE. The risks to the growth outlook relate to: i) higher-for-longer inflation; ii) a material deterioration in growth prospects in the euro area; and/or iii) energy supply disruptions. In the longer run, the transition to electric vehicles could pose challenges for the automotive industry because of heightened competition from Chinese car manufacturers⁸. Slovakia is also exposed to competition from CEE peers to attract the battery sub-industry. This could impact the country’s growth potential, estimated at 2.5%, should it underperform peers on global export markets and logistics chains.

Despite outstanding credit challenges, Slovakia’s A+ ratings are anchored by the following credit strengths.

Firstly, Slovakia benefits from being a member of the EU and the euro area, which supports access to EU funds. The government’s proposed amendments to the RRP that were approved in 2021 include the introduction of a REPowerEU chapter to support the transition away from Russian oil and gas before 2030 (grant allocation of EUR 366.4m) and the reallocation of Slovakia’s share of the Brexit Adjustment Reserve (EUR 36.3m). The modified RRP, amounting to EUR 6.4bn (or about 7% of GDP) instead of EUR 6.0bn⁹, is among the largest in the euro area as a share of GDP. It allocates 46% of this total to climate objectives, up from 42% in the original plan, and enlarges the scope of renewable energies eligible for funding. The modified RRP has been endorsed by the European Commission and the European Council¹⁰. Some EUR 1.9bn in grants have been disbursed to date. Policy conditionality includes strengthening public finances with the introduction of expenditure ceilings, improving the sustainability of the pension system, and reforming public investment management¹¹. However, the caretaker government’s inability to pass laws in parliament to make progress on milestones could delay the disbursement of EU funds, as could uncertainty about the policy framework after legislative elections. Slovakia has one of the lowest rates of EU funds absorption in the CEE (around 50% over the 2014-20 EU multi-annual period as of September 2021). Still, the disbursement of EU funds in the long run supports robust GDP growth (which had averaged 3.1% between 2010 and 2019).

Secondly, Slovakia has displayed strong fiscal discipline and has moderate levels of government debt. Notwithstanding political uncertainty, the country benefits from a robust fiscal framework that includes a debt brake and a correction mechanism to prevent an excessive rise in public debt levels. The framework was enhanced in 2022-23 in the context of the first payment of the EU RRP via the introduction of multi-annual expenditure ceilings over the full electoral cycle. After legislative elections, the Council for Budgetary Responsibility (CBR) is expected to submit expenditure limits for the next four years to be approved by the parliament. The assessment of compliance with expenditure limits will then be ensured by the CBR. The enhanced framework also includes an escape clause supporting fiscal flexibility under exceptional circumstances. Moreover, the planned amendment to the Constitutional Law on Budgetary Responsibility, including narrowing of the sanction bands, could further strengthen the framework. Scope believes Slovakia’s fiscal framework, the forthcoming reintroduction of European fiscal rules and the country’s reliance on EU funds are likely to partially ease pressure on public expenditure over the medium term.

Finally, Slovakia has modest general government debt (57.8% of GDP in 2022) relative to the euro-area average (90%). Slovakia also benefits from a supportive debt profile, with the ECB holding more than 40% of outstanding government bonds. The average maturity of public debt is relatively high (above eight years), and almost all debt carries a fixed coupon and is denominated in euros. Funding flexibility is also anchored by sizeable liquid financial assets compared to public-sector gross financing needs. The former is equivalent to 10% of GDP as of end-2022 according to the government¹, while the latter is estimated at EUR 9bn in 2023 (7.8% of GDP) and EUR 10bn in 2024 (7.9% of GDP).

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 ‘bbb+’ for Slovakia. Slovakia receives a one-notch positive adjustment to this indicative rating due to the euro under the reserve-currency adjustment of Scope’s methodology. As a result, the ‘a-’ final 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 based on analysts’ assessments.

Scope has identified the following relative credit strengths for Slovakia under the QS: i) fiscal policy framework; ii) debt profile and market access; iii) current account resilience; iv) external debt structure; v) banking sector performance; and vi) banking sector oversight. By contrast, the following credit weakness has been identified relative to sovereign peers in the QS: i) macroeconomic stability and sustainability.

The QS generates a two-notch positive 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 ESG issues into its rating process via the Sovereign Rating Methodology’s standalone ESG sovereign risk pillar, with a 25% weighting under the quantitative model (CVS).

Environment-related risks in Slovakia remain material. The country performs poorly in terms of its CVS score for carbon emissions per GDP compared to most of its peers, while it displays relatively better performance in terms of greenhouse gas emissions per capita. The country’s energy mix reflects exposure to higher energy prices given a 26% share of energy from natural gas as of 2021 – of which 85% is imported from Russia. This is followed by nuclear energy (24%), oil (22%) and coal (15%). Renewables represent 13% of final energy consumption. European funds, including a partnership agreement for 2021-27, plus investment in nuclear and renewables could support Slovakia’s climate objectives to reduce carbon emissions and achieve full carbon neutrality by 2050. This drives Scope’s ‘neutral’ qualitative assessment on ‘environmental factors’ on the complementary QS.

Slovakia’s performance across key social dimensions is mixed. Socially-relevant credit factors are reflected in steadily increasing old-age dependency ratios and high regional inequalities (among the highest in the OECD). These are offset by moderate unemployment rates (5.7% in Q2 2023) and below-EU-average poverty ratios and risk of social exclusion. This mix drives Scope’s ‘neutral’ qualitative assessment on ‘social factors’ on the QS.

Under governance-related factors, Slovakia’s performance is weaker than that of other euro-area Member States in the CEE, as assessed quantitatively via the World Bank’s Worldwide Governance Indicators, with negative performance particularly on corruption and government effectiveness. Timely implementation of reforms will be crucial for Slovakia to further strengthen its governance framework. This drives a ‘neutral’ qualitative assessment on ‘governance factors’ on the QS.

Rating committee
The main points discussed by the rating committee were: i) growth outlook; ii) debt and fiscal trajectories; iii) external sector developments; iv) financial sector developments; and v) peers comparisons.

Rating driver references
1.Ministry of Finance, Stability Programme 2023-2026, April 2023
2.Ministry of Finance, Investors Presentation, May 2023
3.JAVYS, Press Release, September 2023
4.Westinghouse Electric Company, Press Release, July 2023
5.Westinghouse Electric Company, Press Release, August 2023
6.Eni, Press Release, April 2023
7.Edison, Press Release, June 2023
8.Allianz Research, The Chinese Challenge to the European Automotive Industry, May 2023
9.European Commission, Press Release, June 2023
10.Council of the European Union, Press Release, July 2023
11.European Commission, Recovery and Resilience Facility, Operational arrangements, December 2021

Methodology
The methodology used for these Credit Ratings and Outlooks, (Sovereign Rating Methodology, 27 September 2023), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The model used for these Credit Ratings and Outlooks is (Core Variable Scorecard Model Version 2.1), available in Scope Ratings’ list of models, published under 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 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   NO
With Access to Internal Documents                                NO
With Access to Management                                          NO
The following 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 the 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 Outlooks and the principal grounds on which the Credit Ratings and Outlooks are based. Following that review, the Credit Ratings were not amended before being issued.

Regulatory disclosures
These Credit Ratings and Outlooks are issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0. The Credit Ratings and Outlooks are UK-endorsed.
Lead analyst: Thomas Gillet, Director
Person responsible for approval of the rating: Giacomo Barisone, Managing Director
The Credit Ratings/Outlooks were first released by Scope on January 2003. The Credit Ratings/Outlooks were last updated on 28 October 2022.

Potential conflicts
See www.scoperatings.com under Governance & Policies/Regulatory 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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