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Rating action

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

Summary and Outlook

The downgrade of Slovakia’s long-term ratings to A is underpinned by the following credit rating drivers:

1. A worsening fiscal position due to large deficits and uncertain consolidation prospects, leading to an expected material rise in the debt to GDP ratio over the forecast horizon; and
    
2. Challenges for the medium-term macro-economic outlook related to the disbursement of EU funds, the moderate growth outlook of EU trade partners, the transition of the automotive manufacturing sector to electric vehicles, and an incomplete transition from Russian energy.

The downgrade reflects Scope’s updated assessments under the ‘public finance risk’ and ‘domestic economic risk’ categories of its sovereign methodology.

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

The long-term ratings/Outlooks could be upgraded if, individually or collectively: i) the fiscal outlook improves, for example, due to a sustained reduction of deficits driving a lower-than-anticipated rise in debt-to-GDP; ii) the macro-economic outlook improves, for example, due to stronger external demand; and/or iii) governance improves, furthermore strengthening prospects for the continued timely disbursement of EU funds.

Conversely, the ratings/Outlooks could be downgraded if, individually or collectively: i) fiscal deficits remain wide and there is a larger-than-expected rise in debt-to-GDP; ii) the macro-economic outlook weakens, for example, due to durably weaker external demand and/or energy supply disruptions; and/or iii) governance weakens, undermining prospects for the timely disbursement of EU funds.

Rating rationale

First driver of the downgrade: a worsening fiscal position

Slovakia’s large general government deficits and uncertain budgetary consolidation prospects underpin a projected rise in the debt-to-GDP ratio to 67.9% in 2028 (against 62.6% projected as of October 2023), up from 56.8% in 2023 and 48.0% in 2019.

Following a vote of confidence in parliament, the three-party government coalition of Prime Minister Robert Fico has relied on a two-year exemption under the national debt brake, until November 2025, to introduce accommodative fiscal measures^1,2 such as increased social transfers, energy and interest rate subsidies, pension and wage revaluation, and higher military spending. Discretionary measures, some of which are indexed on inflation (forecast at 5.2% in 2024, after 10.9% in 2023), are expected to have a longer-term impact on public finances. The headline deficit is projected to widen to 6.5% of GDP in 2024 and in 2025 (against 4.8% and 4.4% projected as of October 2023), from 5.7% in 2023, one of the highest among Slovakia’s indicative sovereign rating peer group. Wide deficits will also result from increasing net interest payments, rising to 3.7% of general government revenue in 2028 (against 3.2% estimated in October), from 2.0% in 2023. In Scope’s opinion, Slovakia’s loose fiscal policy will raise government gross financing needs in 2024 and 2025 (estimated at 10% of GDP) and further weaken fiscal metrics post Covid and cost-of-living crises.

Moreover, Slovakia’s fiscal challenges are compounded by uncertainties on budget consolidation plans. The government has committed to accelerating the reduction of the deficit by 2025 through a EUR 1.5bn package of measures (valued at about 1% of GDP) to be finalised over the coming months. At the current juncture, Scope foresees delays in the reduction of the fiscal deficit and projects the deficit at 4.8% of GDP in 2026 and around 4.0% of GDP in 2028. Despite moderating over time, fiscal deficits are unlikely to meet requirements under revised EU fiscal rules, raising the likelihood of an Excessive Deficit Procedure. Finally, a recent record of political instability, following last year’s early legislative elections, could delay the execution of far-reaching reforms and weigh on fiscal metrics. This could relate, for example, to rising ageing-related spending due to adverse demographics.

Second driver of the downgrade: challenges for the medium-term macro-economic outlook

Slovakia is exposed to a number of downside risks that could weigh on the macro-economic outlook and growth potential (currently estimated at around 2.5% per year).

The government of Prime Minister Fico intends to revise the criminal code, including the dissolution of the special prosecutor's office through a fast-track procedure and the softening of penalties for corruption offences, triggering concerns from the European Parliament over the rule of law³. If implemented, Scope considers that this policy could hinder the timely disbursement of EU cohesion funds⁴ (EUR 12.8bn over 2021-2027) and Recovery and Resilience Facility (RRF) monies (EUR 6.4bn of grants over 2021-26)^5,6. A third payment of EUR 662m was made in December 2023 under the RRF. Despite a low absorption rate historically (around 50% over the 2014-20), the disbursement of EU funds remains critical to supporting public investment, energy supply diversification and climate transition.

Furthermore, Slovakia’s small, open economy is exposed to lower external demand resulting from subdued growth among EU trading partners, such as Germany, the Czech Republic, Hungary, and Poland. In those economies, which together account for about 50% of Slovak exports⁷, Scope projects average growth of 1.8% in 2024 and 2.6% in 2025, against -0.2% in 2023. Moreover, the automotive manufacturing sector faces challenges related to the transition to electric vehicles. Uncertainty around the economic policy framework and disbursement of EU funds could weigh on foreign direct investment required to adjust production capacities and develop the battery sub-industry. An unsuccessful transition would have wide economic implications as the sector accounts for more than 10% of output, about half of industrial production and more than 30% of exports. Real growth for Slovakia is projected at a below-potential of 1.9% in 2024, after 1.4% in 2023, and 2.3% in 2025.

Finally, the incomplete transition from Russian energy imports raises risks around energy security. Slovakia’s full diversification will require more time than expected, as reflected by the EU decision to grant another one-year exemption, until December 2024, to continue importing Russian energy. As upgrading domestic infrastructure and strengthening interconnection networks with neighbouring countries is a multi-year process, dependence on Russian imports durably exposes businesses to energy supply disruptions.

Additional rating drivers: EU and euro area memberships; competitive, export-oriented industrial base

Slovakia’s A long-term ratings reflect the following credit strengths: i) membership in the European Union and euro area, conferring advantages via access to substantive structural and recovery funds, a strong reserve currency, access to the European Central Bank’s asset purchases and refinancing operations, and the EU fiscal framework; and ii) a competitive, export-oriented industrial base, anchored by robust foreign direct investment inflows, particularly into the automotive industry.

Sovereign Quantitative Model (SQM) and Qualitative Scorecard (QS)

Scope’s SQM, which assesses key sovereign credit fundamentals, provides a first indicative rating of ‘bbb+’ for Slovakia. Under Scope’s methodology, the indicative rating receives i) a one-notch positive adjustment for the euro as reflecting a global reserve currency, and ii) no negative adjustment for political risks. As such, the ‘a-’ final SQM rating can be changed by the analyst 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 qualitative credit strengths for Slovakia under the QS: i) current account resilience; ii) external debt structure; and iii) banking sector performance. By contrast, the following credit weakness has been identified relative to indicative sovereign peers in the QS: i) macro-economic stability and sustainability.

The QS generates an aggregate one-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 in ESG issues in its rating process via the Sovereign Rating Methodology’s standalone ESG sovereign risk pillar, with a 25% weighting under the quantitative model (SQM) and 20% weight in the methodology’s qualitative overlay (QS).

Slovakia performs poorly under the SQM for its CO2 emissions per GDP compared to most of its sovereign peers. Oil, natural gas and coal account for about 64% of energy supply. The country has a comparatively better performance in terms of greenhouse gas emissions per capita and passed its first climate law in February 2023 with the objective to be carbon neutral by 2050. This drives our ‘neutral’ assessment on ‘environmental factors’ in the QS.

Slovakia’s performance across key social dimensions is mixed. Socially related credit factors are reflected in demographic trends being less adverse than those of EU central and eastern European peers, a below EU-average poverty level and moderate unemployment rates, but high regional inequalities. This drives our ‘neutral’ assessment on ‘social factors’ in the 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. The authorities reaffirmed their pro-EU orientation and commitment to NATO membership ahead of presidential election in March-April this year and EU elections in June 2024. This drives our ‘neutral’ assessment on ‘governance factors’ in 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) sovereign peers considerations.

Rating driver references
1. Draft law amending some laws in connection with improving the state of public finances, Government of Slovakia
2. Slovak Republic: Staff Concluding Statement of the 2023 Article IV Mission, IMF
3. Parliament concerned about the rule of law in Slovakia, European Parliament
4. EU Cohesion Policy, July 2022, European Commission
5. Commission endorses positive preliminary assessment of Slovakia's request, European Commission
6. Commission disburses payments under the Recovery and Resilience Facility, European Commission
7. Investor Presentation, March 2023, Debt and Liquidity Management Agency

Methodology
The methodology used for these Credit Ratings and/or Outlooks, (Sovereign Rating Methodology, 29 January 2024), is available on https://scoperatings.com/governance-and-policies/rating-governance/methodologies.
The model used for these Credit Ratings and/or Outlooks is (Sovereign Quantitative Model (ex CVS Model) Version 3.0), 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 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 and/or Outlooks 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: Thomas Gillet, Director
Person responsible for approval of the Credit Ratings: Giacomo Barisone, Managing Director
The Credit Ratings/Outlooks were first released by Scope on January 2003. The Ratings/Outlooks were last updated on 6 October 2023.

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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