DBRS Confirms A (high) Rating to Slovak Republic, Stable Trend

DBRS, Inc. has confirmed issuer ratings of A (high) for the long-term foreign and local currency debt of the Slovak Republic, and issuer ratings of R-1 (middle) for its short-term foreign and local currency debt. The trend on all ratings is Stable.

The A (high) ratings reflect Slovakia’s strong macroeconomic performance and deep integration with major Eurozone economies. Slovakia attracts high quality foreign investment, has a healthy banking sector and a solid fiscal framework. The ratings are constrained by high unemployment, regional disparities and a relatively low level of productivity. Slovakia also faces unfavorable demographics, with adverse consequences for pension, health and old age expenditures.

Slovakia’s ratings are underpinned by its solid macroeconomic performance, being among the top growth performer in the EU during the last decade. Growth has averaged 3.8% led by both consumption and investment. Consumption has been supported by rising employment, real wages and favorable credit conditions. Slovakia is among the biggest beneficiary of EU funds transfers. This has buttressed public sector investments while private sector investments have been supported by accommodative ECB policies and improving lending conditions. Conditions are likely to remain favorable in the medium term with the IMF projecting growth to range between 3.2% to 3.7%, reflecting sustained domestic demand as well as higher exports due to new auto investments.

Slovakia’s commitment to the EU fiscal compact is evident from the 5% reduction in the deficit since 2009, with it exiting the EU’s Excessive Deficit Procedure in 2013. While the 2015 deficit exceeded targets coming in at 3%, this was due to additional spending on account of higher investments connected with the accelerated draw-down of EU funds. The Stability Program has targeted a deficit of 2.1% of GDP in 2016 and 1.3% in 2017, with the aim of reaching its medium-term budgetary objective of a structural deficit of 0.5% of GDP in 2019.

Slovakia’s debt ratios have stabilized (52.9% of GDP in 2015) with the underlying debt dynamics pointing to a stable debt trajectory. Near term fiscal risks are mitigated by the benign interest rate environment and favorable debt composition. The government is committed to balancing its budget and adhering to the Fiscal Responsibility Act, which specifies debt ceilings and measures to be implemented if ceilings are breached.

The banking sector in Slovakia has strong fundamentals as reflected in healthy profit growth, adequate levels of capitalization and robust asset quality. The main banks are foreign subsidiaries, but their reliance on external funding is limited. It is a traditional retail-oriented business model with stable domestic deposit-based funding.

Despite, its resilience, Slovakia faces many challenges, with labor market imperfections, the primary challenge. While overall unemployment levels have seen a cyclical improvement from 14.2% in 2013, it remains relatively high at 9.9% (2Q 2016) and regional disparities remain. Likewise, while the long-term unemployment rate has fallen sharply from 10% in 2013 to 5.8% in 2Q 2016, it still remains higher than the EU average of 4.5%.

Secondly, Slovakia’s demographics coupled with low fertility are amongst the most adverse in Europe. As per the European Commission Ageing report 2015, the share of the population aged 65 is projected to increase from 20% to 72% of the population aged 20-64 between 2020 and 2060. Effective 2017, the pension age will likely be linked to life expectancy. Nonetheless given Slovakia’s demographics, sustainability of public finances remains a challenge and could have implications not only for debt dynamics, but also for medium term growth prospects.

While Slovakia has a healthy banking sector, private sector leverage growth is among the highest in the EU. The combination of increasing private sector leverage and rising property prices is a risk that DBRS is monitoring. Despite the rapid increase in housing loans, credit remains at relatively low levels, and repayment capacity is supported by low real interest rates and rising disposable income.

Lastly, while the domestic growth story is strong, risks to growth could emerge on the external front due to uncertainty on the implications of Brexit and the implications of lower growth in its trading partners, given Slovakia’s growing participation in global value chains. In addition to trade and investment flows, Slovakia is also of the largest beneficiaries of EU transfers and is budgeted to receive up to EUR 15.3 billion for the period 2014-2020 equivalent to 2.6% of GDP on an annual basis. Given Slovakia’s demographics, if Brexit does lead to a reduction in EU transfers to the region, it will be difficult for Slovakia to maintain trend growth.

RATING DRIVERS

The Stable trend reflects DBRS’s assessment that risks to the ratings are broadly balanced. Strong investment that enhances productivity, combined with measures to address unemployment and regional disparities could be positive for the credit profile. In addition, a reduction in the structural deficit combined with a steady decline in public debt could put upward pressure on the ratings. On the other hand, the ratings could be lowered if the fiscal stance weakens significantly, leading to a deterioration in public debt dynamics.

Notes:
All figures are in Euros unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website under Methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website under Rating Scales. These can be found at http://www.dbrs.com/about/methodologies.

The sources of information used for this rating include National Bank of Slovakia; Slovak Finance Ministry; ARDAL; IMF; European Commission; Haver Analytics; DBRS. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

The rated entity or its related entities did participate in the rating process. DBRS did not have access to the accounts and other relevant internal documents of the rated entity or its related entities.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

For further information on DBRS’ historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository see http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period while reviews are generally resolved within 90 days. DBRS’s trends and ratings are under constant surveillance.

Lead Analyst: Rohini Malkani
Rating Committee Chair: Roger Lister
Initial Rating Date: April 22, 2016
Most Recent Rating Update: April 22, 2016

For additional information on this rating, please refer to the linking document under Related Research.