DBRS Confirms Republic of Slovenia at A, Stable Trend

DBRS Ratings Limited confirmed the Republic of Slovenia’s Long-Term Foreign and Local Currency – Issuer Ratings at A and its Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (low). The ratings trend is Stable.

KEY RATING CONSIDERATIONS

The confirmation of the ratings and trends reflects DBRS’s view that Slovenia is well placed in the A category. The impressive growth performance of the Slovenian economy in recent years has accelerated the repair of fiscal accounts and has improved debt dynamics. Slovenia’s credit strengths stem from its wealthy and high value-added economy compared to A category regional peers, its effective debt management and a judicious fiscal framework, and its membership of European institutions.

Nonetheless, the ratings are principally constrained by the high stock of public sector debt. The government expects general government debt around 70% of GDP this year, a noteworthy 13 percentage point reduction since 2015, but still above regional peers. Long-run debt reduction could be challenged by rising age-related spending. Poor demographic trends are expected to place structural pressure on public expenditures in the absence of healthcare and pension reform. The structural reform agenda, key to improving economic growth potential and accelerating debt reduction, is complicated by the recently formed minority coalition government that consists of five disparate political parties.

RATING DRIVERS

DBRS considers Slovenia secure in the A category and would need to see sustained evidence of large fiscal buffers, greater convergence towards EU income levels, and significant debt reduction before moving the country into the AA rating category. Positive ratings pressure could emerge within the A category if (1) the decline in the government debt burden overperforms the government’s current projections or (2) structural reform measures strengthen medium-term growth prospects without generating large macroeconomic imbalances.

The ratings could face downward pressure if the improving trend on debt dynamics reverses due to a shock to Slovenia’s small and open economy that causes (1) significant economic underperformance, (2) material fiscal slippage, or (3) a substantial realization of contingent liabilities.

RATING RATIONALE

Domestic and External Demand Support Slovenia’s Impressive Economic Growth Performance

The impressive performance of the Slovenian economy in recent years has been broad-based. Growth reached 4.9% in 2017, from a 2.8% annual average between 2014-2016, due to strengthened domestic demand. Sustained wage and employment gains and growing household disposable incomes have led to upbeat consumer confidence. The steady resurgence of investment, from improved private sector balance sheets and the delivery of EU structural funds, also support GDP growth results. Despite the economic slowdown in the first half of 2018, DBRS sees potential upside to the EC’s 4.4% 2018 growth projection and its 3.5% growth forecast for 2019.

Slovenia’s competitive external sector supports its large current account surplus. Slovenia is integrated into the regional supply chain and manufactures a diverse range of high value-added component parts. Improved cost competitiveness and a strong pick-up in external demand in recent years contributed to a steady rise in trade volumes. DBRS expects the strong current account surplus position, at 6.9% of GDP as of the first quarter 2018, to continue to narrow the net international investment position (IIP). Latest data show IIP improved to -30.5% of GDP from -50.1% in 2012.

Despite Improved Fiscal and Debt Metrics, Structural Weaknesses Remain in Slovenia’s Public Finances

Fiscal consolidation in recent years has been significant due to expenditure control, strong revenue growth from economic over-performance, and a reduction in the interest burden. Following a 5.5% of GDP deficit result in 2014, the government posted a small surplus last year, expects a 0.5% of GDP surplus for 2018, and small headline surpluses through 2021.

Improved fiscal and economic conditions and a comfortable funding profile have placed debt as a share of GDP on a firm downward path. After peaking in 2015 at 82.6%, the government forecasts an aggressive debt reduction through the end of the decade. The ratio declined to 74.1% in 2017 due to strong economic performance, improvement in the fiscal deficit, and a reduction in public sector cash buffers. The EC expects the debt ratio to reach 65% in 2019. This assumption excludes possible stock-flow debt reductions that could likely occur from the privatization of state assets, or the reduction of liquid assets, which accounted for €5.6 billion or 12.3% of GDP as of the third quarter 2018.

Despite improved fiscal and debt outcomes, Slovenia’s public finances face medium-term challenges. The EC calculates a structural deficit of 1.6% of potential GDP in 2018. While the government’s calculations are more benign, the government expects the structural deficit to widen from 0.2% of potential GDP this year to 0.9% in 2019. Slovenia’s structural fiscal performance is weighed by increasing age-related costs from deteriorating demographic trends. Further progress on healthcare and pension reforms are likely necessary for Slovenia to comply with its structural objectives over the medium term. Moreover, the public debt burden is high when compared against regional peers of similar economic size. The high debt stock limits shock absorption capacity and redirects public funds towards debt servicing. Despite low bond yields, the debt-stock increase caused interest costs to rise from 1.0% of GDP in 2007 to 2.3% in 2017.

Improved Financial Sector Indicators and Updates to the Banking Sector Privatization Plans

The banking sector has worked through its crisis-legacies and is broadly in repair. In the context of strong economic performance, credit growth has returned to positive in the non-financial private sector. Loans to households have been particularly strong. Banking sector resilience is evident by improved capital and funding positions and the dramatic improvement in asset quality. Claims with arrears over 90 days to total claims declined from 18.1% at the end of November 2013 to 2.8% as of July 2018.

Current privatization plans are meant to reduce the state’s presence in the economy and its contingent liabilities. Even though negotiations have been delayed, the government and the EC have updated their agreement on the sale of assets of the largest state bank, Nova Ljubljansa Banka (NLB). The government committed to selling at least 50% plus one share of NLB by the end of 2018 and reduce its shareholding to 25% plus one share by 2019. Privatisation of state-owned bank Abanka is scheduled for 2019.

Notwithstanding Fractured Politics, Slovenia has Stable Policy-Making Institutions

Prime Minister (PM) Marjan Sarec, formed a government in September 2018. Despite winning the largest share of votes with 25%, Janez Jansa of the Slovenia Democratic Party was unable to form a government. This allowed Sarec to form a 5-party minority coalition government. The fragmented nature of the new administration complicates the reform agenda and does not preclude another early election.

Despite the political volatility, Slovenia has strong institutions. The country benefits from its membership of both the EU and Euro area, which functions as a stability anchor for macroeconomic policy. Slovenia also benefits from a healthy inflow of EU structural fund investments directed towards productive areas. The country’s credible policy framework is underpinned by its strong performance on the World Bank’s Governance Indicators when compared with its peers, particularly the Rule of Law and Government Effectiveness. The main policy challenge facing the next few governments will be how it manages the fiscal and economic consequences of its aging population.

RATING COMMITTEE SUMMARY

The DBRS Sovereign Scorecard generates a result in the A (high) to A (low) range. The main points discussed during the Rating Committee include the outlook for fiscal policy, SOE and bank privatizations, economic performance, and debt management.

KEY INDICATORS

Fiscal Balance (% GDP): 0.1 (2017); 0.5 (2018F); 0.2 (2019F)
Gross Debt (% GDP): 74.1 (2017); 70.3 (2018E); 66.6 (2019F)
Nominal GDP (EUR billions): 43.0 (2017); 45.5 (2018F); 47.8 (2019F)
GDP per Capita (EUR): 20,815 (2017); 21,983 (2018F); 23,051 (2019F)
Real GDP growth (%): 4.9 (2017); 4.2 (2018F); 3.5 (2019F)
Consumer Price Inflation (%): 1.7 (2017); 1.8 (2018F); 2.0 (2019F)
Domestic Credit (% GDP): 124.7 (2017); 122.4 (Mar-2018)
Current Account (% GDP): 7.2 (2017); 6.3 (2018E); 5.5 (2019F)
International Investment Position (% GDP): -32.3 (2017); -29.3% (Jun-2018)
Gross External Debt (% GDP): 101.9 (2017); 97.4 (Jun-2018)
Governance Indicator (percentile rank): 83.7 (2016); 84.6 (2017)
Human Development Index: 0.89 (2016); 0.90 (2017)

Notes:

All figures are in EUR unless otherwise noted. Public finance statistics reported on a general government basis unless specified. The fiscal balance and gross debt projections are taken from the 2019 Draft Budget Plan. Governance indicator represents an average percentile rank (0-100) from Rule of Law, Voice and Accountability and Government Effectiveness indicators (all World Bank). Human Development Index (UNDP) ranges from 0-1, with 1 representing a very high level of human development.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website www.dbrs.com at http://www.dbrs.com/about/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 at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.

The sources of information used for this rating include the Ministry of Finance, Bank of Slovenia, Institute of Macroeconomic Analysis and Development, European Commission, Statistical Office of the European Communities, OECD, IMF, World Bank, UNDP, Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.

This rating included participation by the rated entity or any related third party. DBRS had no access to relevant internal documents for the rated entity or a related third party.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS’s outlooks and ratings are under regular surveillance.

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Ratings assigned by DBRS Ratings Limited are subject to EU and US regulations only.

Lead Analyst: Jason Graffam, Vice President
Rating Committee Chair: Thomas R. Torgerson, Co-head of Global Sovereign Ratings
Initial Rating Date: November 17, 2017
Last Rating Date: April 20, 2018

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