DBRS Confirms Republic of Slovenia at A, Stable Trend

DBRS Ratings Limited (DBRS) confirmed the Republic of Slovenia’s Long-Term Foreign and Local Currency – Issuer Ratings at A. At the same time, DBRS confirmed the Republic of Slovenia’s Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (low). The trend on all ratings 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 accelerated the repair of fiscal accounts and 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 judicious fiscal framework, and its membership of European institutions.

Despite these strengths, the ratings are principally constrained by the small and open nature of the Slovenian economy that makes it vulnerable to external shocks, and the country’s high stock of public sector debt. The government expects general government debt to have declined 70.3% of GDP in 2018, a noteworthy reduction of 12 percentage point since 2015, but still above regional peers. Long-run debt reduction could be challenged by rising age-related spending. Unfavourable 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 quickening debt reduction, may be complicated by the recently formed 5-party minority coalition government.

RATING DRIVERS

Positive ratings pressure is likely to emerge if (1) the government’s financial condition continues to improve – driven by prudent fiscal management and a reduction in contingent liabilities, in a context of sustained economic growth – or (2) policy measures strengthen medium-term growth prospects without generating large macroeconomic imbalances.

Although DBRS sees risks to the ratings as somewhat tilted toward the upside, 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) substantial realization of contingent liabilities.

RATING RATIONALE

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

Slovenia’s recent economic performance has been remarkable. Following 4.9% growth in 2017, real GDP growth reached 4.5% in 2018, underpinned by strong domestic demand and strong albeit decelerating export growth. 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. Export growth has recently expanded at a slower pace due to slowdown among Slovenia’s main trading partners. The EC expects growth to moderate at 3.1% in 2019 and 2.8% in 2020.

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 7.4% of GDP as of the third quarter 2018, to continue to narrow the net international investment position (IIP). Latest data show IIP improved to -26.9% 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 favourable economic conditions, the adoption of measures to control expenditures, and strong revenue growth. Following a 5.5% of GDP deficit result in 2014, the government expects a 0.8% surplus in 2018 and a surplus of 0.6% is planned for 2019. Despite the improvement, Slovenia’s public finances face challenges. Given Slovenia’s weak demographic outlook, the age-related costs are expected to increase and will likely weigh on Slovenia’s structural fiscal performance. The EC calculates the structural deficit narrowed to 0.5% of potential GDP in 2018 and widens to 0.6% in 2019. DBRS views that any additional progress made on healthcare and pension reform would support the long-term sustainability of public finances.

Improved fiscal and economic conditions and a comfortable funding profile have placed debt as a share of GDP on a firm downward path. Since 2015, when it reached its peak at 82.6%, the debt to GDP ratio declined by 12 percentage points to an estimated 70.3% in 2018. The government forecasts an aggressive debt reduction through the end of the decade due to strong economic performance, continued improvement in the fiscal balance, and a reduction in public sector cash buffers. Nevertheless, 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 1.1% of GDP in 2008 to 2.0% in 2018.

Improved Financial Sector Indicators and Progress on Privatisations

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. Non-performing exposures (NPE), mostly legacy loans concentrated in the real estate and construction sectors are on a declining trend. The overall NPE ratio declined from 14.2% at the end of June 2015 to 4.0% as of December 2018. After strong growth of 10% in 2017, real estate prices in Slovenia continued to increase in the first half of 2018, recording the second highest growth in the euro area. Given the limited supply of housing and the high demand for it, DBRS expects price pressure to continue. Despite the upward trend in house prices, comfortable private sector debt ratios and macroprudential measures appear to mitigate risks.

Current privatization plans are meant to reduce the state’s presence in the economy and its contingent liabilities. Even though negotiations were delayed, Slovenia sold 65% of its largest state bank, Nova Ljubljansa Banka (NLB), through an IPO in late 2018 and committed to sell another 10% by the end of 2019. The privatisation of NLB is part of Slovenia’s commitment to the EC for the approval of the state aid to the bank in 2013.The privatisation of the third largest bank, Abanka is scheduled for this year.

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, bank privatizations, economic performance, and debt management.

KEY INDICATORS

Fiscal Balance (% GDP): 0.07 (2017); 0.8 (2018E); 0.6 (2019F)
Gross Debt (% GDP): 74.1 (2017); 70.3 (2018E); 66.0 (2019F)
Nominal GDP (EUR billions): 43.3 (2017); 45.9 (2018E); 48.6 (2019F)
GDP per Capita (EUR): 20,815 (2017); 22,184 (2018E); 23,493 (2019F)
Real GDP growth (%): 4.9 (2017); 4.5 (2018E); 3.3 (2019F)
Consumer Price Inflation (%): 1.6 (2017); 2.0 (2018); 2.3 (2019F)
Domestic Credit (% GDP): 124.1 (2017); 121.3 (Sep-2018)
Current Account (% GDP): 7.2 (2017); 7.5 (2018E); 7.2 (2019F)
International Investment Position (% GDP): -32.3 (2017); -26.9% (Sep-2018)
Gross External Debt (% GDP): 101.9 (2017); 93.7 (Sep-2018)
Governance Indicator (percentile rank): 83.7 (2016); 84.6 (2017)
Human Development Index: 0.89 (2016); 0.90 (2017)

EURO AREA RISK CATEGORY: LOW

Notes:

All figures are in euros (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 updated 2019 Draft Budget Plan (January 2019). Nominal GDP (Statictical Office of the Republic of Slovenia/European Commission), GDP Per Capita (Statictical Office of the Republic of Slovenia/European Commission), Real GDP Growth (Statictical Office of the Republic of Slovenia/European Commission), Inflation (Statictical Office of the Republic of Slovenia/European Commission), Domestic Credit (BoS), Current Account (Bank of Slovenia/ European Commission), International Investment Position (Bank of Slovenia), 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.

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

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

Lead Analyst: Jason Graffam, Vice President, Global Sovereign Ratings
Rating Committee Chair: Thomas R. Torgerson, Co-head of Global Sovereign Ratings
Initial Rating Date: November 17, 2017
Last Rating Date: October 19, 2018

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