Morningstar DBRS Confirms Republic of Slovenia at A (high), Stable Trend

DBRS Ratings GmbH (Morningstar DBRS) confirmed the Republic of Slovenia (Slovenia)'s Long-Term Foreign and Local Currency - Issuer Ratings at A (high). At the same time, Morningstar DBRS confirmed Slovenia's Short-Term Foreign and Local Currency - Issuer Ratings at R-1 (middle). The trend on all ratings is Stable.

KEY CREDIT RATING CONSIDERATIONS
The Stable trends reflect Morningstar DBRS' view that Slovenia's credible macroeconomic policy framework positions the country well to weather the consequences of adverse global and domestic shocks. While fiscal deficits are expected to remain moderate over the medium term, GDP growth is likely to pick up, after slowing down to 1.6% in 2023. Easing inflation and more favourable financial conditions, along with fiscal impulse from flood-related reconstruction, will help GDP growth to gather pace. The European Commission (EC) forecasts real GDP growth to accelerate to 2.3% this year and to 2.6% in 2025. Despite the catastrophic floods in August 2023, the fiscal deficit ended up at 2.5% of GDP in 2023, lower than initially estimated due to higher revenues and lower than planned reconstruction expenditures. Flood-related reconstruction costs appear manageable for the fiscal accounts. The EC expects the budget deficit to increase to 2.8% of GDP this year, with the one-off reconstruction spending estimated at 0.7% of GDP, before falling to 2.2% of GDP in 2025. The public debt-to-GDP ratio is expected also to continue to decline after the peak of 79.6% in 2020, to 66.4% by 2025.

Slovenia's credit strengths reflect its wealthy and high value-added economy compared to other `A' category peers in the region, its effective debt management and credible fiscal framework. Moreover, the country benefits from its membership of European institutions as well as EU resources. Nevertheless, the credit ratings are constrained by the country's comparatively high stock of public sector debt in a context of unfavourable demographic trends and rising age-related costs. Furthermore, Slovenia's small and open economy makes it vulnerable to external shocks.

CREDIT RATING DRIVERS
The credit ratings could be upgraded if the public debt ratio materially declines, due to the government effectively implementing policy measures that strengthen medium-term growth prospects or that address rising age-related public spending.

The credit ratings could be downgraded if there is a lasting deterioration in government debt dynamics, due to prolonged economic underperformance or weaker fiscal outcomes.

CREDIT RATING RATIONALE

GDP Growth Slowed Down Last Year, But is Set to Pick Up in 2024

Following growth of 2.5% in 2022, the Slovenian economy slowed to 1.6% in 2023, mainly reflecting weak domestic demand, including a fall in inventories. The catastrophic floods in August 2023 caused damages to properties and infrastructures but overall had a limited impact on the economy. Rather, the reconstruction works on residential properties, businesses, and infrastructure had a positive impact on construction activity. According to the Institute of Macroeconomic Analysis and Development (IMAD), the economy is expected to grow by 2.4% this year and by 2.5% in 2025. Investment growth is expected to be strong; easing inflationary pressures and further real growth in households' income should support consumers' purchasing power; and recovering external demand will boost export growth.

The labour market remains tight, with a low registered unemployment rate, estimated at 4.7% in March 2024. Inflation (CPI) fell to 2.5% in May 2024, from the peak of 10.9% in July 2022 and is expected to gradually converge to the ECB's target going forward. This will help households, which are experiencing rapid wage growth, to gain further purchasing power. Risks to the outlook, beyond a more prolonged period of high interest rates, are related to an escalation in geopolitical conflicts that could lead to renewed supply shocks affecting Slovenia's export-oriented industries. The main upside risk stems from the efficient absorption of EU funds. The Recovery and Resilience Facility makes available EUR 2.7 billion (5.1% of 2021 GDP) in grants and loans and total disbursements amounted to EUR 840 million, corresponding to around 31% of the total allocation. Slovenia will also benefit from EUR 3.2 billion in EU cohesion funds for the period 2021-2027. These funding plans include important reforms to pension, healthcare, and the long-term care systems. Successful execution and absorption of these funds could increase Slovenia's economic productivity and strengthen its growth potential.

Fiscal Outcome Better Than Expected in 2023; Deficit Anticipated To Increase Marginally in 2024

Slovenia's fiscal performance deteriorated in recent years due to measures to counter the impact of the pandemic and of the energy crisis on businesses and households. From a small surplus during the 2018-19 period, the fiscal position turned into a deficit of 7.6% of GDP in 2020 and 4.6% in 2021, before improving to 3.0% of GDP in 2022. Despite the government's measures in response to the floods and energy-related support, the deficit reached 2.5% of GDP in 2023, lower than the 4.5% deficit that was initially budgeted. Net borrowing will likely increase marginally to 2.8% of GDP this year, before declining to 2.2% in 2025 as economic growth picks up and energy-related support peters out. Risks to the fiscal outlook over the medium-term will depend on the scale of spending ultimately allocated for reconstruction. Likewise, planned reforms to the public sector wage system, and the pension and healthcare systems, will be important for the health of Slovenia's fiscal accounts. The country's demographic outlook contributes to age-related expenditure costs.

Slovenia's Debt-to-GDP Ratio Expected to Continue to Decline

The country's public debt ratio is expected to continue to decline going forward and to benefit from a robust debt profile. Following a fall in the public debt ratio by 17.2 percentage points of GDP during the 2015-19 period, Slovenia's debt-to-GDP ratio increased to 79.6% in 2020 from 65.4% in 2019, due to the pandemic shock. The public sector debt ratio is expected to decline to 66.4% of GDP in 2025 from 69.2% in 2023 driven by growth of nominal GDP, moderate deficits and a reduction in state budget liquidity reserves. Other key debt management metrics are also strong. Even with the rapid rise in interest rates, the implicit interest rate declined to 1.6% in 2023 from 4.4% in 2014. The average maturity of public debt increased to 9.7 years in 2023, from 5.7 years in 2013, and almost all debt is in euros and at fixed rates. These factors reduce the government's sensitivity to rising interest rates and currency fluctuations.

Risks To Financial Stability Are Contained; Slovenia's Banking System Has Remained Resilient

Slovenia's banking system has showed resilience in the current weaker macroeconomic environment with banks remaining liquid, improving profitability and enjoying sound capitalisation. Asset quality has remained relatively stable with non-performing exposures (NPEs) in the portfolio of non-financial corporations standing at 1.8% as of March 2024 and the NPE ratio in the household portfolio at 1.7%. The impact of the multiple shocks the country has faced over the last years on banks' asset quality has been limited thus far, although looking ahead, high interest rates could lead to some deterioration in banks' asset quality. So far, the consequences of the floods on the banking system have been limited and the impact of the temporary banks' levy is expected to be manageable.

The real estate market is cooling and risks appear more moderate. After reaching a peak of 17% growth in the first quarter of 2022 compared to a year earlier, the Slovenian real estate market is cooling down, with annual price growth of 6.8% in last quarter of 2023. While the Bank of Slovenia identifies some overvaluation in the real estate market relative to price fundamentals, risks linked to high real estate price growth are mitigated by the moderate level of private sector indebtedness. The household debt-to-GDP ratio in particular is low, standing at 39.1% at the end of 2023, compared to 88% in the euro area.

Slovenia's Current Account Returns To Surplus; The Worsening in External Competitiveness Mitigated by Stronger External Demand and Improvements in Terms of Trade

The country's credit ratings benefit from a sound external position as a result of a dynamic export-oriented sector and an improved net international investment position (NIIP). The weakening in external competitiveness, due to rapid growth in unit labour costs over the last few years, will likely be mitigated by an improvement in external demand and in terms of trade. After a deficit of 1.0% of GDP in 2022, a current account surplus of 4.5% of GDP was achieved in 2023 as a result of energy and other commodity prices moderating along with lower real imports. The EC expects the annual surplus to narrow in coming years to 1.4% of GDP in 2024-26 period, as the trade balance is set to turn into deficit with imports accelerating more than exports related to higher domestic demand. From a stock perspective, years of strong external savings have led to an improvement in the country's NIIP from a net debtor of 44.0% of GDP in December 2012 to a net creditor of 3.7% in 2023.

Slovenia Has Stable Policymaking Institutions

Slovenia has a stable political system, strong institutions as reflected in the robust performance on the World Bank's Worldwide Governance Indicators when compared with its peers. EU and euro area memberships anchor macroeconomic policymaking and the country's credible policy framework. The current government, comprising the green-liberal Freedom Movement (GS) party, the Social Democrats and the Left, is implementing an agenda focusing on accelerating the green and digital transitions, the post-flood reconstruction works, while enhancing preparedness for climate events, as well as passing pension and healthcare reforms.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

ESG Considerations had a significant effect on the credit analysis.

Environmental (E) Factors
There were no Environmental factors that had a relevant or significant effect on the credit analysis.

Social (S) Factors
The following Social factors had a significant effect on the credit analysis: The Human Capital and Human Rights factor affects Slovenia's ratings. Slovenia's per capita GDP was relatively low at USD 32,233 in 2023 compared to its euro area peers. Nonetheless, Morningstar DBRS notes the improvement in Slovenia's per capita GDP in recent years. This factor has been taken into account within the "Economic Structure and Performance" building block.

Governance (G) Factors
There were no Governance factors that had a relevant or significant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (23 January 2024) https://dbrs.morningstar.com/research/427030/morningstar-dbrs-criteria:-approach-to-environmental,-social,-and-governance-risk-factors-in-credit-ratings.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments at: https://dbrs.morningstar.com/research/434091/.

EURO AREA RISK CATEGORY: LOW

Notes:
All figures are in euros unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal methodology is the Global Methodology for Rating Sovereign Governments (6 October 2023) https://dbrs.morningstar.com/research/421590/global-methodology-for-rating-sovereign-governments. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://dbrs.morningstar.com/research/427030/morningstar-dbrs-criteria:-approach-to-environmental,-social,-and-governance-risk-factors-in-credit-ratings in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

The sources of information used for these credit ratings include Ministry of Finance (Draft Budgetary Plan 2024, Debt portfolio overview presentation - May 2024), Bank of Slovenia (Financial Stability Review - May 2024, Review of Macroeconomic Developments - April 2024), IMAD (Spring 2024 Forecast of Economic Trends, Slovenian Economic Mirror No. 2 / Vol. XXX / 2024) European Commission (European Economic Forecast Spring 2024 - May 2024, Commission opinion on the 2024 Draft Budgetary Plan of Slovenia - November 2023, Integrated National Energy and Climate Plan of the Republic of Slovenia), Statistical Office of the European Communities, Republic of Slovenia Statistical Office, OECD, IMF (Republic of Slovenia: Staff Concluding Statement of the 2024 Article IV Mission - May 2024), WEO, World Bank, IFS, Bank for International Settlements, European Central Bank, Social Progress Imperative, Haver Analytics. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings to be of satisfactory quality.

With Rated Entity or Related Third Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO

Morningstar 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.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and credit ratings are under regular surveillance.

For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key credit rating assumptions can be found at: https://dbrs.morningstar.com/research/434089/.

These credit ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Carlo Capuano, Senior Vice President, Sector Lead, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director, Global Sovereign Ratings
Initial Rating Date: 17 November 2017
Last Rating Date: 8 December 2023

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