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

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

KEY RATING CONSIDERATIONS

The confirmation of the A (high) ratings and Stable trends reflect DBRS Morningstar’s assessment of Slovenia’s credible macroeconomic policy framework, even when confronted with the current health and economic crisis. DBRS Morningstar expects the shock to the global economy brought on by the Coronavirus disease (COVID-19) and the associated confinement measures to contract the Slovenian economy this year and to significantly deteriorate its public finances. However, Slovenia arrived to the crisis following three consecutive years of budgetary surplus and the public debt ratio on a firm downward trajectory. As such, Slovenia had ample capacity at the onset of the crisis to support the economy without lasting deterioration in credit quality, albeit contingent on the duration of the crisis.

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. However, the ratings are principally constrained by the country’s still high stock of public sector debt, and the small and open nature of the Slovenian economy that makes it vulnerable to enduring external shocks. Notwithstanding the noteworthy reduction in the public debt ratio in recent years, government debt is expected to return to previous highs this year, and long-run debt reduction could be challenged by rising age-related spending. To accompany the current crisis-related costs, unfavourable demographic trends are expected to place structural pressure on public expenditures.

RATING DRIVERS

For the time being, upward ratings action is unlikely. Ratings could be upgraded once the crisis has passed if strong economic performance and prudent fiscal management cause the government’s debt ratio to materially decline. Passage of policy measures that strengthen medium-term growth prospects or address rising age-related spending would also be credit positive.

The ratings could be downgraded if the health and economic crisis proves more durable and causes a deterioration in debt dynamics well beyond current expectations. This could result from significant and lasting economic underperformance, material fiscal deterioration, or substantial realization of contingent liabilities.

RATING RATIONALE

Despite Comparatively Better Control of the Virus, Slovenia’s 2020 Economic Contraction will be Severe

The number of confirmed COVID-19 cases and deaths are significantly lower in Slovenia than in larger European countries. With under 2,500 cases and 129 deaths as of August 21, 2020, Slovenia has registered just over six deaths per 100,000 people. This relatively more favourable result is likely due to lower population density, less cross-border transit, and an early and effective policy response. Urgent measures were implemented in early March 2020 to combat the epidemiological crisis and on May 15, the government adopted an ordinance declaring an end to the epidemic. Case counts since have increased slightly as social restrictions have eased. The reproductive rate remains below one.

The COVID-19 pandemic and the associated lockdown measures will cause a severe economic contraction this year. The Institute of Macroeconomic Analysis and Development (IMAD) expects the economy to contract by 7.6% in 2020, according to its Summer Forecast. Following a first quarter 4.5% quarter-over-quarter contraction, the fall in economic activity will be most pronounced in the second quarter, when strict distancing measures were in place across Europe. The economic contraction is the result of weaker domestic demand from confinement measures, and of lower external demand for Slovenia’s manufactured goods and its business and tourism services. Assuming moderate control of the virus and continued loosening of measures, economic activity should recover in the second half of the year and into 2021, when IMAD expects a 4.5% recovery in GDP.

Years of Budget Consolidation and Debt Reduction Opened Fiscal Space for Slovenia’s Policy Response to the Crisis

Slovenia had been among the fastest euro area countries to repair its large fiscal deficits and reduce its debt-to-GDP ratio. Fiscal consolidation in recent years was significant due to favourable economic conditions, strong revenue growth, and a steady decline in interest expenditure. The fiscal deficit was 5.5% of GDP in 2014. From 2017 to 2019, Slovenia recorded small headline fiscal surpluses and primary surpluses averaging 2.2% of GDP. As a result of this fiscal performance and strong economic growth, the debt ratio was for many years on a firm downward trajectory. The debt-to-GDP ratio declined by 16.5 percentage points from 2015 to 2019, when the ratio reached 66.1%.

However, the COVID-19 crisis reverses that progress this year. Since mid-March, the government has passed three rounds of budgetary support measures to offset the health and economic effects of the crisis. Taken together, the measures amount to EUR 2 billion (4.2% of GDP) of direct spending towards healthcare, the preservation of employment, and protection to vulnerable households. In addition, the government has implemented loan guarantee schemes and mortgage payment deferrals schemes for household and corporate borrowers.

The current crisis further complicates existing medium-term pressures on public finance. The government expects the deficit to widen to around 8% of GDP in 2020 and projects debt to increase in 2020 to 82.4% of GDP. Even absent the current crisis, Slovenia’s weak demographic outlook and the associated increase in age-related costs are expected to weigh on the country’s long-term fiscal performance. Additional progress on healthcare and pension reform are perhaps even more urgent now to support the long-term sustainability of public finances.

Slovenia Started 2020 having Improved Financial Sector Indicators and having Progressed with Privatisations

The completed sales of Nova Ljubljanska Banka (NLB) and Abanka were important achievements. The government relinquished 65% of NLB, Slovenia’s largest bank, following an IPO in late 2018 and another 10% in June 2019. It then completed the sale of Abanka, the third largest bank, in February 2020 to previously privatised bank Nova KBM (NKBM). DBRS Morningstar considers the divestment of these banks to be an important step in the government’s efforts to reduce the historically high direct involvement of the state in the economy and to reduce the government’s exposure to potential calls for capital to support these banks. For further details, see DBRS Morningstar’s commentary “Bank Divestment in Slovenia is an Important Achievement.”

The banking sector worked through its legacy challenges prior to the onset of the COVID-19 crisis. Banking indicators at the start of 2020 showed improved capital and funding positions and an improvement in asset quality. Classified claims more than 90 days in arrears, mostly legacy loans concentrated in the real estate and construction sectors, declined from 18.1% in November 2013 to 1.2% as of June 2020. Notwithstanding the progress, there are key challenges. The longer the current crisis persists, the more pressure will mount on the banking sector. Furthermore, the current environment is less favourable for banks to generate net interest income and there has been persistent risk arising from the real estate market. DBRS Morningstar makes a negative qualitative assessment to account for financial risks in the “Monetary Policy and Financial Stability” building block.

Slovenia’s External Sector has Strengthened Significantly in Recent Years

Slovenia’s healthy external position serves as a savings buffer against the shock to cross-border trade. The current account position shifted from a deficit of 5.3% of GDP in 2008 to a surplus of 6.6% in 2019. Slovenia continued to register external surpluses in the first half of 2020. This progress reflects improved cost competitiveness and the strong pick-up in external demand in recent years, which contributed to a steady rise in trade volumes. The strong external savings position narrowed the net international investment position, which improved to -19.3% of GDP in 2019 from -44.0% in 2012. The improved external accounts helps absorb a shock to trade growth associated with the current crisis. The performance of Slovenia’s external sector will depend in large part on the recovery of key trading partners such as Germany and Italy. Slovenia is integrated into the regional supply chain and manufactures a diverse range of high value-added component parts.

Despite the Political Volatility, Slovenia has Stable Policy-Making Institutions

In January 2020, Marjan Sarec announced his resignation as Prime Minister, after failing to secure parliamentary support for healthcare legislation. The five party coalition government in November 2019 lost the support of the opposition Left Party over disagreements about the 2020 Budget, making it difficult for the government to ensure support for its agenda. Fresh elections were avoided when Janez Jansa formed an unexpected coalition led by his Slovenian Democratic Party. This is the third time Jansa leads a government. With two years until the next scheduled election, there remains uncertainty over the future of the existing coalition government.

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. Strong governance results are reflected by the effective management thus far of the health and economic shock. The main policy challenges facing the next few governments will be how it manages the fiscal and economic consequences of the current crisis and its ageing population.

ESG CONSIDERATIONS

Human Rights and Human Capital (S) were among the key ESG drivers behind this rating action. Slovenia’s per capita GDP is relatively low at $26,000 in 2019 compared with its euro system peers. A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/366028.

EURO AREA RISK CATEGORY: LOW

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

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The principal methodology is the Global Methodology for Rating Sovereign Governments (27 July 2020) https://www.dbrsmorningstar.com/research/364527/global-methodology-for-rating-sovereign-governments

The sources of information used for this rating include the Ministry of Finance (Stability Programme 2020), Bank of Slovenia (Macroeconomic Developments July 2020), Institute of Macroeconomic Analysis and Development (Summer Forecast 2020), European Commission, Statistical Office of the European Communities, Republic of Slovenia Statistical Office, OECD, IMF, World Bank, Bank for International Settlements, UNDP, Haver Analytics. DBRS Morningstar 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.

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

DBRS Morningstar 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 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

For further information on DBRS Morningstar 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.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/366026

Ratings assigned by DBRS Ratings GmbH are subject to EU and U.S. regulations only.

Lead Analyst: Jason Graffam, Vice President, Global Sovereign Ratings
Rating Committee Chair: Nichola James, Managing Director, Co-Head of Sovereign Ratings
Initial Rating Date: November 17, 2017
Last Rating Date: February 21, 2020

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