Home Ratings and Research Currently valid ACRA Europe affirms unsolicited credit ratings of A+ to Slovakia, outlook Stable
ACRA Europe affirms unsolicited credit ratings of A+ to Slovakia, outlook Stable
Friday, 13 March 2020

The Slovak Republic (hereinafter, Slovakia, or the country) has been assigned the following ratings:

  • Long-term foreign currency credit rating at A+ and local currency credit rating at A+;
  • Short-term foreign currency credit rating at S1 and local currency credit rating at S1.

The outlook on the long-term foreign currency credit rating is Stable and local currency credit rating is Stable.

The Stable outlook assumes that the rating will most likely stay unchanged within the 12 to 18-month horizon.


Credit rating rationale

Positive rating assessment factors

· Stable economic development.

· Declining interest expenditures, long maturity structure of outstanding public debt.

· Very low foreign currency share of public and private external debt.

· The European Central Bank’s public debt backstop.

· The euro’s reserve currency status.

Negative rating assessment factors

· Moderate debt load mostly held by non-residents.

· Low innovative capacity, high dependency on automotive exports.

· Deteriorating current account balance, high external debt.

· Weak institutional quality by EU standards.

Stable outlook

· The stable outlook assumes that the rating will most likely stay unchanged within the 12 to 18-month horizon.

Potential rating upgrade factors

· Substantial decline in public debt load.

· Increase in domestic holding of public and private debt.

· Material improvement in governance.

Potential rating downgrade factors

· Substantial increase in public debt load.

· Material deterioration in governance.

· Severe risk of Eurozone breakup.



Sovereign model results  

Block

Indicative credit rating for the block

Modifier

Score

Modifier corrections to the indicative credit rating

Final credit rating for the block

Macroeconomic position

AAA

Potential economic growth

-1

-1

AA+

Sustainability of economic growth

-1

Efficacy of structural, economic and monetary policies

0

Public finance

A-

Contingent liabilities and risk of them materializing on the sovereign balance sheet

0

+1

A

Fiscal policy framework and fiscal flexibility

0

Market access and sources of funding

+1

Debt sustainability

0

External position

AA-

Balance of payment vulnerabilities

0

+1

AA

External debt sustainability

+1

Stability of currency regime

0

Institutional framework

A

Willingness to pay

0

0

A

History of defaults

0

Political instability and recent political decisions

0

Involvement in geopolitical conflicts, exposure to geopolitical risks

0



Assigned credit rating

Indicative credit rating

A+

Modifier corrections to the indicative credit rating

0

Final credit rating

A+

Assigned credit rating

A+



MACROECONOMIC SITUATION AND ECONOMIC POTENTIAL


The structure of the Slovak economy makes it more susceptible to the global economic cycle.

The Slovak Republic is an advanced economy with a GDP per capita (by PPP) of more than 36,000 international dollars (IMF, 2019 estimate). It is a member of the European Union, Eurozone, OECD, Schengen Area, and NATO. The economy is among the most open (185% of GDP in 2019) and most manufacturing-oriented (gross value added in manufacturing stood at 19% of GDP in 2019) in the EU, and is highly dependent on the automotive industry (14.3% of total output in 2018). This structure makes the economy more susceptible to the global economic cycle.

Since the global financial crisis, Slovakia has enjoyed solid and fairly stable economic growth accompanied by low inflation and, in recent years, the country has also experienced strong job creation. However, recent developments have exposed the weaknesses of the export-based growth model with a strong concentration on a single industry. With the weakening external environment, GDP growth has declined from 4.0% in 2018 to 2.3% in 2019, mainly due to the strongly negative contribution of net exports. The slowdown is higher compared to Slovakia’s regional peers, which have somewhat less open and more diversified economies.

Figure 1. Comparison of 2018 and 2019 GDP growth rates for Slovakia and peers

f1

Source: Eurostat, ACRA Europe

The short-term economic outlook remains uncertain as the gradual recovery from the global manufacturing recession (indicated by soft data) is being hampered by the spread of the coronavirus disease (COVID-19). At the same time, risks arising from global trade tensions have not gone away. Major institutions forecast the country’s GDP to grow slightly above 2% in 2020, fueled mainly by household consumption. However, as noted before, this figure is subject to significant uncertainty and is very likely to be lower.

The long-term growth outlook is constrained by a relatively low innovative capacity and negative demographic trends.

From a long-term perspective, the growth potential is constrained by weak innovative capacity compared to peers and negative demographics. In 2016–2018, the share of R&D expenditures as a proportion of GDP stood at 0.84%, the worst among the Visegrád Group  (V4) countries (Poland, the Czech Republic, Hungary,  and Slovakia). Similarly, Slovakia scored the worst in the 2018 PISA testing out of its regional peers. Looking at the demographic trends, the working age population is expected to decline by 11% by 2040 under Eurostat’s baseline scenario, constraining the capacity of the economy to grow on the basis of labor input.

PUBLIC FINANCE

Interest expenditures declined to the lowest level ever.

Risks to fiscal sustainability in the medium term are low. The general government consolidated debt to GDP ratio has been declining since having reached its peak at 54.7% in 2013, and is projected to decline to around 48% at the end of 2019. At the same time, interest expenditures are declining sharply on the back of the ECB’s low interest rate environment. In 2019, their share in GDP is expected to reach 1.2% of GDP, the lowest ever. The average residual maturity of government debt stood at a comfortable 8.6 years as of January 2020, by far the longest in the V4 group.

Government debt is mostly long-term and local currency denominated.

The share of debt held by non-residents stood at 57.5% at the end of 2018. While this figure is high by global standards, Eurozone countries tend to have a higher share of external government debt due to the almost non-existent currency risk within the monetary union. Moreover, the government’s external debt is almost exclusively denominated in euros (95%), implying a very low susceptibility to FX risks. Last but not at least, Slovak government debt is subject to the ECB’s conditional government bond backstop via the Outright Monetary Transactions program introduced at the peak of the debt crisis in 2012, which provides an additional buffer against loss of market confidence.

Nonetheless, recently adopted measures, which were largely motivated by governing parties’ efforts to gain popularity prior to the elections, are very likely to increase public deficits and decrease the long-term sustainability of public finances if adequate counterbalancing measures are not provided for them. These include, inter alia, increasing parental benefit payments, increasing the level of non-taxable income, VAT reductions for certain foodstuffs, and, most notably, changes to the pension system:

  • Capping the pension age at 64 years. The pension age was indexed to Slovakia’s life expectancy in the previous system;
  • Setting the minimum pension at 33% of the average wage of the two preceding years, along with relaxing the requirements for granting the minimum pension;
  • Introducing a 13th monthly pension (equal to the average monthly pension payment), which will replace the more modest “Christmas pension”.

Deficit is very likely to increase substantially in 2020.

As a result, the Council for Budget Responsibility expects the deficit to increase from 1.1% of GDP to as high as 1.4% in 2019, and to 2.4% in 2020, should the new government fail to enact counterbalancing measures. It is noteworthy that the adopted 2020 budget envisaged a deficit of 0.5% of GDP as required by the EU’s Fiscal Compact rules. This exposes the weakness of the fiscal framework with respect to adherence to the adopted budget and the balanced budget rule (which calls for either structural deficits of no higher than 0.5% of a country’s GDP or establishing an appropriate path to achieve this objective) resulting from inadequate sanction and correctional mechanisms.

At the same time, the debt rule, which is embedded in Slovakia’s constitution and far more important for the sustainability of public finances than the budget-balancing rule, has much stronger sanction mechanisms. These will be tested in the coming years as the sanctions range is gradually declining by one percentage point per year, from 50–60% of GDP in 2017 to 40–50% in 2027. For 2020, the lower bound of the sanctions range stands at 47% of GDP. Under a no-policy-change scenario, ACRA Europe expects the debt to GDP ratio to increase slightly in 2020 to 48.5–49% of GDP (with risks tilted to the upside as restrictions due to the COVID-19 outbreak might have a strong negative impact on the GDP and tax collection). In this case, the Ministry of Finance would be obliged to propose debt-reduction measures.

Fiscal flexibility has decreased due to recently adopted measures.

Aside from the debt rule, recent measures along with a sharp increase in public sector wages (10% in both 2019 and 2020) have also weighed on budget flexibility. The share of wages, social expenditures and interest payments in the general government revenue are expected to increase from 70.8% in 2018 to above 75% in 2020, one of the highest among the EU countries and by far the highest among the V4 countries.

Figure 2. Share of compensation of employees, interest expenditures and social expenditures on total revenue for EU countries (including 2020 forecasts for Slovakia)

f2

Sources: Eurostat, Council for Budget Responsibility, ACRA Europe, 2018

The sustainability of the pension system has declined following the recently imposed cap on the retirement age.

The aforementioned amendments to the pension system have decreased the long-term sustainability of public finances. According to the European Commission, pension expenditures in proportion to GDP should increase from 8.6% in 2016 to 13.8% in 2070, instead of 9.8% prior to the changes in the pension system. This figure is likely to increase after the next update, as it does not include the loosening of the conditions for granting the minimum pension and the introduction of the 13th monthly pension, which were adopted only recently.

EXTERNAL RISKS

The current account deficit is driven by dividend outflows.

Slovakia’s external position is solid. As a Eurozone member, the country uses the euro, a reserve currency with relatively low volatility. The current account deficit has widened from 2.6% of GDP to 2.9% in 2019, mainly on the back of the deteriorating trade balance. Nevertheless, the trade balance remains in a mild surplus (0.3% of GDP), while the current account balance is being dragged into negative territory by the negative income balance (dividends, reinvested profits) resulting from the economy’s FDI-heavy growth model, a situation similar to the one faced by other EU CEE countries. Current account deficits are predominately financed by FDIs and capital account surpluses (mainly EU funds), which are considered to be more stable sources of funding than portfolio investments and other investments.

External debt in proportion to GDP has stabilized in recent quarters; in Q3 2019 it stood at 113% of GDP. Although high by global standards, its structure is sound. Only 11% of external debt is denominated in foreign currencies (assuming the external debt unallocated by currency has the same currency composition as the allocated part). Moreover, most external debt can be attributed to stable sectors — government, central bank, and intercompany borrowings. Only 22% of external debt is attributed to the banking and private non-financial sectors, which are more prone to refinancing risk.

INSTITUTIONAL FACTORS

Governance indicators, which are at above-average levels on the global scale, have declined slightly since their peak in the mid-2000s. On the other hand, institutional quality falls behind the EU average with the Rule of Law and Control of Corruption categories being the main laggards. This is also demonstrated by the second-lowest perceived independence of courts and judges among the general public in the EU, according to the 2019 EU Justice Scoreboard.

Governance indicators are low by EU standards.

Parliamentary elections held at the end of February have brought a change in the country’s leadership. The anti-corruption, populist, big tent movement (with a predominately conservative focus) Ordinary People and Independent Personalities (OĽANO) won 53 of the 150 seats in the National Council. At the current stage of the talks, the most likely scenario is a big coalition of four parties with a constitutional majority (95 seats), OĽANO, the conservative populist movement We Are Family (17 seats) and two center-right parties: Freedom and Solidarity (13) and For the People (12). The Direction – Social Democracy party (38 seats), which held the prime minister’s seat for 12 of the past 14 years, will be in opposition.

This coalition’s comfortable majority would increase the odds of the new government completing its term, considering the loose structure of OĽANO and its history of MPs frequently leaving the parliamentary group. The most likely priorities of the future coalition government are reforming the justice and public prosecution system, improving the business environment, improving the healthcare and education systems, and increasing public investment. On the international front, ACRA Europe expects the new government to be moderately pro-European, except on the issues of illegal migration.

The new government will be focused on justice and prosecution reforms.

Success in improving the institutional quality, which is by no means guaranteed, would be a credit positive factor. Conversely, one of the potential governing parties is proposing massive public investments outside the general government budget (public-private partnership projects; carving out certain public entities from the general government and using them as investment vehicles in the unlikely event that the European Commission would permit such an action). Pursuing such policies would lead to an increase in contingent liabilities and, thus, be credit negative.

For a more detailed assessment of the creditworthiness of the Slovak Republic, see our autumn report.

Appendix 1. Comparative analysis of Slovakia and the sample group

Comparison of macroeconomic and institutional indicators

 

Slovakia

Czech Rep.

Poland

Hungary

Slovenia

Period

Macroeconomics

GDP per capita (1,000 USD, PPP)

36.6

38.8

33.9

34.0

38.4

2019 E

Real GDP growth (% y-o-y)

2.3

2.4

4.1

4.9

2.4

2019

HICP inflation (% y-o-y average)

2.8

2.6

2.1

3.4

1.7

2019

Openness of economy (% of GDP)

185

145

107

163

160

2018

Unemployment

5.7

2.0

2.9

3.5

4.6

2019 Q4

Public finance

Consolidated government debt (% of GDP)

48.4

32.0

47.4

68.2

68.1

2019 Q3

External consolidated government debt (% of GDP)

28.3

13.0

24.3

25.3

43.9

2018

Consolidated government budget balance (% of GDP)

-1.1

1.1

-0.2

-2.3

0.8

2018

Interest payments (% of GDP)

1.3

0.8

1.4

2.4

2.0

2018

External position

Current account (% of GDP)

-2.9

-0.1

1.1

-0.3

6.5

2019

Net international investment position (% of GDP)

-65.7

-18.6

-51.5

-49.2

-17.9

2019 Q3

External debt position (% of GDP)

113.4

79.2

60.3

96.5

94.2

2019 Q3

Short-term external debt to total external debt (%) *

39.2

45.6

15.0

10.7

24.0

2019 Q3

Export diversification index **

0.48

0.43

0.40

0.41

0.46

2018

Institutional framework ***

Political stability and absence of violence

0.75

1.04

0.55

0.76

0.91

2018

Government effectiveness

0.71

0.92

0.66

0.49

1.13

2018

Rule of law

0.53

1.05

0.43

0.56

1.06

2018

* At original maturity, excluding direct investments.

** Indicates the extent of differences between the country’s trade structure and the average world indicator and ranges approximately from 0 (weak differences) to 1 (strong differences).

*** Assessment of effectiveness ranges from approximately -2.5 (weak) to 2.5 (strong).

Sources: Eurostat, ECB, IMF, World Bank, UNCTAD

Appendix 2. List of material data sources

International Monetary Fund

World Bank

Eurostat

The Bank for International Settlements

European Central Bank

European Commission

Organisation for Economic Co-operation and Development

National Bank of Slovakia

Statistics Office of the Slovak Republic

Council for Budget Responsibility of the Slovak Republic


Appendix 3. Key indicators

Balance of payments, EUR bln

 

2015

2016

2017

2018

2019

Balance of goods

0.80

1.25

0.60

-0.22

-0.73

Exports

64.6

66.7

70.5

75.7

78.1

Imports

63.8

65.4

69.9

75.9

78.8

Balance of services

0.13

0.38

0.88

0.92

1.02

Exports

7.3

8.4

9.3

10.2

10.7

Imports

7.2

8.0

8.5

9.3

9.7

Balance of income

-2.59

-3.86

-3.10

-3.08

-3.06

Income receivable

4.5

3.2

4.0

4.3

4.5

Income payable

7.1

7.1

7.1

7.4

7.5

Current account 

-1.67

-2.22

-1.62

-2.37

-2.77

Current account, % of GDP 

-2.1

-2.7

-1.9

-2.6

-2.9

International reserves at the end of the period

2.64

2.74

3.02

4.57

6.76

Sources: NBS, Eurostat, ECB

 

External position (assets and liabilities), EUR bln

 

2015

2016

2017

2018

2019 Q3

External debt

67.4

74.9

91.5

101.9

105.5

long-term

45.8

45.7

49.6

50.7

55.4

short-term (up to 1 year)*

21.6

29.2

41.9

51.2

50.1

External liabilities

67.4

74.9

94.2

101.9

105.5

Sovereign issuer, including

36.0

39.0

52.8

61.0

63.5

monetary authorities

9.6

12.3

25.4

33.3

33.1

consolidated government

26.4

26.7

27.4

27.7

30.4

Banks

6.6

8.0

9.0

9.6

10.4

Other sectors

24.8

27.9

29.7

31.3

31.6

including intra-corporate loans

14.1

17.3

17.8

19.1

18.9

External assets, excluding shares

44.6

51.7

64.5

72.0

75.0

Sovereign issuer, including

15.3

16.6

29.0

36.1

37.5

international reserves

2.6

2.7

3.0

4.6

6.6

other external assets

12.7

13.8

25.9

31.5

31.0

Banks

9.7

9.4

10.5

10.2

10.3

Other sectors

19.6

25.8

25.0

25.7

27.1

Net debt

22.8

23.2

27.0

29.9

30.5

Sovereign issuer

20.6

22.4

23.9

24.9

26.0

Banks

-3.1

-1.4

-1.5

-0.6

0.1

Other sectors

5.2

2.2

4.7

5.6

4.5

International investment position (net),% of GDP

-63.9

-66.8

-68.3

-68.1

-65.7

External debt, % of GDP

84.5

92.4

108.2

113.6

113.4

* At original maturity.

Sources: ECB, Eurostat

Budget indicators, % of GDP

Consolidated government

2015

2016

2017

2018

Income

43.1

40.2

40.6

40.8

Expenses

45.8

42.7

41.5

41.8

including debt servicing expenses

1.8

1.7

1.4

1.3

Primary budget balance

-0.9

-0.8

0.5

0.3

Overall budget balance

-2.7

-2.5

-1.0

-1.1

Consolidated government debt

51.9

52.0

51.3

49.4

% of income

120.4

129.4

126.5

121.2

Central government

 

 

 

 

Income

27.4

24.3

24.3

24.7

Expenses

30.1

27.1

25.6

26.0

including debt servicing expenses

1.7

1.7

1.4

1.3

Primary budget balance

-0.9

-1.1

0.1

0.1

Overall budget balance

-2.6

-2.8

-1.3

-1.3

Central government debt

51.9

51.9

51.3

49.5

% of income

189.4

213.6

211.0

200.5

Note: nominal GDP, EUR bln

79.8

81.0

84.5

89.7

Sources: Eurostat, ACRA Europe

Rating history

The rating was first released for distribution on October 5, 2018 with last review on October 4, 2019.

Regulatory disclosure

The sovereign credit ratings have been assigned to Slovakia under the international scale based on the Methodology to assess Sovereign entities. An explanation of the importance of each rating category and a default definition is included in the ACRA Europe website. Information on the rate of historical failure is available at www.cerep.esma.europa.eu. The default rate means a percentage of ratings that were changed to default from the overall number of ratings, for each rating category and given period. The disclosure of the unsolicited rating and outlook was preceded by the approval of the Rating Committee. Since July 30, 2012, ACRA Europe has been a registered credit rating agency according to Regulation (EC) No 1060/2009 of the European Parliament and of the Council of September 16, 2009, on credit rating agencies.

The sovereign credit ratings and their outlook are expected to be revised within 6 months following the publication date of this press release as per the Calendar of planned sovereign credit rating revisions and publications.

The credit rating was issued as unsolicited. The rated entity did not participate in the credit rating assignment. ACRA Europe did not have access to the rated entity’s internal documents or management. ACRA Europe, in the context of routine care, verified all sources entering the rating process and considers the scope and quality of the information entering the analytical process to be sufficient to assign a credit rating. The rated entity was notified on March 11, 2020, and after the notification there were no changes or amendments in the rating.

ACRA Europe provided no additional services to the Slovak government. No conflicts of interest were discovered in the course of the sovereign credit rating assignment.

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