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Fitch affirms Slovenia at 'A', outlook stable

Author Radomir Ralev
Fitch affirms Slovenia at 'A', outlook stable Source: Slovenian finance ministry

LJUBLJANA (Slovenia), May 23 (SeeNews) - Fitch Ratings said it affirmed Slovenia's long-term foreign-currency Issuer Default Rating (IDR) at 'A' with a stable outlook.

"Slovenia's ratings are supported by high governance and human development indicators, improving external finances, and a credible policy framework anchored by EU and eurozone membership. These strengths are balanced against high public debt relative to 'A' rated peers, the economy's small size, and slow progress in implementing structural reforms to address medium-term fiscal and growth challenges associated with an ageing population," Fitch said in a statement on Friday.

Here is what else Fitch said in the statement:

"Growth Outlook Weakens: We forecast GDP growth to slow to 3.9% in 2022 and 3.1% in 2023 following a solid 8.1% expansion in 2021 that was driven by a recovery across all sectors of the economy. Growth this year will be above the eurozone (3%) but this is partly due to a very strong carry-over (4Q21 qoq growth stood at 5.1%). Private consumption will be affected by higher inflation and only modest wage rises while ongoing supply chain disruptions and weaker external demand will also affect exports and private investment (the latter saw a sharp recovery in 2021). Public investment tied to EU programmes will provide some support over the forecast period, even as capacity constraints are likely to increase to higher labour and input costs.

War in Ukraine Key Downside Risk: Slovenia's direct economic links with Russia and Ukraine are very limited (trade with these two countries is 4% of total) but energy dependency is substantial and represents a key downside risks to both our macro and fiscal baseline. Slovenia is particularly vulnerable to a sudden stop in Russian gas, as it accounts for around 80% of total gas consumption (provided mainly via intermediates in Austria). Although gas only represents around 14% of total energy consumption, it is a key input for some metallurgy, chemical and paper companies that would struggle to find alternatives. Dependency on Russian oil is less of a concern as there are viable alternatives and the country has three-month reserves (unlike gas, which is has no domestic storage capacity), but price issues would be a concern.

Inflation Reaches New Highs: Fitch projects that harmonised inflation (HIPC) will average 7% in 2022, the highest rate in two decades, as a result of high commodity prices feeding through all price categories. The authorities have implemented a series of measures to help deal with higher prices, including capping petrol and electricity prices, that will somewhat offset inflationary pressures. Although inflation expectations have increased across household and corporates, the effect on wages still appears muted, partly due to very modest increases in public wages budgeted thus far. Nevertheless, we think wage demands will accentuate pressure on the new government to hike salaries, while labour shortages will act as catalysts for higher wages in private sector. We expect inflation to moderate to 3.5% in 2023 but with significant upside risks.

Modest Fiscal Consolidation: Following a better-than-expected fiscal deficit of 5.2% of GDP in 2021 (versus budget target of 7.5%), we expect consolidation to slow down significantly in 2022 with a projected deficit of 5% versus 4.1% in the Stability Programme (drafted under a no-policy change scenario). Our forecasts assume further support for households and businesses over the coming quarters, beyond the EUR300 million that has already been approved (with direct budget costs of close to 0.5pp of GDP). In the 2020-2021 pandemic years, Slovenia was very generous in terms of providing fiscal support and we expect this stance to remain in place this year as outperformance last year created some fiscal space and EU fiscal rules have been lifted.

High, But Declining Public Debt: Under our baseline assumption, we expect the budget deficit to fall further to 3.5% of GDP in 2023 as expenditure trends normalise. Combined with solid nominal growth, this will help reduce public debt/GDP to 71.2% in 2023 from 74.7% in 2021. Debt levels remain well above the 'A' peer median of 56.6%, although debt servicing costs are close to the median with interest payments back to 2009 levels in 2021 (at 1.3% of GDP, even though debt levels have doubled). Large cash reserves, at EUR8.4 billion in April (around 18% of GDP), provide financing flexibility in the context of rising yields.

Elections Open Door for Stable Coalition: The victory of the newly established centre-left Freedom Movement (41 out of 90 seats in parliament) in the April elections has increased the probability of a stable coalition in the next legislature. Freedom Movement is finalising a coalition agreement with two leftist parties, with an immediate focus on dealing with the energy crisis. The government needs to fulfil a series of major reforms, including pensions and healthcare in the next two years as part of milestones of the Recovery and Resilience Facility. This will likely test coalition unity. At present there is little clarity on other policy priorities, but we expect broad commitment to fiscal prudence and macro-stability, as well as ongoing EU integration and common response to Ukraine crisis.

Improved External Balance Sheet: Slovenia has posted persistent current account surpluses since 2012 thanks to a resilient export sector and we do not expect major changes in 2022-2023 (even as higher energy costs lead to moderately higher imports). Combined with rising savings in the private sector, this has led to a rapid narrowing of the net external debt position to only 1.7% of GDP by end-2021 from 43.9% in 2012 according to our estimates (and now below the 'A' peer median ratio of 2.7%). The net international investment position has also improved significantly, removing potential vulnerabilities for the small open economy.

Slovenia has an ESG Relevance Score (RS) of '5[+]' for both Political Stability and Rights and for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption, as is the case for all sovereigns. Theses scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. Slovenia has a high WBGI ranking in the 79th percentile, reflecting its track record of stable and peaceful political transitions, well established rights for participation in the political process, high institutional capacity, effective rule of law and a moderate level of corruption.

RATING SENSITIVITIES
Factors that could, individually or collectively, lead to negative rating action/downgrade:

Macro: A large adverse macroeconomic shock, for example due to energy rationing, which would materially lower medium-term growth prospects compared with Fitch's current expectation

-Public Finances: Persistent upward trend in general government debt/GDP as the pandemic recedes, for example due to a more pronounced and longer period of fiscal loosening, and/or a materialisation of contingent liabilities

Factors that could, individually or collectively, lead to positive rating action/upgrade:

-Public Finances: Downward trend in government debt/GDP over the medium term, sufficient to bring the ratio closer to the peer median, for example through a post-coronavirus-shock fiscal consolidation.

-Macro/Structural: Implementation of structural reforms to improve the business environment and lift medium-term growth potential above Fitch's current expectations, and to reduce longer-term public debt sustainability pressures associated with an ageing population.

SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)

Fitch's proprietary SRM assigns Slovenia a score equivalent to a rating of 'A' on the Long-Term Foreign-Currency (LT FC) IDR scale.

Fitch's sovereign rating committee did not adjust the output from the SRM to arrive at the final LT FC IDR

Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.

BEST/WORST CASE RATING SCENARIO

International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG CONSIDERATIONS

Slovenia has an ESG Relevance Score of '5[+]' for Political Stability and Rights as World Bank Governance Indicators have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and a key rating driver with a high weight. As Slovenia has a percentile rank above 50 for the respective Governance Indicator, this has a positive impact on the credit profile.

Slovenia has an ESG Relevance Score of '5[+]' for Rule of Law, Institutional & Regulatory Quality and Control of Corruption as World Bank Governance Indicators have the highest weight in Fitch's SRM and are therefore highly relevant to the rating and are a key rating driver with a high weight. As Slovenia has a percentile rank above 50 for the respective Governance Indicators, this has a positive impact on the credit profile.

Slovenia has an ESG Relevance Score of '4[+]' for Human Rights and Political Freedoms as the Voice and Accountability pillar of the World Bank Governance Indicators is relevant to the rating and a rating driver. As Slovenia has a percentile rank above 50 for the respective Governance Indicator, this has a positive impact on the credit profile.

Slovenia has an ESG Relevance Score of '4[+]' for Creditor Rights as willingness to service and repay debt is relevant to the rating and is a rating driver for Slovenia, as for all sovereigns. As Slovenia has a track record of 20+ years without a restructuring of public debt and captured in our SRM variable, this has a positive impact on the credit profile."

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