June 15 (SeeNews) - S&P Global Ratings said it has affirmed its 'AA-/A-1+' long- and short-term foreign and local currency sovereign credit ratings on Slovenia, with a stable outlook.
"We think that existing fiscal and external buffers, following years of robust growth without the buildup of major macroeconomic imbalances, will allow Slovenia to weather the temporary shock from the COVID-19 pandemic," S&P said in a statement on Friday.
S&P added it expects the Slovenian economy to contract by close to 8% this year, as a result of the pandemic, before recording 5% growth in 2021.
The stable outlook reflects the S&P's expectations that the Covid-19 crisis will have a contained negative impact on Slovenia's economy and public finances in the next two to three years, against a backdrop of strong existing fiscal and external buffers.
The global ratings ratings agency also said:
"Downside scenario
We could lower the ratings if the fallout from the pandemic had a deeper and more protracted impact on public finances, with debt remaining on an upward trend, or if the damage to the economy was more severe and longer-lasting than we currently expect.
Upside scenario
We could raise the ratings on Slovenia if, following the temporary shock, the country's economy were to return to its previous strong trajectory, boosting its GDP per capita without creating imbalances.
Rationale
The growth outlook for the Slovenian, European, and global economies has deteriorated in 2020, mainly due to the COVID-19 pandemic and measures to contain its spread. We think that the past decade of private sector deleveraging and a decline of government debt to GDP since 2015 give Slovenia substantial buffers to weather the temporary shock without a lasting adverse impact on its credit metrics.
At the same time, Slovenia's economic expansion in recent years has been coupled with high current account surpluses, which helped reduce net external debt to 2.5% of GDP in 2019 from over 40% in 2012. Economic growth has been balanced, without emergence of macroeconomic imbalances. Taken together, these factors underpin our view that Slovenia entered into the recession from a much improved starting point compared with previous crises. We also think that the Slovenian government's policy response, along with sizable European Central Bank (ECB) monetary support, will help preserve Slovenia's productive capacity ahead of the recovery, which we project to take off toward the end of 2020.
Our ratings on Slovenia continue to reflect the country's high GDP per capita and its eurozone membership, which affords its small open economy the benefits of the ECB's monetary policy. The current account is set to remain in surplus, while we project government debt will return to its downward path following the surge in 2020 as consolidation ensues from 2021. We also factor into our ratings Slovenia's broadly stable and effective institutional framework.
Institutional and economic profile: The pandemic will hit Slovenia's small, open economy in 2020
We expect the Slovenian economy will contract by 7.8% in 2020 before recovering in 2021.
The new government, in office since March, will focus on limiting the economic repercussions from the COVID-19 pandemic in the near term.
The government's fiscal response will help cushion the pandemic's impact on the labor market and on businesses.
Slovenia's economy will contract sharply by almost 8% in 2020 as measures to contain the spread of COVID-19 have significantly deteriorated the global, European, and Slovenian growth outlook. As a small, open economy, Slovenia is highly exposed to the economic developments of its key trading partners, particularly core eurozone economies such as Germany. Slovenia is tightly integrated into core European supply chains, notably German manufacturing. While Slovenia's export-orientation has supported strong growth in recent years, it means that the supply chain disruption owing to the pandemic will strongly affect the country. However, in the medium- to long-run, with its strong export-oriented manufacturing sector, Slovenia could be well-positioned if the pandemic were to trigger increased nearshoring and simplification of manufacturing supply chains. This remains uncertain at this stage though, and risks to global trade outweigh potential opportunities.
Slovenia was the first EU country to declare the end of the pandemic, in May. While some precautions remain, we think that the reopening of the economy will pave the way for the recovery, and we thus forecast real GDP growth of 5.2% in 2021. Support for the recovery could come from public infrastructure projects, such as the second railway track to the port of Koper or the Karavanke tunnel, not least as EU funds will spur investments.
Slovenia has launched sizable fiscal support measures, and the fiscal response is supported by the ECB's crisis response as well. We currently anticipate that Slovenia's direct discretionary measures amount to about 5% of GDP in 2020. They include wage subsidies for suspended workers, a reduction in electricity prices, tax deferrals, and some exemptions and income support for vulnerable groups. A package from late April provided a guarantee framework for up to €2 billion in loan principal (about 4.5% of GDP), aiming to preserve the liquidity of otherwise solvent businesses. The latest package from end-May focuses on the economic recovery, with subsidies for shorter working time arrangements, tourism vouchers, and liquidity loans.
We think that these measures will help preserve the productive capacity of the economy and dampen the shock to the labor market. However, we still project the unemployment rate will increase to over 7%, from 4.5% in 2019, which was the lowest rate in a decade.
Slovenia's ability to withstand external shocks at the onset of the pandemic was substantially better than it was at the onset of the 2009-2013 financial crisis. Private sector deleveraging over the past decade and declining government debt since 2015 has helped build substantial buffers. The current account has been in a substantial surplus, and is set to decline only moderately. Overall, economic expansion has been balanced and not accompanied by brisk credit expansion. Therefore, growth has not been to the detriment of financial sector stability, and banks' balance-sheet repairs have made steady progress up until early 2020. Slovenia has also been able to preserve cost competitiveness, although wage growth in 2019 was the fastest in a decade. Cost competitiveness has been maintained particularly since import of labor from neighboring countries has contributed most of recent years' employment increase.
A new government took office in March 2020, following the resignation of the previous prime minister. Center-right SDS leads the government coalition with three smaller parties. We think that the near-term focus of the new government will be on the economic recovery, before tackling some of its announced policy initiatives, such as the reduction of red tape. Structural reforms, for example in education, the taxation of labor, long-term care, public administration, or the state-owned enterprise (SOE) sector will be important for raising Slovenia's potential growth. At the same time, we continue to believe that long-entrenched constraints on institutional and corporate governance could slow the pace and effectiveness of the structural reform agenda.
Flexibility and performance profile: Strong fiscal and monetary response to support the recovery, while current account surpluses persist
The general government deficit will widen to nearly 8% of GDP in 2020, pushing net debt to almost 60% of GDP.
Despite rising borrowing needs, the ECB's crisis response, low interest rates, and Slovenia's fiscal buffers will contain debt service costs.
We project that the current account will remain in a sizable surplus over 2020-2023.
We project Slovenia will post a deficit approaching 8% of GDP in 2020, as a result of discretionary fiscal measures in response to the pandemic as well as automatic stabilizers at play. With the expected recovery, we project the deficit will narrow in 2021. The pace of deficit reduction will depend on the speed of the recovery and while we expect consolidation to ensue, we think that fiscal policy will take into account the impact on growth as well. That said, Slovenia has built a credible track record, with general government surpluses in the past two years. This, has afforded Slovenia the space for its policy response, despite still relatively high debt.
We now project net general government debt will increase to 59% of GDP this year, before returning on a declining path. We also note the significantly increased cash buffers in 2020 compared with previous years. In gross terms, general government debt is set to increase to about 80% of GDP this year.
Slovenia's active debt management and accommodative monetary policy have helped reduce the interest burden, and we continue to project interest expenditure will average less than 5% of general government revenue over 2020-2023. As with our treatment of debt of all asset-management companies ("bad banks"), our estimates of Slovenia's gross and net general government debt include obligations related to the Bank Asset Management Co. (BAMC; set up in 2013 following a period of banking sector stress) issued to purchase loans and other distressed assets from participating Slovenian banks at a discount-to-market value. At the same time, our forecast does not incorporate the future proceeds generated by the sale of BAMC assets. To the extent they materialize, we expect they will further contribute to government debt reduction. In line with our approach toward government guarantees extended to the European Financial Stability Facility (EFSF), we exclude these guarantees from the general government debt stock (see "S&P Clarifies Its Approach To Accounting For EFSF Liabilities When Rating The Sovereign Guarantors," published Nov. 2, 2011, on RatingsDirect).
We think that government guarantees in response to the pandemic are set to increase, especially under the newly set-up €2 billion program. State-owned development bank, SID Bank, will play a key role in the management of the guarantee program. But the uptake and ultimate fiscal cost for the government cannot yet be predicted. In recent years we have observed that government guarantees to large government-related entities (GREs) have been declining, which reflects a cautious approach on granting guarantees to large GREs. We also think that the financial standing of large GREs has strengthened in past years owing to the strong macroeconomic environment.
In response to COVID-19, the ECB has pushed back against rate divergence within the Monetary Union by launching the Pandemic Emergency Purchase Programme (PEPP). Under the PEPP, the ECB committed initially to purchase €750 billion (6.5% of eurozone GDP) in government and corporate bonds this year, over and above the €360 billion (3.1% of GDP) in the existing asset purchase programs. This has been increased by €600 billion to a total of €1,350 billion at the June 4 ECB Governing Council meeting. Although the ECB noted that government bond purchases would be linked to the "capital key" of the national central banks, it promised that it would take a flexible approach toward purchases, and that there would be fluctuations away from the capital key in some jurisdictions, depending upon market conditions. In the context of the increase in government borrowing needs, we believe that the planned expansion of the ECB's balance sheet is oriented toward absorbing them at relatively low borrowing costs.
We forecast the current account will remain in a substantial surplus in 2020 since we expect exports and imports will fall in tandem. Over our forecast horizon of 2020-2023, we think that the current account will remain in a surplus of slightly below 6% of GDP on average, while both exports and imports are set to recover. That said, risks to the Slovenian tourism sector remain elevated, due to travel restrictions this year and the potential for changing travel patterns in the future. This could slow recovery of tourism receipts, which accounted for 7% of current account receipts in 2018. Slovenia's high current account surpluses have enabled the Slovenian economy to build sizable buffers, with external balance sheets improving markedly. As mentioned, Slovenia remains exposed to external macroeconomic risks via its exports even after the immediate COVID-19 shock. For example, Slovenia could be affected by protracted economic weakness in Italy, Slovenia's second-most important trading partner after Germany. However, we think that risks through trade or financial sector linkages are relatively contained, due to Slovenia's economic and export diversification.
While we expect Slovenian banks' earnings and asset quality will weaken through end-2020 and into 2021, we believe the Slovenian banking system have sufficient buffers to cope with the more difficult operating conditions, not least due to strong deleveraging and improvements in asset quality in the private sector in recent years. Additionally, we regard banks' capitalization and profitability as solid, and we anticipate that these will provide adequate buffers to absorb higher risk costs and pressures on revenue. We also expect the liquidity stress that originated from the mandatory loan moratorium and increased loan extension will be manageable for Slovenian banks, given their solid liquidity buffers and the central bank's support measures.
Supported by ECB supervision of its large banks, the sector now has similar underwriting and governance practices to most eurozone countries. This will minimize the rise in nonperforming loans and credit losses for banks.
Private sector credit growth picked up only slowly in recent years, but the consumer loans segment had been increasing quickly. This led the central bank to impose measures such as limiting the maximum maturity and debt service-to-income ratio, which were eased in response to the pandemic. That said, we think that credit has not been fueling recent years' rise in real estate prices in parts of the country. We expect that inflation will slow to 0.7% in 2020 before slightly accelerating to levels above the eurozone average again in 2021-2023."