S&P raises Slovenia's ratings to 'A+/A-1' on improving debt dynamics

S&P raises Slovenia's ratings to 'A+/A-1' on improving debt dynamics Credit Rating by NY (http://nyphotographic.com), Licenced under Creative Commons 3 - CC BY-SA 3.0

LJUBLJANA (Slovenia), June 19 (SeeNews) - Standard & Poor's Global Ratings said it has raised its long-term foreign and local currency sovereign credit ratings on Slovenia to 'A+' from 'A', on improved debt dynamics, with a stable outlook.

S&P has also affirmed its 'A-1' short-term sovereign credit ratings, it said in a statement late on Friday.

"Strong domestic demand and sound export growth underpin Slovenia's economic expansion and the recovery of its financial sector, which we believe will gradually improve credit conditions and support further investment and growth", the rating agency explained.

S&P also said:

"The upgrade reflects our expectation that net general government debt will fall below 60% by the end of 2018. This is based on our assumption that the Slovenian economy will continue on its robust growth trajectory in 2017 and following years, as domestic demand continues to soar with rising employment lifting disposable incomes and investments picking up. At the same time, export growth remains sturdy, due to buoyant demand from European trading partners. Slovenia benefits from its integration into the eurozone's core supply chains in a number of key industries, such as automotive, pharmaceuticals, and electrical equipment. Slovenia's bright economic outlook and labor market conditions support the recovery of its financial sector, as nonperforming loans continue to decline and appetite for lending in the economy returns. Despite the European Central Bank's (ECB's) expansionary monetary policy, credit growth remains timid in Slovenia. We anticipate credit conditions to gradually normalize and overall domestic credit to return to positive growth rates in 2017. We consider further sustained positive credit growth, in particular in the corporate sector where production capacity is enhanced, as positive to Slovenia's long-term growth outlook.

The government has succeeded in putting debt in relation to GDP--and interest costs--on a firm downward trend. Other vulnerabilities regarding the government's debt burden, for example regarding the interconnectedness with the banking sector, are also reducing. Despite the sizable fiscal consolidation in recent years, some uncertainties remain regarding the extent of further fiscal adjustment in 2017-2020, not least as Slovenia's 2018 parliamentary elections are approaching.

That said, any further progress on privatization could also be delayed as political momentum fades, which would hinder a further reduction of the state's prominent role in the economy. Contingent liabilities posed by large government-related entities remain significant, but we believe the likelihood of such risks materializing is mitigated by strong overall economic conditions.

Slovenia continued its strong growth in first-quarter 2017, with GDP expanding by more than 5% in real terms year on year. Accordingly, we revised upward our growth projections for 2017 and 2018 to 3.7% and 3.4%, respectively. This is driven by rising private consumption, due to sound employment growth and higher incomes. We also expect continued growth in investments to result in capacity expansion in Slovenia's export-oriented industry. We also believe that construction activity is recovering, no longer creating a drag on economic growth.

We believe that, in the current expansion phase, wage growth is picking up from subdued post-crisis levels. Nonetheless, external competitiveness, for example in terms of unit labor costs or export market shares, is improving. In that vein, we project that Slovenia will continue to post sizable current account surpluses, albeit narrowing to a still-high 5.5% of GDP by 2020 from 6.8% in 2016 on the back of domestic demand-driven imports. The sizable current account surpluses and reduced external leverage highlight the much lower external vulnerabilities compared with the pre-2009 expansion phase.

On aggregate, loans to the nonfinancial sector, including both household and corporate sectors, have been increasing by 3% in annual terms as of March 2017. However, growth has been mostly in the household sector, especially related to consumer loans, while lending to the corporate sector remains still fragile and subdued, and we believe it will only turn slightly positive in 2017. We believe that firms will continue to use alternative resources other than bank funding to finance investments, for example own reserves, intercompany loans, or debt issuance in eurozone capital markets. At the same time, household credit was up by 6.5% year on year in March and is set to increase further in the current economic environment. We still view the monetary and credit transmission mechanism to the real economy in Slovenia as hampered in the aftermath of the banking crisis, despite the ECB's expansionary monetary stance. However, we expect banking sector activities and monetary conditions will normalize further in 2017-2018.

In that vein, we anticipate that the ratio of nonperforming claims of 5.3% (as of February 2017) will further decline, given the economic growth and further restructuring efforts, especially in the small and midsize enterprises sector. Inflation is set to rise to 1.5% in 2017, following deflation of 0.2% in 2016.

We believe that the authorities will drive the general government deficit to below 1% of GDP in 2017. The economic recovery, increasing tax collection and social security contributions, and interest expenditure savings following recent debt-management operations awarded the government some fiscal leeway to digest this year's public-sector wage rises while keeping within the existing expenditure ceilings. However, looking at 2018 and beyond, we think that the political appetite for further fiscal consolidation could decrease and be complicated by difficult negotiations with trade unions, for example on reversing past years' consolidation measures. Therefore, we expect that the general government deficit will remain at around 1% on average in 2017-2020, in contrast to the government's forecast of a slight surplus by 2019. We note that lawmakers have adopted a fiscal rule that establishes limits for general government expenditures, aiming to achieve a structurally balanced budget in the medium term, but the effectiveness is yet to be tested.

We expect that contained budget deficits and strong nominal GDP growth will contribute to decreasing net general government debt to below 60% of GDP by end-2018 from 62% in 2016. 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 Company (BAMC) issued to purchase loans, and other distressed assets from participating Slovenian banks at a discount to market value. At the same time, we exclude from the general government debt stock the guarantees related to the European Financial Stability Facility (EFSF; see " S&P Clarifies Its Approach To Accounting For EFSF Liabilities When Rating The Sovereign Guarantors," published Nov. 2, 2011, on RatingsDirect). We forecast the ratio of general government interest expenditures to general government revenues will be about 6% in 2017, down from over 7% in 2016, before declining further thanks to locking in the favorable borrowing conditions, supported by the ECB's Public Sector Purchase Programme, which is currently scheduled to run until end-2017.

In our forecast, we currently do not incorporate any future proceeds from the ongoing privatization process (for example, of the largest state-owned bank Nova Ljubljanska Banka [NLB] and the telecommunication company Telekom Slovenije) or sale of assets from BAMC, which took over nonperforming claims totaling €5 billion (about 12% of 2016 GDP) from the banking sector. If these sales revenues were applied to government debt reduction, net general government debt relative to GDP could decline at an even faster pace than we currently anticipate.

We believe Slovenia's banking performance will increase only moderately over the next two years, mainly because of thinner interest margins. According to Bank of Slovenia data, the total capital ratio (on a consolidated basis) was 19% in December 2016, above the EU average of 15%. We believe that the regulatory framework has materially strengthened, driven by the transfer of the supervisory functions to the ECB for the largest part of the banking system, as the Single Supervisory Mechanism now oversees 75% of the system's assets. Market confidence in local banks remains hampered, though, in our view, since these banks still have to demonstrate success and sustainability under the new setup after restructuring in recent years. The repayment of substantial external liabilities and loan deleveraging, together with growth of customer deposits, has led to improvements in banks' funding positions, which we expect to persist.

We think that political posturing will increase as the parliamentary elections will take place at the latest by mid-2018. That could mean that progress on planned structural reforms, for example in the health care system, could stall and fiscal consolidation could become less of a priority. Political disagreements could also interfere in planned privatizations, as shown in recent discussions on the privatization of the country's largest lender NLB. We believe addressing these long term structural issues is important to ensure sustainable growth and continued debt reduction. However, given the continued fragmentation in the political landscape and different political viewpoints, we think that the reduction of the state's role in the economy could continue to be delayed until the next election or even later.

We think that long-entrenched political patronage and only slowly improving institutional and corporate governance could hamper the pace and effectiveness of growth-enhancing structural reforms, including in judicial and administrative areas, due to the vested interests of incumbents in these sectors. This could potentially slow the economic restructuring under way and prevent a more efficient allocation of resources in the economy, with negative implications for future economic growth prospects.


The stable outlook on Slovenia balances the upside potential from further reduction of debt and contingent liabilities against structural reform complacency, risk of fiscal slippage, and reemerging external imbalances.

We could raise the ratings if structural reforms were implemented to support sustainable economic growth and fiscal improvement, resulting from a consistent reduction in government debt. Moreover, if progress on privatization were to reduce the government's role in the economy significantly, containing contingent liabilities and further contributing to public debt reduction, we could also raise the ratings.

Conversely, we could lower the ratings on Slovenia if we observed that the current surge in growth and rising imports led to persistent current account deficits that increased the country's external imbalances, or if external competitiveness was undermined by rising labor costs. A material slippage in Slovenia's budgetary trajectory and a significant rise of net general government debt could also put negative pressure on the ratings."

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