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      FRIDAY, 15/11/2019 - Scope Ratings GmbH
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      Scope affirms Slovakia’s credit rating of A+, Outlook remains Stable

      Euro area membership, favourable economic performance and moderate public debt support the rating. External vulnerabilities, political and demographic headwinds, and rising household debt pose challenges.

      For the rating action annex, click here.

      Scope Ratings has today affirmed Slovakia's A+ long-term issuer and senior unsecured local- and foreign-currency ratings, along with its short-term issuer rating of S-1+ in both local and foreign currency. All Outlooks are Stable.

      Rating drivers

      Slovakia’s A+ rating is underpinned by the country’s euro area membership, continued favourable economic performance, and moderate levels of public debt. However, vulnerabilities to external shocks, unfavourable demographic trends, rising household indebtedness and political headwinds remain credit weaknesses. The Stable Outlook reflects Scope’s assessment that risks to Slovakia’s ratings over the next 12-18 months are broadly balanced.

      First, the A+ rating is supported by Slovakia’s membership within the European Union’s large common market, a strong reserve currency in the euro, an independent European Central Bank (ECB) effectively acting as a lender of last resort, and a robust economic and macroprudential governance framework that supports credible macroeconomic policies.

      Next, Slovakia’s A+ rating is anchored by the nation’s strong macroeconomic fundamentals with real growth averaging 3.5% during 2015-18, benefitting from large investments into its automotive industry, including recently the launch of Jaguar Land Rover’s new plant in Slovakia. This has led to steady improvements in labour market outcomes, with the unemployment rate falling to an all-time low of 5.7% in Q2 2019. Looking ahead, growth is projected to moderate to around 2.7% both in 2019 and 2020 owing to weaker demand from the rest of the euro area. Downside risks to Slovakia’s growth outlook stem from regional growth deceleration, including in Germany, as well as from ongoing trade conflicts, including the risk of potential US tariffs on EU car imports.

      Scope expects domestic demand to become the main contributor to economic growth, driven by favourable labour market conditions, public sector wage growth and public investments supported by high EU fund absorption. Regarding the EU’s 2021-27 multi-annual financial framework, the European Commission (EC) is proposing to reduce Slovakia’s EU fund allocation by almost 20% compared to that over 2014-20. This proposal accounts for the UK’s planned EU exit, Slovakia’s ongoing per capita income convergence with EU averages and proposed new criteria for EU fund allocations. Scope expects the EC’s proposal to be amended in upcoming negotiations between the European Council and the European Parliament, which could result in a meaningful change in expected fund allocations to Slovakia.

      Slovakia’s A+ rating accounts for the country’s sound fiscal position with a moderate debt burden, supported by favourable financing conditions and credible constitutional budgetary rules and debt constraints foreseeing corrective measures should a certain debt threshold be exceeded. The debt-to-GDP ratio declined gradually from 51.9% in 2015 to 48.4% as of Q2 2019, well below the EU’s reference value of 60%. Scope expects debt to decrease further to 46.9% of GDP by 2021, supported by moderate economic growth and decreasing interest payments. The government is also planning the introduction of expenditure ceilings to support fiscal discipline whilst maintaining consistency with both national debt rules and the EU’s Stability and Growth Pact.

      Scope views positively the government’s measures to improve tax collection, including through electronic taxpayer services, supporting budgetary revenues (according to the 2019 Stability Programme, around 20% of the increase in tax revenues in 2018 owed to better tax collection). Thus far, the strong labour market and improved tax compliance have supported revenue growth, enabling increases in public sector wages and social transfers. Moreover, Slovakia’s debt servicing costs are declining, with interest payments to fall to a projected 1.2% of GDP in 2019 from 1.8% as of 2015, increasing the extent of fiscal space.

      Scope is mindful of rising risks to Slovakia’s fiscal consolidation. Slovakia’s headline fiscal balance, after a slight improvement to -0.9% of GDP in 2019, is expected to slightly deteriorate to -1.2% in 2020, due to moderating economic growth and planned tax relief measures in 2020 for small firms and individuals, partly in the context of upcoming parliamentary elections. Overall consolidation efforts by the government have slowed since the implementation of past reforms to health and social spending, with the structural balance projected to remain at around -1.7% of GDP through 2021. As a result, the European Commission expects deviations in both 2020 and 2021 in Slovakia’s adjustment towards its medium-term budgetary objectives, which for Slovakia will change from targeting a structural deficit of 0.5% of GDP as of 2019 to targeting a 1% deficit over 2020-22, consistent with Stability and Growth Pact rules.

      Despite these credit strengths, Slovakia faces several medium- to long-term challenges. As a small, open economy that is specialised in the automotive industry, Slovakia is reliant on external demand and vulnerable to external shocks. Slovakia’s exposure to international value chains is one of the highest in the EU, with foreign inputs and domestically produced inputs used in third countries’ exports amounting to around 64% of Slovakia’s total exports. Furthermore, around 40% of Slovakia’s industrial exports are sourced in the car industry, which makes the economy vulnerable over the longer term to structural changes taking place in the sector, including rising demand for electric automobiles, the strong cost-competitiveness of other eastern European car manufacturers and the automation of jobs in the industry. Scope expects these risks in the near term to be partially mitigated by the flexibility and comparative advantages of Slovak car producers. Furthermore, around 42% of Slovakia’s total external liabilities relate to inward foreign direct investment, which curbs the risk that capital inflows reverse in times of market distress and enhances the long-term sustainability of Slovakia’s external position.

      Additional challenges remain due to unfavourable demographics that weigh on public finances, compounded by the government’s decision in 2019 to cap the retirement age at 64. The old-age dependency ratio is projected by the European Commission to increase from 21% in 2016 to 32.9% by 2030 – one of the highest such projected increases among EU countries – driven by population ageing. The level of the ratio, however, would remain the fourth lowest in the EU by 2030. Additionally, the continued tightening of the labour market is pushing wage growth above productivity growth, potentially damaging the price competitiveness of domestic exporting producers. In this context, Scope views positively the government’s recent initiatives to further improve labour market flexibility, including easing the hiring process for foreign workers, improving female employment rates and integrating better disadvantaged groups.

      Slovakia’s banking sector remains well capitalised, with a system-wide tier 1 capital ratio of 17% of risk-weighted assets as of Q2 2019. The non-performing-loan ratio fell to 2.9% of total loans as of the same quarter, down from 3.4% in Q2 2018. However, the ratio of household debt to disposable income grew to 77.4% in Q2 2019, amounting to around a 10 percentage point increase since Q2 2016, driven by mortgage lending. This, alongside rising housing prices, which averaged 8% YoY growth over the first three quarters of 2019, has made households and banks more vulnerable to economic downturns. In response, Slovakia’s central bank introduced macroprudential policy measures to tighten credit standards, including raising the countercyclical capital buffer rate for banks and revising loan-to-value limits on mortgage loans. Going forward, Scope expects favourable labour market conditions to continue to support disposable incomes of households.

      The coalition government in Slovakia, in place since 2016, has seen instability caused by intra-coalition disputes and the loss of its parliamentary majority in September 2019. The government has also made limited progress in improving governance standards, as reflected in Slovakia’s deteriorating World Bank Worldwide Governance Indicators since 2016. Administrative and regulatory barriers to business and public procurement, alongside weaker comparative government transparency, remain challenges.

      Government formation following the next parliamentary elections scheduled for February 2020 could prove challenging as a result of increasing political fragmentation in Slovakia. According to recent opinion polls, support for the long-dominant Smer-SD, which leads the present coalition, stands at around 21%, down from 28.3% after the last parliamentary elections in 2016. Moreover, support for liberal parties has increased, as reflected in March 2019 via the election as President of Zuzana Čaputová, a member of the pro-European and liberal party, Progressive Slovakia.

      Sovereign rating scorecard (CVS) and Qualitative Scorecard (QS)

      The rating committee reviewed Scope’s Core Variable Scorecard (CVS), which is based on the relative rankings of key sovereign credit fundamentals and assigned an indicative ‘A’ (‘a’) rating range for Slovakia. This indicative rating range can be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the size of relative credit strengths or weaknesses versus peers based on qualitative analysis.

      For Slovakia, the following relative credit strengths are identified: i) growth potential of the economy; and ii) market access and funding sources. The following relative credit weakness is identified: i) current account resilience.

      The combined relative credit strengths and weaknesses generate a one-notch upward adjustment and indicate a sovereign rating of A+ for Slovakia.

      A rating committee has discussed and confirmed these results.

      Factoring of Environment, Social and Governance (ESG)

      Scope considers sustainability issues during the rating process as reflected in its sovereign methodology. Governance factors are explicitly captured in Scope’s assessment of ‘institutional and political risk’ under its methodology, under which Slovakia has below-average performance among euro area Central and Eastern European countries as assessed by the World Bank’s Worldwide Governance Indicators.

      According to the European Commission, Slovakia’s performance across key social dimensions is mixed. This is reflected in improvements in the economy’s employment rate, which stood at 68.1% (of those aged 15-64) in Q2 2019, below EU-average levels of poverty (with levels falling further), but high regional disparities – among the highest among OECD countries. Slovakia lacks a research and innovation strategy and remains highly dependent on EU funding for R&D. The European Commission’s Digital Economy and Society Index 2019, which assesses EU member states’ digital competitiveness, ranks Slovakia in 21st place, below the EU’s average rank. Slovakia ranks 49th among the 193 countries included in the United Nations’ E-Government Survey 2018, which measures countries’ effectiveness in the delivery of public services via information and communication technologies. The share of renewable energies in Slovakia’s final energy consumption stood at 11.5% in 2017, below both the EU average of 17.5% and the EU’s target of 20% by 2020.

      Outlook and rating-change drivers

      The Stable Outlook on Slovakia’s A+ rating reflects Scope’s view that risks to the ratings will be balanced over the next 12 to 18 months.

      The ratings and/or Outlook could be upgraded if, individually or collectively: i) the implementation of structural reforms improves Slovakia’s growth potential and economic diversification; and/or ii) fiscal consolidation leads to stronger-than-expected debt reduction.

      Conversely, the ratings and/or Outlook could be downgraded if, individually or collectively: i) there is a sharper-than-projected deterioration in growth prospects; ii) public finances deteriorate due to a weakening commitment to fiscal discipline; and/or iii) financial stability concerns increase due to amplified risks in the banking sector.

      Rating committee
      The main points discussed by the rating committee were: i) Slovakia’s growth outlook; ii) labour market and demographics; iii) external sector developments and car industry; iv) productivity and wage developments; v) fiscal policy framework and debt sustainability; vi) financial sector developments; vii) upcoming parliamentary elections; and viii) peer considerations.

      Methodology
      The methodology used for this rating and/or rating outlook, ‘Public Finance Sovereign Ratings’, is available on www.scoperatings.com.
      Historical default rates of the entities rated by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default as well as definitions of rating notations can be found in Scope’s public credit rating methodologies at www.scoperatings.com.
      The rating outlook indicates the most likely direction in which a rating may change within the next 12 to 18 months.

      Solicitation, key sources and quality of information
      The rating was not requested by the rated entity or its agents. The rated entity and/or its agents did not participate in the ratings process. Scope had no access to accounts, management and/or other relevant internal documents for the rated entity or related third party.
      The following material sources of information were used to prepare the credit rating: public domain and third parties. Key sources of information for the rating include: National Bank of Slovakia, Ministry of Finance of Slovakia, Debt and Liquidity Management Agency (ARDAL), the European Commission, the European Central Bank (ECB), the Statistical Office of the European Communities (Eurostat), the IMF, the OECD, the BIS and Haver Analytics.
      Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.
      Prior to the issuance of the rating, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds upon which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

      Regulatory disclosures
      This credit rating and/or rating outlook is issued by Scope Ratings GmbH.
      Lead analyst: Levon Kameryan, Analyst
      Person responsible for approval of the rating: Dr Giacomo Barisone, Managing Director
      The ratings/outlook were first assigned by Scope in January 2003. The ratings/outlooks were last updated on 23 February 2018.

      Potential conflicts
      Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings.

      Conditions of use / exclusion of liability
      © 2019 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Analysis GmbH, Scope Investor Services GmbH and Scope Risk Solutions GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstrasse 5, D-10785 Berlin.

      Scope Ratings GmbH, Lennéstrasse 5, 10785 Berlin, District Court for Berlin (Charlottenburg) HRB 192993 B, Managing Directors: Torsten Hinrichs and Guillaume Jolivet.

       

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