Home Ratingové hodnotenia a Výskum Aktuálne platné ERA affirms A+ rating to Slovakia, outlook Stable
ERA affirms A+ rating to Slovakia, outlook Stable
Piatok, 05 Apríl 2019

Affirmation of the unsolicited credit rating A+ assigned to Slovakia stems from strong economic growth, strict debt rule, and the European Central Banks's (ECB) conditional guarantee of government debt via the Outright Monetary Transactions program. The assessment is constrained by weaker governance indicators, moderate debt load, inadequate export diversification, and a build-up of imbalances in household balance sheets.

Rating components

Macroeconomic factors

Economic factors

High

Debt and current account sustainability factors

High

Public finance factors

High

Private finance factors

Moderate

Foreign exchange stability factors

High

Liquidity factors

Very high

Final assessment

High

Forward-looking factors

Political and economic stability

High

Efficiency and reforms potential

High

Final assessment

High

Overall score

High

Final rating

A+

Macroeconomic factors of rating assessment

The Slovak economy is growing at a strong rate. While outlook remains optimistic, lower diversification of exports is a source of concern. Government deficits are low and the debt-to-GDP ratio is declining, also thanks to a strong debt rule. Vulnerabilities in the financial sector are increasing as a result of strong growth in household debt.

Favorable economic conditions to tackle global slowdown:

The Slovak economy enjoys favorable economic conditions. Real GDP growth has been above 3% for the past four years, supported by household consumption, investment, and foreign trade. In 2018, economic growth accelerated from 3.2% to 4.1%. ERA expects the growth to continue at a solid pace (around 3.5%) in 2019-2020, despite slowing external demand, as a result of a strong labor market and new export capacities.

Robust and job-rich economic growth has led to a strong decline in the unemployment rate from above 14% in 2014 to 6.0% in Q4 2018, the lowest on record. The rapid absorption of spare capacity in the labor market has translated into labor shortages and the acceleration of wage growth. Figures from January 2019 show that one third of companies in manufacturing and more than 20% in the service sector have trouble finding skilled workers. Nominal wages grew by 6.2% in 2018 (3.6% in real terms) and robust growth is expected to continue in 2019-2020 not only due to labor shortages, but also as a result of already agreed upon rapid wage increases in the public sector.

The second factor dampening the effect of the global slowdown is the launch of new export capacities in the automotive industry. The recently opened automotive plant is expected to reach the full capacity of 150K cars produced annually by 2020, increasing the country's annual vehicle production by almost 15% and thereby providing a boost to its net exports.

Unemployment rate in Slovakia, EU, and Eurozone (end of period)

fig1

Source: Eurostat, ERA

Catch-up growth is likely to continue. Risks stem mainly from export structure:

The medium-term outlook beyond 2020 remains optimistic. As a country with GDP per capita and labor productivity lower than the EU average, Slovakia will most likely continue to grow at catching-up rates, with potential GDP growing at 2.5-3%. Such development should be supported by a smooth transfer of capital and technology in the EU.

In the long-run, however, Slovakia will be faced with considerable challenges, which, if left unaddressed, are likely to decrease the potential growth rate significantly. These include an ageing population, weak education results (PISA scores are well below the average of its regional peers), brain drain, and low R&D expenditures.

Slovakia's economic structure is another source of concern. As a small open economy with an exports to GDP ratio close to 100% (the fourth highest in the EU), Slovakia is too focused on the automotive industry, making it more susceptible to sector-specific shocks. Slovakia is the clear global leader with an annual production of almost 200 motor vehicles produced per 1000 people. The industry directly employs almost 5% of the workforce and accounts for about 30% of the country's exports.

Structure of merchandise exports (2018)

fig2

Source: Statistics office of the Slovak Republic

In the short-term, the challenges for the sector stem mainly from the US threat of tariffs on EU-car exports and the possibility of a no-deal Brexit. In the longer-term, the sector is expected to undergo major changes due to the increasing penetration of electric vehicles, growing shared economy, and the emergence of self-driving cars. Failing to respond to these challenges might have a considerable negative impact on economic growth and employment.

Low deficits and declining debt:

Slovakia's public finances are in good shape. The general government debt to GDP ratio has been declining since its peak at 54.7% in 2013; according to preliminary estimates it fell below 49% in 2018. The decline has been primarily driven by GDP growth, with declining deficits and interest rates on government debt also being important contributing factors. In 2018, general government deficit fell to 0.7% GDP according to preliminary estimates, the lowest ever.

An important factor behind the declining debt is the country's fiscal framework. Its most important component is the constitutional "debt brake" that has been in force since 2012, which initially capped the debt to GDP ratio at 60%, with sanctions starting at 50%. If the debt is in sanction range, the government is obliged to report what measures are being taken to reduce the debt amount. This sanction range has been automatically declining since 2018 by one percentage point every year from 50-60% GDP and will reach 40-50% by 2027. Such pre-implemented tightening along with constitutional force makes Slovakia's debt rule one of the strongest in the EU. According to preliminary estimates, the debt to GDP-ratio fell below the sanction range in 2018 for the first time since the adoption of the debt rule.

General government debt in Slovakia (with sanction band) and Eurozone (% GDP)

fig3

Source: Eurostat, ERA

You can read more on ERA's assessment of the fiscal rules in the EU in our latest research.

The second component of the fiscal framework is the ordinary "balanced budget" law required by the European Fiscal Compact, which calls for structural deficits no higher than 0.5% of country's GDP, or appropriate adjustment path towards this objective. With the economy growing above its potential and an estimated fiscal deficit at 0.7% in 2018, the government structural deficit estimated at 0.9% is above the medium-term budgetary objective required the EU fiscal pact. This occurs despite the fact that the government has recorded surprisingly high revenues in recent years, though they have not been used to improve its fiscal position.

Overall, ERA assesses the strength of the country's fiscal rules as strong (especially the debt rule, which has an adequate sanction mechanism to prevent the debt-to-GDP ratio increasing to less-sustainable levels) and compliance with those rules as moderate. Debt-to-GDP ratio is declining at a moderate pace and is the sixth-lowest in the Eurozone. ERA expects this trend to continue in the coming years. Nevertheless, ERA considers the government's ambition to achieve balanced budgets in 2019-2020 as optimistic in light of the global slowdown, upcoming parliamentary elections in 2020, and low priority for using unexpected revenues to lower deficits demonstrated in prior years.

An important component of the assessment of the access to market funding is the ECB's Outright Monetary Transactions program. This program, which has been in force since 2012, allows unlimited purchases of government-issued bonds that mature in 1 to 3 years, provided that the bond-issuing countries agree to certain domestic economic measures. The programs also significantly reduces the risk of losing market access even if the government debt-to-GDP ratio substantially increases.

Strong increase in household debt has increased the vulnerability of the financial sector:

The Slovak financial sector shows some signs of vulnerability, mainly as a result of strong household credit growth fueled by a low-interest rate environment coupled with a strong appetite for homeownership. In the last five years, the household debt-to-GDP ratio rose by 12.2 percentage points to 41% in Q3 2018. While lower than the unweighted EU-average (52.3%), the ratio is the highest among the former Eastern Bloc EU countries (with an unweighted average of 27.9%), where mortgages are a relatively new phenomenon.

Household debt in Slovakia, EU, and CEE countries (% of GDP)

fig4

Source: Eurostat, ERA

The growth in the household debt-to-GDP ratio will most likely continue in the future due to older generations that are almost mortgage-free (during the post-communist transformation, they were offered residential properties from the state for a low price) and a very high appetite for homeownership (90.1% in 2017, the third highest in the EU). This could increase the risk of unsustainable development in the housing market. Another source of concern is the high share of lower-income groups (with less than 60% of median income) among debtors compared to the EU-average.

There are, however, two factors mitigating the risk of unsustainable development. Firstly, the increase in housing prices resulting from the recent credit expansion has been to a large extent matched by the increase in household income. The ratio of average price for a square meter of residential property to average wage has shown only a slight increase in recent quarters and is still one-third below its peak in 2008. For flats, whose prices are rising more rapidly, this ratio is 23% below its 2008 peak. The risk of a strong decrease in housing prices is, therefore, limited and is likely to occur only in the case of a severe external shock.

Secondly, the central bank is taking active steps to mitigate the risks in the housing market and the financial sector. It has limited the share of new mortgage loans with loan-to-value above 80% to 25% (20% starting in July 2019) and the share of new mortgages with a debt-to-income ratio above 8 to 10%, as well as capped the loan-to-value at 90% and the debt service to total income rate at 80%. Moreover, to ensure that the banks build up extra shock absorbers, it has increased the counter-cyclical capital buffer from 1.25% to 1.5% (in force starting in August 2019), the third highest in the EU. According to the Financial Stability Report, the central bank is prepared to take additional measures should the overheating continue.

Banking sector statistics are mixed. Although the capital ratios have increased substantially since the crisis, they are below the unweighted EU average (CET1 ratio at 15.5% vs 17.4% in Q3 2018). Moreover, the credit expansion caused a deterioration in the share of banks' liquid assets. In Q3 2018, only 22% of short-term liabilities were covered by liquid assets, whereas the unweighted EU average stood at 41%. On the other hand, the Slovak banking sector shows higher profitability (mainly thanks to higher credit origination), lower leverage, and better asset quality compared to the EU average.

Current account deficits can be attributed to high foreign investments:

The external position of the Slovak economy is sound. Deficits on the current account (2.5% GDP in 2018) and a negative international investment position (-66% GDP in Q3 2018) can be largely attributed to foreign direct investments and are not a sign of excessive domestic consumption financed by external debt. In fact, the private financial and non-financial sectors (excluding intra-governmental lending of foreign investors) account only for 21% of the external debt. The majority of external debt (which stood at 116% GDP in Q3 2018) is attributed to the general government and the central bank (both 28%) and is almost exclusively denominated in EUR. Moreover, trade balance has been in surplus since 2012.

Current account balance and trade balance (% GDP)

fig5

Source: National Bank of Slovakia, ERA

Foreign reserve coverage ratios are very low by standard metrics (below one month of imports). This is not, however, a source of concern as the euro has reserve currency status and therefore Eurozone countries tend to hold much lower foreign exchange reserves compared to most of the world.

Forward-looking factors of rating assessment

Governance indicators, although above average on global scale, are low by EU-standards, with corruption being the main laggard.

Governance indicators are below EU-average:

Governance indicators, which are on above-average levels on the global scale, have been on a slight decline since their peak in mid-2000s. The most notable declines have been recorded in the control of corruption (which has the lowest score among governance indicators) and the regulatory quality categories. Corruption was identified as the most problematic factor for doing business in the 2017-2018 World Economic Forum survey (by 19.1% of respondents). In 2018, Slovakia ranked 57th in the Transparency International corruption perception index from 180 countries (higher rank means lower corruption), the sixth worst in the EU. This implies a relatively high level of rent-seeking in the economy and constitutes a drag on economic growth.

As for other indicators lagging behind the EU average, regulatory quality is constrained by frequent law changes. The weaker rule of law score is demonstrated by the lowest perception of judicial independence among companies and the second-lowest among the general public in the EU (according to the most recent EU justice scorecard). The weaker score for government effectiveness is demonstrated by the second place for "inefficient government bureaucracy" in the problematic factor ranking for doing business according to the 2017-2018 World Economic Forum survey. The only governance indicator above the EU-average is the political stability and absence of terrorism indicator.

Selected World Governance Indicators for Slovakia and EU (ERA score, 1-10)

fig6

Source: World Bank, ERA

Outlook: Stable

The outlook has been assigned based on expectations of soft landing of the country's main trading partners, political stability in the Eurozone, and the government's adherence to the debt rule.

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

Key assumptions

• Economic growth in the range of 2.5-4% in the medium-term;

• Soft landing of the global economy from the current cyclical slowdown;

• Continuation of the ECB's conditional guarantee of government debt;

• Government's adherence to the debt rule;

• Stability in the housing market.

Potential outlook and/or rating change factors

A negative rating action may be prompted by:

• Material decline in exports, above 10 percent year on year;

• End of ECB's conditional government bonds guarantee;

• Substantial deviation from the debt rule;

• Stress in the banking sector resulting from elevated household debt.

A positive rating action may be prompted by:

• Substantial improvement in governance indicators;

• Decline in government debt-to-GDP ratio close to 40%.

Appendix 1. Peer-analysis materials. Stance among the peer-group sovereigns

General government debt/GDP (%).

fig7

Source: IMF, ERA

General government balance (% GDP)

fig8

Source: IMF, ERA

Appendix 2. Major sovereign indicators

Indicators

2014

2015

2016

2017

2018_E

2019_F

GDP, bln EUR

76.1

79.1

81.2

84.9

90.2

95.8

GDP growth rate, %

2.8

4.2

3.1

3.2

4.1

3.7

GDP per capita, ‘000 EUR

14.0

14.6

14.9

15.6

16.5

17.5

Population, mln

5.4

5.4

5.4

5.4

5.5

5.5

Unemployment, year-end, %

12.4

10.7

8.8

7.5

5.9

5.7

Consumer inflation, year-average, %

-0.1

-0.3

-0.5

1.4

2.5

2.4

External debt to GDP, year-end %

90

85.2

92.2

111.0

117.5

124

Public debt to GDP, %

53.5

52.2

51.8

50.9

48.9

47.6

Gross Domestic Investment to GDP, %

22.0

24.2

22.6

22.4

23.5

23.3

International reserves, bln EUR

2.6

2.9

2.7

3.0

4.6

5.1

Trade balance, bln EUR

2.9

1.2

2.1

1.6

0.8

0.4

Exports, bln EUR

69.5

72.0

75.5

80.7

86.2

93.2

Imports, bln EUR

66.5

70.7

73.4

79.1

85.4

92.8

Current account to GDP, %

1.1

-1.7

-2.2

-2.0

-2.5

-1.7

Appendix 3, List of material data sources

International Monetary Fund

World Bank

Eurostat

The Bank for International Settlements

National Bank of Slovakia

Statistics office of the Slovak Republic

Regulatory disclosure

The unsolicited credit rating and outlook were issued in accordance with ERA methodology for sovereign entities in the version from July 4, 2018 (available at www.euroratings.co.uk, section Methodology). In the same section is a rating scale including an explanation of the importance of each rating category and a default definition. Information on the rate of historical failure is available at www.cerep.esma.europa.eu, and the explanatory statement of the meaning of those default rates is available at www.euroratings.co.uk (Regulatory Framework/Disclosure). This rating is issued as an unsolicited rating, i.e. was not initiated by the rated entity or a related third party. The rated entity did not participate in the rating process and the information and documentation for its development was obtained from publicly available sources in accordance with ERA methodology. ERA did not have access to the rated entity's internal documents. ERA, in the context of routine care, verified all sources entering the rating process. ERA considers the scope and quality of the information entering the analytical process to be sufficient to assign a credit rating. The disclosure of the unsolicited rating and outlook was preceded by the approval of the Rating Committee. No actual or potential conflicts of interest have arisen. Since July 30, 2012, ERA 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 rated entity was notified on April 3, 2019, and after the notification there were no changes or amendments in the rating. The rating was first released for distribution on October 3, 2018.

Download pdf:

Slovakia_affirmation_report_05.04.2019.pdf


Approved by the Rating Committee:

Zuzana Hrebičková, Acting

Head of credit rating analysts

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