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Rating Action:

Moody's changes Slovakia's outlook to stable from positive, affirms A2 ratings

27 Sep 2019

Frankfurt am Main, September 27, 2019 -- Moody's Investors Service ("Moody's") has today affirmed the Government of Slovakia's foreign currency and local currency long-term issuer and senior unsecured ratings at A2. Concurrently, the outlook has been changed to stable from positive.

The key drivers of the decision to change the outlook to stable from positive are:

(1) The absence of material improvements to Slovakia's institutional strength, which continues to lag A1 rated peers;

(2) The deterioration in long term fiscal sustainability due to the partial reversal of past pension reforms; the expected slowing pace of reduction of the government's debt burden towards the A1 median;

(3) Slovakia's economic strength, which despite improvements, remains lower than that of A1 rated peers;

The affirmation of Slovakia's A2 ratings balances government fiscal metrics that remain strong in a global comparison against a level of institutional strength that, although high in a broader international comparison, continues to be constrained by long-standing issues related to the rule of law and control of corruption. The affirmation of the A2 ratings also reflects the country's relatively high wealth levels and solid track record of sustained economic growth as well as our expectation that risks to the sovereign's balance sheet from the banking sector will remain low.

Slovakia's long-term local and foreign currency bond and bank deposit country ceilings remain unchanged at Aaa. Its short-term foreign currency bonds and bank deposits country ceilings also remain unchanged at Prime-1(P-1).

RATINGS RATIONALE

RATIONALE FOR THE CHANGE IN THE OUTLOOK TO STABLE FROM POSITIVE

FIRST DRIVER: THE ABSENCE OF MATERIAL IMPROVEMENTS TO SLOVAKIA'S INSTITUTIONAL STRENGTH

The first driver of the outlook change is based on the absence of material improvements to Slovakia's institutional strength, which continues to lag A1 rated peers. Although the institutional environment in Slovakia has benefitted greatly from the country's integration into the European Union, the euro area and the OECD, and our assessment of Slovakia's institutional strength remains high in a broader international comparison, it continues to lag the median for A1 rated sovereigns.

The country's institutional challenges are principally related to control of corruption and the rule of law, with Slovakia's scores for the rule of law, control of corruption and also government effectiveness on the World Bank's Worldwide Governance Indicators continuing to lag behind the median of all single A rated peers. However, Slovakia continues to rank above close peers such as Poland (A2 stable) for the rule of law. Slovakia also receives the sixth worst score in the EU on Transparency International's Corruption Perceptions Index and among the lowest scores for the perception of judicial independence on the EU's Justice Scoreboard.

Furthermore, institutional challenges also contribute to the very high value of payments of EU funds where "fraudulent and non-fraudulent" irregularities have been detected. For the period 2014-2018, the financial impact of such irregularities was 19.3% of total payments, against 2% for the EU as a whole, according to the EU's anti-fraud office OLAF. Such issues limit the ability of EU funds to function as an effective catalyst for growth, for instance in areas such as research and innovation.

Public concern over corruption and the rule of law were also an important underlying factor behind the public protests sparked by the murder of an investigative journalist and his partner in February 2018 that ultimately forced the resignation of the then prime and interior ministers in March 2018. While some efforts have been made to seek to remedy institutional challenges in recent years, such as the introduction of a whistleblower protection act in 2015 that was recently reinforced, sustained reform efforts and enforcement of regulations over time will be needed to materially improve the quality of the institutional environment in Slovakia.

SECOND DRIVER: THE DETERIORATION IN LONG TERM FISCAL SUSTAINABILITY DUE TO THE PARTIAL REVERSAL OF PAST PENSION REFORMS; THE EXPECTED SLOWING PACE OF REDUCTION OF THE GOVERNMENT'S DEBT BURDEN

The second driver relates to the deterioration in Slovakia's long term fiscal sustainability due to the partial reversal of past pension reforms as well as the expected slowing pace of reduction of the government's debt burden towards the A1 median.

The Slovakian parliament in March this year passed a constitutional amendment capping the retirement age at 64 years. Following reforms enacted in 2012, the statutory pension age was previously set to increase with life expectancy without upper limit. While the fiscal impact of this change will be relatively muted until the mid-2030's, it will nonetheless have a clear negative impact for long-term fiscal sustainability.

Following the 2012 reforms, increases in pension expenditure had been projected to be relatively contained despite the ageing of the country's population, with health and long term care expenditure representing the primary long-term fiscal challenge. With the capping of the retirement age, pension expenditure will increasingly contribute to ageing related fiscal pressures for Slovakia. By 2050, public pension expenditure is expected to be almost 1.4 percentage points of GDP higher compared to the baseline scenario of the European Commission's 2018 Ageing Report, in which total expenditure on pensions, health care and long-term care was expected to increase by 2 percentage points of GDP between 2020 and 2050.

Slovakia's government debt as a share of GDP has gradually declined from a peak of 54.7% in 2013 to reach 48.9% at end-2018. However, this remains significantly above the A1 rated median of 32.6% of GDP. While we expect the debt-to-GDP ratio to remain on a declining trajectory, we also expect the pace of decline to moderate, making it more difficult for Slovakia to catch up with A1 rated peers. This results from the lowering of our growth projections for 2019 and 2020 as well as our expectation that the government will not be able to meet its target of a balanced headline fiscal position in 2019 and beyond (owing to a combination of factors such as higher than planned local government spending and lower non-tax revenues in 2019, increased spending ahead of next year's parliamentary elections and weaker revenue growth due to slowing growth in Slovakia, driven by a slowdown in the euro area). We now expect government debt to reach 48.1% of GDP at the end of this year and 47.5% of GDP at the end of 2020.

THIRD DRIVER: SLOVAKIA'S ECONOMIC STRENGTH WHICH DESPITE IMPROVEMENTS REMAINS BELOW THAT OF A1 RATED PEERS

The third driver is underpinned by our assessment of Slovakia's economic strength, which despite improvements, continues to lag A1 rated peers. The Slovak economy has registered robust GDP growth in recent years, averaging 3.6% annually in 2015-2018. This has also translated into a sustained increase in wealth levels with GDP per capita increasing steadily to stand at 35,130 USD in purchasing power parity terms at end-2018. However, while fully in line with the metrics of its A2 rated peers, on the whole, Slovakia continues to lag the A1 rated median for our assessment of economic strength.

Despite the steady increase in income levels in recent years, Slovakia continues to lag the A1 rated median on this metric. Slovakia's relatively small size compared to A1 peers also remains a constraining factor. While Slovakia has benefitted significantly from its integration into European and international value chains since joining the European Union in 2004, its very high degree of economic openness (with combined exports and imports standing at 192% of GDP at end-2018) and relatively high degree of concentration with regard to export products and destinations leaves the economy vulnerable to changes in the external environment. The latter is evidenced by the impact on economic growth of the sharp decline in net exports in the second quarter of 2019 (in large part driven by the slowdown of the German economy), with our growth forecasts for Slovakia being revised downward to 2.5% and 2.2% of GDP in 2019 and 2020 respectively, from 3.7% and 3.5% of GDP in 2019 and 2020 in April this year.

The Slovak economy also faces structural challenges to its competitiveness and growth potential over the medium to long term, which will make it more difficult to catch up with A1 rated peers. Aside from the challenge of population ageing, which will negatively impact most regional peers, weaknesses in for instance the education system (where Slovakia's score on the OECD's PISA assessment continues to lag that of close peers and are on a declining trend) and the institutional environment that remain to be comprehensively addressed, will likely increasingly constrain the development of the Slovak economy over the medium to long term. Slovakia also continues to score significantly below the A1 rated median on the World Economic Forum's Global Competitiveness Index, receiving particularly low scores for its institutions, product market and innovation capability.

RATIONALE FOR THE AFFIRMATION OF THE RATING AT A2

Our assessment of Slovakia's economic strength is in line with that of the median of A2 rated peers, reflecting wealth levels that are high in a broader international comparison and Slovakia's track record of sustained economic growth. Despite remaining issues related to the rule of law and control of corruption, we also assess Slovakia's institutional strength to be in line with the A2 rated median. Slovakia's level of fiscal strength is somewhat higher than that of A2 rated peers, reflecting moderate debt levels, strong debt affordability as well as a low level of foreign currency debt and contingent liabilities related to state-owned enterprises. Our assessment of Slovakia's susceptibility to event risk, which is driven by risks to the sovereign's balance sheet stemming from the banking sector, are also in line with that of the median for A2 rated sovereigns.

FACTORS THAT COULD LEAD TO AN UPGRADE

We would consider assigning a positive outlook on Slovakia's A2 ratings and eventually upgrading Slovakia's rating to A1 if we were to see significant progress on tackling structural weaknesses related for instance to the education system and institutional environment, that constrains the economy's longer term productivity and growth potential. Comprehensive and sustained efforts to address issues related to the control of corruption and the rule of law would also be credit positive. A significant reduction of the government debt burden, which brings it more into line with that of A1 rated peers, would also support a potential upgrade.

FACTORS THAT COULD LEAD TO A DOWNGRADE

We would consider assigning a negative outlook and eventually downgrading Slovakia's rating if we were to see a marked deterioration in the government's fiscal position, leading to a notable increase in the debt-to-GDP ratio. A deterioration in Slovakia's economic strength as well as the country's institutional environment would also be credit negative, as would signs that risks to the sovereign's balance sheet from the banking sector are materially increasing.

GDP per capita (PPP basis, US$): 35,130 (2018 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 4.1% (2018 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 1.9% (2018 Actual)

Gen. Gov. Financial Balance/GDP: -0.7% (2018 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: -2.5% (2018 Actual) (also known as External Balance)

External debt/GDP: [not available]

Level of economic development: High level of economic resilience

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 24 September 2019, a rating committee was called to discuss the rating of the Slovakia, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have materially increased. The issuer's institutional strength/ framework, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has not materially changed. The issuer's susceptibility to event risks has not materially changed.

The principal methodology used in these ratings was Sovereign Bond Ratings published in November 2018. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.

REGULATORY DISCLOSURES

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Petter Bryman
Asst Vice President - Analyst
Sovereign Risk Group
Moody's Deutschland GmbH
An der Welle 5
Frankfurt am Main 60322
Germany
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Yves Lemay
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Releasing Office:
Moody's Deutschland GmbH
An der Welle 5
Frankfurt am Main 60322
Germany
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

No Related Data.
© 2019 Moody’s Corporation, Moody’s Investors Service, Inc., Moody’s Analytics, Inc. and/or their licensors and affiliates (collectively, “MOODY’S”). All rights reserved.

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