ACRA has affirmed the following ratings of the Slovak Republic (hereinafter, Slovakia, or the country) under the international scale:
- Long-term foreign and local currency credit ratings at A+;
- Short-term foreign and local currency credit ratings at S1.
The outlook on the long-term foreign currency credit rating is Negative and local currency credit rating is Negative.
The Negative outlook assumes the possibility of a negative rating action within the 12 to 18-month horizon.
The Negative outlook is due to the significant dependence of the country’s economic growth on external demand, which is slowing down due to the COVID-19 pandemic. The extent of the final impact on Slovakia’s economy will depend on the severity of the second wave of COVID-19 and its impact on the economic growth of the country’s main trading partners. ACRA notes that EU funds may support investment and economic growth in the medium term. ACRA continues to monitor the situation closely.
Credit rating rationale
Slovakia’s A+ sovereign credit ratings are based on a relatively wealthy economy that has grown rapidly in the last few years, strong public finances, moderate debt, a sustainable external position, and good institutional factors. However, the country’s GDP growth outlook is a source of concern due to high concentration on the automotive industry, which means exposure to industry-specific risks and risks associated with global trade tensions. Moreover, the country’s economic potential is constrained by the quality and quantity of the labor force, as well as the economy’s small size and considerable openness. The latter makes the country highly vulnerable to the negative consequences of the COVID-19 pandemic.
Prior to the COVID-19 pandemic, Slovakia had benefited from a favorable economic environment. Economic growth has been more than 3% over the last five years (3.3% compared to the EU average of 2.1%). On the back of rapid industrialization, a strategically good location in the center of Europe, large FDI inflows, an abundance of low-cost and skilled labor, and access to EU structural funds, the income level in Slovakia has converged to the average EU level. Now it is the third highest (36,640 international dollars) among Eastern EU countries. Above average growth has contributed to the record low unemployment rate and higher than EU average inflation. However, according to the most recent forecast from the Ministry of Finance, the drop in employment this year will be around 1.5%.
ACRA expects the country’s GDP to contract by 6−7% in 2020, which is better than the previous expectations of 5−10%. The revision is based on signs of economic recovery as evidenced by improved high-frequency economic indicators in June and July such as the industrial production index and economic sentiment indicator compared to April 2020. However, ACRA notes that improvement might be temporary given the prospect of a second COVID-19 wave and its negative impact on the country’s main trade partners. The country’s openness is the highest among Central and Eastern European (CEE) countries, with the average of export and import to GDP amounting to 93% in 2019. Moreover, the country’s economy is concentrated on the automotive industry, which has been badly hit by the pandemic.
One of the long-term constraints on economic growth is the quality and size of the labor force, which may shrink due to negative demographic trends. Factors that negatively impact the quality of the labor force are brain drain, weak education scores compared to CEE peers, and insufficient R&D spending. All this could compromise the country’s competiveness. Another long-term factor is Slovakian carmakers being exposed to major changes as electric vehicles become more prevalent, the sharing economy increases, and self-driving cars hit the market. The delayed response of Slovakia’s car manufacturers to these challenges could have a considerable negative impact on the country’s economic growth and employment in the long term.
Slovakia’s public finances have benefited from a favorable economic environment, Eurozone membership, and a strong debt rule. High GDP growth in recent years has led to a decline in the general government consolidated debt to GDP ratio from 54.7% in 2013 to 48% at the end of 2019.
However, the country’s public finance position is set to deteriorate in 2020. Tax revenue decreases due to GDP contraction, combined with a hike in social spending and tax cuts before the parliamentary elections in February 2020, are likely to push Slovakia’s debt to GDP ratio to about 60−62% in 2020. In ACRA’s view, the budget deficit will widen to about 8% GDP in 2020 due to decreased tax collection and a fiscal package to support the economy. ACRA notes that the expected budget deficit might be overestimated as the fiscal package is being utilized at a slower pace. For 8M 2020, the budget deficit of the central government, the core part of the country’s consolidated budget, stood at EUR 4 bln compared to the initial Ministry of Finance estimate of EUR 12 bln for the whole year.
Although the share of public debt held by non-residents is high (around 57% in Q1 2020), ACRA does not consider it a concern. This is because Slovakia is a member of a monetary union whose currency has reserve status. Moreover, the outright monetary transaction program (OMT) launched by the ECB in 2012 provides a conditional backstop for government bonds. The latter also has a positive impact on borrowing costs together with a low interest rate environment and the Pandemic Emergency Purchase Programme launched by the ECB. Although the increase in public debt is expected to be significant this year, interest expenditures will remain low.
Contingent liability risks are contained. The level of public guarantees was one of the lowest among CEE peers in 2018. The IMF estimate of the guarantees schemes adopted by the government to support SMEs and large companies stands at about EUR 4 bln (4.2% of 2019 GDP). However, their utilization is quite low. In ACRA’s opinion, financial stability in the non-financial sector is also supported by Slovakia’s low debt load compared other CEE peers and the EU average. Contingent liability risks related to the banking sector are mitigated by its strong capital adequacy and asset quality metrics prior to the coronavirus crisis. Moreover, the National Bank of Slovakia’s (NBS) effective macroprudential measures and an increase in household income, which has been matched by an increase in real estate prices, contain the risks associated with the growth of the household debt-to-GDP ratio.
ACRA expects the current account deficit to widen this year from 3.2% in 2019 to 3.5−4% of GDP due to sluggish external demand. However, this will not lead to a significant deterioration of the country’s external position. Slovakia’s external position is strong due to its euro reserve currency status, which means that the external debt is predominately denominated in the domestic currency. In addition, the rise in external debt, which reached 112.5% in 2020 Q1 compared to 85% in 2015, was mainly associated with the increase of foreign deposits in the NBS. This can be viewed as low-risk debt. The net investment position is one of the lowest among the EU countries at negative 67% GDP. This, however, reflects the country’s FDI-intensive growth model rather than the result of a trade deficit. Institutional factors are above average on the scale ACRA uses to assess countries, but lower compared to countries with the same level of creditworthiness. The biggest constraint for Slovakia is its relatively low Control of Corruption score in the World Governance Indicators, which are compiled by the World Bank. In 2019, Slovakia ranked 59th (1st indicating the lowest level of corruption) in the Transparency International Corruption Perception Index for 180 countries. The Ordinary People Party (OL’aNO) won the parliamentary elections in February 2020. As this party has an anti-corruption reform agenda, ACRA expects that it might improve the country’s institutional framework in the future.
Sovereign model application results
Slovakia has been assigned an A+ Indicative credit rating in accordance with the core part of ACRA’s sovereign model. A number of modifiers in the modifiers part of the model allow the Indicative credit rating to be increased. These include the following, which are determined by the Methodology for Credit Rating Assignment to Sovereign Entities under the International Scale:
- Market access and sources of funding;
- External debt sustainability.
Negative modifiers are the following:
- Potential economic growth;
- Sustainability of economic growth;
- Debt sustainability.
The Assigned A+ credit rating coincides with the Indicative credit rating as the total impact of positive modifiers is offset by the total impact of negative modifiers. There are no extraordinary factors that could adjust the Final credit rating.
Potential rating upgrade factors
- Decline in public debt;
- Increase in domestic holding of public and private debt;
- Material improvement in governance.
Potential rating downgrade factors
- Increase in public debt;
- Potentially serious external or industry-specific shocks and developments that may lead to decline in economic growth;
- Risk of redenomination.
Issue ratings
No outstanding issues have been rated.
Regulatory disclosure
The sovereign credit ratings have been assigned to Slovakia under the international scale based on the Methodology for Credit Rating Assignment to Sovereign Entities under the International Scale and the Key Concepts Used by the Analytical Credit Rating Agency Within the Scope of Its Rating Activities.
The sovereign credit ratings of Slovakia were first published by ACRA on October 25, 2019. The sovereign credit ratings and their outlook are expected to be revised within 182 days following the publication date of this press release as per the Calendar of planned sovereign credit rating revisions and publications.
The sovereign credit ratings are based on information from publicly available sources, as well as ACRA’s own databases. The sovereign credit ratings are unsolicited. The Government of Slovakia did not participate in the credit rating assignment.
ACRA provided no additional services to the Government of Slovakia. No conflicts of interest were discovered in the course of the sovereign credit rating assignment.
