Research Update: Slovenia 'A+/A-1' Ratings Affirmed; Outlook Remains Positive
On 14 December 2018, S&P Global Ratings affirmed its 'A+/A-1' long- and short-term foreign and local currency sovereign credit ratings on Slovenia. The outlook remains positive.
The positive outlook reflects Slovenia's rapidly declining government and external debt burdens amid improving economic fundamentals. We could raise the ratings on Slovenia over the next 12-18 months if Slovenia's economy continues to expand without any build-up of macroeconomic imbalances, leading to further income convergence toward the EU average. We could also raise the ratings if government debt continues to decline further or if contingent liabilities deriving from the large state-owned enterprise sector were to decline. We could revise the outlook to stable if imbalances emerged--for example in the labour and housing markets--with adverse implications for economic growth or financial stability. We could also revise the outlook to stable if we observed that the Slovenian economy were becoming increasingly unsynchronised with that of the eurozone, via higher price and wage inflation than its trading partners.
The ratings on Slovenia reflect the country's educated workforce, its eurozone membership, and the benefits the country enjoys from the European Central Bank's (ECB's) monetary policy as a small open economy. The ratings also reflect Slovenia's strong external performance, driven chiefly by its export-oriented manufacturing sector, as well as sound fiscal results. We also factor into our ratings Slovenia's high GDP per capita, strong recent growth rates, and the broad stability and effectiveness of the country's institutional framework.
Institutional and Economic Profile: Growth is set to moderate slightly, as focus shifts to domestic demand
• We project Slovenia's economic expansion will moderate to 3% on average over 2019-2021, following a brisk expansion in 2017-2018.
• Despite increasing external demand uncertainties, export growth continues to exceed headline GDP, as does investment growth (since last year).
• The government comprises five parties with different policy priorities following this year's elections, but we expect broad policy continuity in the next two to three years.
Over the next few years, however, there are grounds for cautious optimism. Despite slowing eurozone growth, Slovenia's exports continued to rise at an elevated pace in the first three quarters of 2018, alongside rising imports. Exports of goods and services now make up over 85% of GDP compared with 70% in 2011. At the same time, investment growth continues to be buoyant, with investments rising in the construction segment as well as in machinery and equipment, which confirms resilient confidence in Slovenia's export-oriented manufacturing sector. Despite a tightening labour market, private consumption has, in contrast, remained sluggish. This partly reflects subdued wage inflation of 3% year on year (yoy) in Q3, 2018, alongside households' high propensity to save. Despite this, we still expect a pickup of private consumption commencing in 2019, supported also by a somewhat looser fiscal stance.
While a relatively high concentration of automotive-related exports remains a risk, we think that the third-quarter slowdown in manufacturing, especially in Slovenia's auto sector, could prove temporary. As there was a similar slowdown in other countries, notably in Germany, related to the implementation of new emission standards, we anticipate that manufacturers will makeup delayed production toward year-end. Capacity utilisation rates in the Slovenian auto sector remain high.
During the third quarter of this year, the unemployment rate fell to 5%. Nonetheless, nominal wage growth has remained sluggish, at just 3% yoy in the third-quarter of 2018. During the summer months, rising immigration from neighbouring countries accounted for more than half of the total employment increase. These workers, traditionally from former Yugoslavian countries, are often employed in sectors with below-average wages, such as construction.
Other medium-term macroeconomic risks include rising real estate prices, given the inadequate supply response to high demand. The Harmonized Index of Consumer Prices indicated that inflation rose to 2.3% in October, chiefly driven by external price developments. We think that inflation will largely remain in line with the eurozone average, and the tightening labour market could drive core inflation up from its current level of around 1%, when wages pick up.
The outcome of the June parliamentary elections reflects the fragmentation of Slovenia's political landscape, with nine parties represented in parliament. The new coalition government consists of five parties and policymaking could be complicated by diverging opinions among coalition partners. However, we think that overall policy consensus is ensured, for example regarding fiscal policies. Progress might be slower in key reform areas such as health care, pensions, and long-term care. Further privatisation of government-owned entities is also likely to be unhurried because of limited approval from the electorate and in the political realm.
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. Progress on structural reforms and on reducing the state's role in the economy is likely to be sluggish. This could potentially slow Slovenia's economic restructuring and prevent a more efficient allocation of resources in the economy, with negative implications for future economic growth.
Flexibility and Performance Profile: Fiscal and external balance sheets have significantly improved
• Government debt remains on a firm downward trend.
• We expect that the government will use proceeds from the recent sale of a 60% share in Nova Ljubljanska Banka (NLB) to reduce debt.
• We expect that the current account will remain in a surplus exceeding 6% of GDP on average in 2018-2021.
We project end-2018 net general government debt at 53% of GDP in 2018 versus 62% two years ago. In November, the government sold 60% of the country's largest lender, state-owned NLB, with an option to extend the sale to 65% depending on the performance of stabilisation activities. We expect that the government will use 90% of the sale revenues for debt reduction, which decreases net general government debt by over 1 percentage point of GDP. In line with its commitments to the European Commission, we anticipate that the state will further decrease its share in NLB to 25% by the end of next year, and corresponding sales revenues will further contribute to debt reduction.
We think that contingent liabilities related to large government-related entities (GREs) are still sizable, although we note that government guarantees are on a declining trend. Moreover, Slovenia's strong economic performance also benefits the financial performance of its GREs and hence mitigates the risk for the government.
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 Co. (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).
For 2019, we expect another small surplus as strong cyclical revenue growth will surpass expenditure growth. Therefore, higher expenditures for example on social spending or public sector wages, but also on investments coupled with higher EU fund absorption, will not endanger the goal of a small surplus, as buoyant employment growth supports tax revenues. We also note that Slovenia's primary balance is set to remain positive until 2021.
Nonetheless, we anticipate spending pressures to rise, resulting in contained general government deficits in 2020-2021 according to our projection. That said, we think that the new government will respect Slovenia's fiscal rules, which set limits for general government expenditure. Despite currently sound nominal fiscal results, ongoing and upcoming budget discussions will be an indicator for the fiscal policy trend in the coming years, and we expect disagreements with the European Commission over Slovenia's structural fiscal effort to drag on. The commission and the authorities have different views on the approach that determines the structural fiscal effort required by Slovenia.
The authorities' success in lowering the interest bill on government debt, supported by the interest rate environment and accommodative monetary policy, has supported fiscal performance. Slovenia reduced its interest payments relative to revenues to below 5% on average in 2018-2021 down from over 7% in 2014-2016. Active debt-management exercises over the past few years have helped lock in favourable interest rates.
Slovenia's high current account surpluses have enabled the Slovenian economy to improve its external balance sheets substantially. This, coupled with the export- rather than credit-driven growth in recent years is a key difference to the pre-crisis growth phase that led to the build-up of macroeconomic imbalances. Driven by resilient performance of Slovenia's competitive export-oriented manufacturing sector, and rising services exports, the current account surplus will average around 6% of GDP in 2018-2021. Rising domestic demand and imports related to EU structural funds will contribute to a slight decline over the forecast horizon. That said, Slovenia is exposed to external macroeconomic risks via its exports. For example, Italy remains Slovenia's second most important trading partner, but we think that risks through trade or financial sector linkages are relatively low, due to Slovenia's economic and export diversification.
*This article is a fragment of the report: "Slovenia 'A+/A-1' Ratings Affirmed; Outlook Remains Positive".