Fitch Affirms Slovakia at 'A '; Outlook Stable
KEY RATING DRIVERS
Slovakia's 'A+ rating is supported by eurozone membership, a proven ability to attract foreign investment and a solid banking sector. The rating is constrained by high level of external debt, volatility in growth and disparities in regional development reflected in a high level of unemployment (11.5% in 2015). Government debt (52.5% of GDP in 2015) has risen above peers as a result of the 2009 economic crisis but Fitch expects it will decline gradually.
Slovakia's 'A+' IDRs also reflect the following key rating drivers:
Fitch estimates GDP growth accelerated to 3.5% in 2015 from 2.5% in 2014, supported by domestic demand in a context of exceptionally high public investment as 2015 was the last year to draw European Union (EU) funds from the 2007-2013 cycle, favourable financing conditions, low inflation (-0.3% on average) and a strong labour market (unemployment rate down 11.5% in 2015 from 13.2% in 2014). From 2016, Fitch forecasts GDP growth will slow to 3.2% and 3.0% in the medium term, in line with its potential.
Fitch expects the government deficit reached 2.7% of GDP in 2015 (from 2.8% in 2014) and will narrow to 2.0% in 2016 and 1.9% in 2017. The tightening reflects the impact of improved economic conditions on revenues, increased tax compliance and a lower level of interest payments and EU funds disbursement. Fitch does not expect a significant tightening of the structural deficit and the agency's base case is Slovakia will miss its EU Medium-Term Objective of reducing its structural deficit to 0.5% of GDP by 2017 from 2.1% in 2015.
Government debt declined to 52.5% of GDP at end-2015 from 53.5% in 2014 as the use of the proceeds from the sale of the state share in Slovak Telekom (EUR800m, 1% of GDP) and the opening of the second pension pillar (0.6% of GDP) reduced the need for new debt issues. Fitch expects government debt will slowly decline, to 47% of GDP by 2022, consistent with some fiscal tightening, real GDP growth around its 3% potential, a recovery in prices towards 2% and continuing low rates on new debt issues.
After a few years of current account surpluses, Fitch expects the current account will be back to deficit, at -1.3% of GDP in 2015 and -0.7% by 2017 from 0.2% in 2014 and 1.9% in 2013. The deterioration primarily reflects the impact of strong domestic demand on imports. External debt has risen in recent years to 89% of GDP in 2015 from 78% in 2010, driven by the increase in non-residents' holdings of government debt as the sovereign issued Eurobonds to fund its growing debt stock. Fitch expects external debt to stabilise.
Banks are relatively strongly capitalised (capital ratio at 17.5% as of 2Q15) and liquid. The sector is predominantly foreign-owned (Austria, Italy) and well-funded locally by a stable deposit base. Fitch estimates bank lending to the private sector grew 11% yoy in 2015. Credit to households has grown rapidly in recent years, at around 13% yoy in 2015. However, households' debt (38% of GDP as of 2Q15) is still low relative to rating peers.
Fitch does not expect a major change in economic and fiscal policy as a result of the March 2016 elections. After a steep increase in government debt during the crisis (debt was 27% of GDP in 2007), political parties broadly agree on the need to tighten public finances. The ruling party Smer of Prime Minister Robert Fico has been in power for the past four years and polls suggest it will win the election, although it might need a coalition partner to reach a majority at Parliament.
World Bank governance indicators on rule of law and control of corruption are weaker than the median for 'A' rated peers.
The Stable Outlook reflects Fitch's assessment that upside and downside risks to the rating are evenly balanced. Nonetheless, the following risk factors could individually or collectively trigger negative rating action:
-A severe economic downturn, for example affecting the automotive industry (which accounts for 39% of total added value and 9% of employment if suppliers are included) that damages fiscal, financial or economic stability.
-Failure to reduce the public debt/GDP ratio in the medium term.
The main factor that could trigger positive rating action is a significantly lower public debt/GDP ratio supported by tighter fiscal stance and stronger GDP growth.
Fitch assumes that under financial stress, support for foreign-owned Slovakian banks would be forthcoming from their parent banks.