On Friday, Moody’s Investors Service affirmed the long-term issuer and senior unsecured bond ratings of Slovenia at A3, while at the same time, maintaining a stable outlook.
The affirmation of Slovenia’s A3 ratings is based on the following key drivers:
- Public finances challenged by the energy crisis and medium-term demographic outlook
- Slovenia’s relative economic resilience to shocks, as reflected in a switch recovery from the pandemic and solid medium-term growth prospects.
Furthermore, Moody’s says that the stable outlook balances Slovenia’s robust economic resilience and solid policy capability as well as favourable debt affordability, with a higher than peers debt burden and the significant challenges posed by the energy crisis and a rapidly ageing population. Moreover, the stable outlook reflects Moody’s expectations that Slovenia’s economic and fiscal metrics will perform in line with similarly rated peers. Also, Moody’s view is that the pension reform is unlikely to make significant progress in the next 12 to 18 months, which poses a credit constraint.
Slovenia’s long-term local and foreign-currency bond country ceilings remain unchanged at Aaa. For euro area countries, a six-notch gap between the local currency ceiling and the local currency rating as well as a zero-notch gap between the local currency ceiling and foreign currency ceiling is typical, reflecting benefits from the euro area’s strong common institutional, legal and regulatory framework, as well as liquidity support and other crisis management mechanisms.
The first driver of the rating affirmation is based on the challenges Slovenia’s public finances face in light of the energy crisis and the adverse medium-term demographic outlook. In 2021, the decline in the debt burden to 74.5% of the GDP from 79.6% in 2020 reflected a reduction in the deficit, as revenues accelerated and pandemic-related expenditures receded. Debt affordability continued to improve in both years, with a decline in the cost of issuance despite higher borrowing needs as the ECB’s very accommodative monetary policy supported euro-area sovereigns. As a result, the interest payments-to-revenue ratio reached 3.7% and 2.8% in 2020 and 2021, respectively. However, Slovenia’s fiscal metrics compare unfavourably to the A3 median due to the country’s higher debt burden, while debt affordability is in line.
Looking ahead, Moody’s forecasts Slovenia’s general government deficit to reach 3.8% of GDP in 2022, 5.6% of GDP in 2023 and 3.5% of GDP in 2024. Revenue growth should remain dynamic, benefitting in the short term from higher inflation. On the spending side, phasing out of pandemic-related support measures is expected to take off 3% of GDP of public spending in 2022 compared to 2021. As a result, Moody’s expects Slovenia’s debt-to-GDP ratio to reach 70.6% in 2022 and 71.2% in 2023.
However, Moody’s believes that risks to the fiscal projection are to the downside considering the elevated uncertainty and the government’s policy response to smooth the impact of the conflict in Ukraine through energy prices on consumers and businesses. The govt. estimates the direct fiscal cost to reach EUR 1.8bn (2.9% of GDP) in 2023. Additionally, the authorities have put forward guarantees and liquidity mechanisms to support energy companies worth around EUR 3.2bn (5.2% of GDP). While these measures do not present a direct cost for the budget, the materialization of adverse scenarios due to further shocks in the energy market would eventually lead to the crystallization of these contingent liabilities onto the government’s balance sheet.
Slovenia’s large cash bugger (16.4% of GDP at the end of Q2 2022) supports the government’s comfortable liquidity position. The forward-looking debt management by Slovene authorities largely shields the country from an abrupt rise in interest payments, with the lengthening of Slovenia’s debt average maturity to 10 years in 2022 from 5.7 in 2013. However, the shift in monetary policy by the ECB will raise Slovenia’s interest payments over time. Under the baseline scenario, Moody’s forecasts Slovenia’s interest-to-revenue ratio to rise from 2.8% in 2021 to 3.3% in 2024, and the interest-to-GDP ratio from 1.2% in 2021 to 1.5% in 2024.
In the medium term, Slovenia’s ageing population represents a substantial challenge for the country’s financial sustainability. According to the 2021 EC ageing report, Slovenia will see the EU’s third largest increase in the total cost of ageing over the next five decades, after Slovakia and Luxembourg: total cost of ageing could reach about 30% of GDP in Slovenia in 20270, up from around 20% of GDP. Because of this, Slovene authorities included a pension reform project in the National Recovery and Resilience programme (NRRP) to ensure fiscal sustainability and adequacy of pensions, as well as a labour market reform to incentivize older workers to stay active for longer. Moody’s doesn’t anticipate a swift implementation of the reform given the topic’s sensitivity and the completion timeline (end of 2024).
The second driver of the affirmation of the rating reflects Slovenia’s economic resilience to a succession of shocks and the country’s support by European Union funds inflows in the context of the Recovery and Resilience Facility (RRF) and the regular funding under the 2021 – 2027 cohesion policy.
Before the pandemic, the reduction in Slovenia’s macroeconomic imbalances had enhanced economic actors’ shock absorption capacity, as reflected in more robust balance sheets for households and corporates, and significantly sounder financial institutions amid the authorities’ large-scale recapitalization and privation programme.
Against this backdrop, the 2020 pandemic-induced recession, with a 4.3% drop in real GDP, was mild and short-lived, followed by a robust 8.2% rebound in 2021. Moody’s forecasts Slovenia’s real GDP to expand by 5.5% in 2022. Domestic demand and export services have supported the recovery, with private consumption benefitting from the rebound in the tourism sector as both domestic and international travelling resumes. Data for January to August 2022 show that overnight stays reached their 2019 levels. The rise in employment and investment activity is also supporting domestic demand.
However,r in the context of the war in Ukraine, the balance of risks tilted to the downside. While Slovenia’s energy dependence on Russia is relatively low, high gas and oil prices, coupled with rising food, goods and services inflation is negatively affecting household incomes and corporate margins. Moody’s forecasts Slovenia’s average inflation to reach 7.6% this year, mainly driven by energy and food prices.
In 2023 and 2024, Moody’s expects Slovenia’s real GDP growth to reach 1% and 1.8%, respectively, below the economy’s potential of around 2.5%. At the same time, average inflation is expected to reach 7% and 3.3% in 2023 and 2024, respectively. This projection assumes a significant slowdown in the euro area, Slovenia’s main export market. Domestically, the forecast assumes gradual implementation of public investments under the RRF, with public investment set to reach above 6% of GDP in 2023, well above the 1995-2021 average of 4% of GDP. Under the RRF, Slovenia is set to benefit from EUR 2.2bn (4.2% of GDP), including EUR 1.5bn in grants and EUR 0.7bn in loans. This comes in addition to EUR 3.3bn in EU cohesion policy funds for the 2021-2027 period.
As a result, Slovenia’s potential growth will likely be driven by capital investment and total factor productivity in the coming years. Overall, potential growth in Slovenia is estimated by the EC and the govt. to hover between 2.5% and 3% and has been largely unaffected by the pandemic.
Lastly, Moody’s commented on the factors that could lead to an upgrade or downgrade of ratings. To get an upgrade, the following would have to happen: There would have to be a firm decline in Slovenia’s debt burden, reflecting a steady reduction in the deficit despite the impact on public spending of higher interest rates. The adoption of a pension reform clearly mitigating the consequences of ageing on public finances would be credit positive, as would policies raising the participation of workers above 55 years in the labour force.
On the other hand, things that would lead to a downgrade are the following: If Moody’s sees a sustained weaker-than-expected economic performance against the backdrop of the energy crisis in Europe. In such a scenario, evidence of permanent scarring would compound pre-existing challenges for Slovenia’s public finances, raising the likelihood of a significant increase in the debt trend. In the context of the pension reform, unfinanced new benefits implying additional budgetary costs would be credit negative.
