Morningstar DBRS Confirms Ratings on Slovakia at "A", Negative Trend

DBRS Ratings GmbH (Morningstar DBRS) confirmed the Slovak Republic's Long-Term Foreign and Local Currency - Issuer Ratings at "A". The trends on the long-term ratings remain Negative. At the same time, Morningstar DBRS confirmed the Slovak Republic's Short-Term Foreign and Local Currency - Issuer Ratings at R-1 (low). The trends on the short-term ratings remain Stable.

KEY CREDIT RATING CONSIDERATIONS
The Negative trend on the long-term credit ratings reflects the risks related to Slovakia's structurally large fiscal deficit, despite the government's fiscal consolidation plan adopted in October 2024. While the plan introduces 1.9% of GDP in consolidation measures that improve our budgetary assumptions and signals the government's strong commitment to improving budgetary outcomes, there remains a lack of specificity around how the country will reach its medium-term targets. The European Commission (EC) expects the fiscal deficit to decline from 5.7% of GDP in 2024 to 4.1% in 2026. Further out in the forecast horizon, there remains a large divergence between deficit projections and targets. The Slovak economy overperformed European neighbours in recent years thanks to investment spending linked to EU funds. Strong employment and a recovery in private consumption should keep economic output sound even as tighter financial conditions, weaker performance from Euro area (EA) peers, and geopolitical uncertainty weigh on growth prospects.

The confirmation of the credit ratings reflects the country's sound macroeconomic features. Slovakia attracts high-quality foreign investment and is well integrated into the European supply chain. The country's credit profile also benefits from its membership of the European Union (EU) and the EA and thus deep integration with major European economies, particularly Germany. These factors have been key to Slovakia's economic catchup process in the years since joining the EU. The country's credit strengths offset structural weaknesses, including its small economy, high reliance on exports, regional disparities, and adverse demographics. Even with the determined consolidation plan, the government will likely need to replicate the effort to rein in budget deficits over the forecast period.

CREDIT RATING DRIVERS
The trend could revert to Stable if the government implements a medium-term consolidation plan. Over time, Morningstar DBRS could upgrade the credit ratings if a substantially improved budget position and sustained economic growth lead to a significant reduction in the public debt ratio and the deteriorating trend in government effectiveness is reversed. Alternatively, the credit ratings could be downgraded if measures are not introduced to rein in high budget deficits and stabilise the public debt ratio, or if there is evidence of structural deterioration in Slovakia's economic performance.

CREDIT RATING RATIONALE

Government Consolidation Plan Improves Near-Term Fiscal Outcomes; Structural Imbalances Remain Wide
The government introduced a substantial fiscal consolidation package in 2024 that has altered our near-term expectations. The fiscal deficit widened from 1.2% of GDP in 2019 to an estimated 5.7% in 2024. Public finances over this period were adversely affected by the compounding macroeconomic disruptions, temporary government support measures to mitigate the economic and social impact of the pandemic and the energy price shock, and more permanent social and defence spending. The program expands revenue, primarily by increasing the VAT by three percentage points to 23%, the introduction of a financial transaction tax, higher corporate income tax for larger corporates, and various other tax and fee measures. The plan results in roughly 1.9% of GDP in budgetary savings thus far, and the government's plan expects the deficit to decline by 1pp of GDP to 4.7% in 2025. Morningstar DBRS is of the view that the government's recent fiscal effort is an important step towards its commitment to reach the 3.0% of GDP fiscal target by 2027.

However, for the government to attain its medium-term objective, Morningstar DBRS considers that additional significant fiscal consolidation will likely be required. The Council for Budget Responsibility (RRZ), Slovakia's fiscal watchdog, says an additional 2.0% of GDP (EUR 3.1 billion) in fiscal savings is needed to meet the 2027 target. RRZ expects the structural fiscal deficit to persistently deteriorate under current assumptions, from 4.5% of potential GDP in 2025 to 5.4% by 2028.

The Public Debt Ratio Gradually Increases Over The Forecast Period

Slovakia's gross government debt-to-GDP ratio increased from 48.0% prior to the pandemic to 61.0% in 2021 because of large fiscal measures to support the public and the economy, and a sizeable increase in liquid assets. The cyclical economic recovery and high inflation deflated the debt ratio in the subsequent years, although the wide structural fiscal deficits prevent debt dynamics from improving over the next few years. The EC forecasts the debt ratio will increase from 58.5% in 2024 to 61.6% by 2027, stabilizing thereafter. Despite the upward debt trend, debt management in Slovakia has favourable features. The country benefits from a comparatively moderate level of public debt and a sound debt profile with a long average maturity of 8.4 years. Notwithstanding higher interest rates, the cost to service outstanding debt increased to 2.32% in 2024, from 1.85% of GDP in 2023. Ardal, the treasury's Debt and Liquidity Management Agency, manages a prudent liquidity cash buffer of around 7-10% of GDP.

Domestic Demand Remains The Main Driver Of Economic Growth; External Demand More Subdued

Slovakia's economy is set to benefit from higher investments over the next two years due to the disbursement and absorption of EU-funds and declining interest rates. Public investment will also be elevated by materially higher spending on defense equipment. At the same time, we anticipate that private consumption will be supported by robust household incomes over the medium-term. A continued recovery of real wages from the inflationary shock in recent years, higher social transfers and the extension of energy subsidies for households are set to outweigh the consumption-dampening effects from the consolidation package's (in particular the VAT increase) and lingering inflationary pressure. Nevertheless, the continued weak performance of the European manufacturing sector limits the prospects of stronger growth contributions of external demand in the short-term. Slovakia's central bank (NBS) projects real GDP to expand by 2.3% in 2025 and 2.0% in 2026, after an estimated 2.1% in 2024.

Structural challenges to Slovakia's industry-heavy export sector and its ageing workforce are set to weigh on medium-term growth prospects. The country is well integrated into European manufacturing supply chains that are challenged by the adaption to new technologies and the pressures to compete globally. The broad-based introduction of tariffs on exports to the US could be another drag on the country's growth prospects over the medium-term. In contrast, any increase in energy supply from the US to global markets that dampen energy price growth could support private consumption. Slovakia has remained relatively resilient to supply-chains disruptions and the energy supply and price shocks in recent years. The growth rate of Slovakia's economy allows it scope to continue to converge towards the economic wealth levels of EU peers. GDP per capita was 77% of the EU's aggregate level in 2024.

Slovakia's External Balances Benefit From A Recovery In Terms-of-Trade And Continued Inflows Of EU Funds

Weaknesses of Europe's manufacturing sector continued to weigh on Slovakian exports last year. The IMF expects Slovakia's current account deficit to have reached 1.7% of GDP in 2024 and to revert to a 1.4% surplus in 2025, as the terms-of-trade recovers from the energy price shock following the Russia-Ukraine war. A resumption of stronger Slovakian exports later in 2025 and 2026 hinges on an external cyclical recovery of the country's major European trading partners, particularly Germany. Slovakia's share of direct exports to the US amount to just about 3% of total exports, although the effect of tariffs on exports would be felt via the larger indirect trade exposure through major European economies. Slovakia, nonetheless, appears well positioned to manage the transition of its auto industry to electric vehicles. There have been major investments in new EV production capacities, illustrating the country's attractiveness for foreign capital. Slovakia's net international investment position (NIIP) stood at about 51% of GDP in Q3 2024. Though comparatively high, it is comprised mostly of foreign direct investment in the form of equity and deposits. These factors positively affected Morningstar DBRS' qualitative assessment of the "Balance of Payment" building block.

Financial Sector Challenges Are Mitigated By Strong Bank Resilience And Healthy Private Sector Balance Sheets

Price pressure in Slovakia remains more persistent than in the rest of the Euro area. Strong energy prices increased harmonized consumer price inflation (HICP) by over 10% year-over-year during parts of 2022 and 2023. It has moderated to 3.2% as of December 2024, above the 2.4% for the overall Euro area. The country continued to diversify supply away from a formerly heavy reliance on gas imports from Russia. Goods prices remained stable on aggregate basis supported by the administered energy price breaks for households which remained in place throughout 2024 and were extended into 2025. Strong increases in service prices against the backdrop of high wage growth dominated the overall inflation dynamic. The NBS forecasts HICP inflation to accelerate to 4.1% this year, driven by the significant VAT increase. The rate declines to 3.0% in 2026, still above the ECB's 2% medium-term target.

Slovakia's banking system is well-capitalized and stable. Net interest income supported bank profits in 2024, despite the introduction of a national bank levy last year. Credit quality has been resilient to the economic stress stemming from lower growth, high inflation, and higher interest rates. Overall non-performing loans was 2.0% of total loans as of September 2024. Likewise, banks operating in Slovakia have capitalization and coverage ratios above the EU average and would therefore be equipped to absorb eventual losses. Property prices have recovered after a gradual contraction from the third quarter of 2022 through to the first quarter to 2024. Risks to financial stability are moderated by generally low household debt at 42% of GDP in the third quarter of 2024 and the NBS' strong macroprudential framework. Bank capital is reinforced by the countercyclical capital buffer rate at 1.5%.

The Volatility Of Slovakia's Politics And The Weakening Of Key Governance Scores Limit Policy Continuity

Slovakia held an early parliamentary election in September 2023, which resulted in another fragmented political outcome. The Direction - Slovak Social Democracy (SMER-SD) party emerged as the largest party by winning 42 seats, followed by Progressive Slovakia (PS - 32 seats) and Voice - Social Democracy (HLAS-SD - 27 seats). The coalition government formed by SMER, HLAS, and Slovak National Party (SNP - 10 seats) and led by Prime Minister Robert Fico was sworn in on October 25, 2023. Slovakia's performance in Transparency International's corruption perceptions index (47th out of 180 countries in 2023), has moderately improved in recent years. Still, Slovakia is a weaker performer compared to similarly rated European peers on the World Bank governance indicators, including the percentile rank scores for the rule of law (68.9) and voice and accountability (76.5). These trends negatively affect Morningstar DBRS' qualitative assessment of the "Political Environment" building block. Improvement in these areas, among many other benefits, could enhance the country's historically low capacity to absorb EU funds¿EU-financed investment subsidies and loans worth about 17% of 2024 GDP¿that are available over the next few years. Morningstar DBRS does not expect Slovakia's divided political environment to dramatically weigh on the progress necessary to receive these EU funds, but implementation delays could occur.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

ESG Considerations had a significant effect on the credit analysis.

Social (S) Factors

The following Social factor had a significant effect on the credit analysis: The Human Capital and Human Rights factor significantly affects Slovakia's ratings. Despite progress with narrowing the EU income gap since Slovakia joined the EU, the country's per-capita GDP remained comparatively low at about USD 26,200 in 2024 compared with its European peers, reflecting a lower level of competitiveness in its workforce. Morningstar DBRS considered this factor in the Economic Structure and Performance building block.

Governance (G) Factors

The following Governance factor had a significant effect on the credit analysis: The Bribery, Corruption, and Political Risks factor is a significant consideration for Slovakia's ratings. DBRS Morningstar considered this factor in the Political Environment building block. Slovakia ranked moderately and in line with peers in the corruption perceptions index (47th out of 180 countries) in 2023 according to Transparency International. The country's percentile rank of governance indicators stood at 68.9 for the rule of law and 76.5 for voice and accountability in 2023, according to the World Bank. The Institutional Strength, Governance, and Transparency factor is a relevant considerations but does not significantly affect the ratings for Slovakia. The government effectiveness score (59.0 percentile rank) and public perception of judicial independence remain low compared to other EU countries, according to the European Commission 2024 Rule of Law Report. This reflects perceptions of interference or pressure from the government and politicians.

There were no Environmental factors that had a relevant or significant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (13 August 2024) https://dbrs.morningstar.com/research/437781.

For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments at https://dbrs.morningstar.com/research/447538.

EURO AREA RISK CATEGORY: LOW

Notes:
All figures are in euros unless otherwise noted. Public finance statistics reported on a general government basis unless specified.

The principal methodology is the Global Methodology for Rating Sovereign Governments (15 July 2024) https://dbrs.morningstar.com/research/436000. In addition Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings https://dbrs.morningstar.com/research/437781 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

The sources of information used for these credit ratings include the Statistical Office of the Slovak Republic, Slovakia Ministry of Finance (National Medium-Term Fiscal-Structural Plan 2025-2028, Budget 2025), Národná Banka Slovenska (Financial Stability Report - November 2024, Economic and Monetary Developments - Winter 2024), European Commission (November Forecast 2024, 2024 Slovakia Country Report, 2024 Rule of Law Report Country Chapter in the Rule of Law in Slovakia - July 2024), Transparency International, The Social Progress Imperative, The Council for Budget Responsibility of Slovakia, Ardal (Investor Presentation November 2024), IMF (World Economic Outlook - October 2024, International Financial Statistics), European Central Bank, Eurostat, Bank for International Settlements, World Bank, and Macrobond. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings to be of satisfactory quality.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, these are unsolicited credit ratings. These credit ratings were not initiated at the request of the issuer.

With Rated Entity or Related Third Party Participation: YES
With Access to Internal Documents: YES
With Access to Management: NO

Morningstar DBRS does not audit the information it receives in connection with the credit rating process, and it does not and cannot independently verify that information in every instance.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and credit ratings are under regular surveillance.

For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key credit rating assumptions can be found at: https://dbrs.morningstar.com/research/447537.

These credit ratings are endorsed by DBRS Ratings Limited for use in the United Kingdom.

Lead Analyst: Jason Graffam, Senior Vice President, Global Sovereign & Financial Institution Ratings
Rating Committee Chair: Nichola James, Managing Director, Global Sovereign Ratings
Initial Rating Date: 22 April 2016
Last Rating Date: 09 August 2024

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