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Supply Chain Risk

Research: Rating Action: Moody’s changes Slovakia’s outlook to negative from stable; affirms A2 ratings



Frankfurt am Main, August 05, 2022 — Moody’s Investors Service (“Moody’s”) has today changed the outlook on the Government of Slovakia to negative from stable. Concurrently, Moody’s has affirmed the foreign and domestic currency senior unsecured and long-term issuer ratings at A2.

The decision to change the outlook on Slovakia to negative from stable reflects the country’s significant energy dependence on Russia. Given Slovakia’s large industrial sector and high interconnectedness with the rest of the European Union (EU, Aaa stable), a permanent reduction in gas supply from Russia has the potential to significantly weaken the country’s economy which would, in turn, negatively affect Slovakia’s public finances and compound pre-existing structural challenges such as population ageing.

The affirmation of the A2 ratings reflects the country’s solid economic strength, in line with peers institutions, solid fiscal metrics and moderate exposure to event risks.

Slovakia’s local and foreign currency country ceilings remain unchanged at Aaa. For euro area countries, where applicable, 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. It also reflects our view of de minimis exit risk from the euro area.

RATINGS RATIONALE

RATIONALE FOR CHANGING THE OUTLOOK TO NEGATIVE FROM STABLE

The decision to change the outlook on Slovakia to negative reflects the country’s significant energy dependence on Russia. As a landlocked country, Slovakia imports all its oil and 75% of its gas from Russia. As a result, Russian imports accounted for 57% of Slovakia’s energy mix in 2020, well above the European average of 24.4%. [1] Home to a large manufacturing sector (22.2% of GDP in 2021 against 17.5% in the euro area), [2] Slovakia’s economy is hence particularly exposed to severe energy supply disruptions: an abrupt cut from Russian gas deliveries, the likelihood of which has increased over the past few months, could lead to energy rationing. In this context, a subsequent significant reduction or halt in energy-intensive industrial production could be imposed, which would raise the risk of an economic recession in the next few quarters.

Given Slovakia’s interconnectedness with the rest of the European Union, which accounts for around three quarters of the country’s total exports, an economic downturn in the region would further intensify negative pressures on Slovakia’s economic activity. In a highly uncertain environment, Moody’s forecasts Slovakia’s real GDP to grow by 1% this year, followed by 1.3% in 2023, well below the country’s long-term average (3.8% GDP growth between 2000 and 2019). Risks are firmly to the downside, with rising inflation reducing consumers disposal incomes and corporate margins.

Beyond its immediate negative impact, a permanent cut in gas supply would significantly weaken Slovakia’s potential GDP growth outlook, currently estimated at 2.8% for 2023 by the European Commission. Permanent output losses due to firms inability to adjust to the new energy landscape would negatively affect Slovakia’s public finances, with lower revenues and higher spending as the government would extend support to the economy. This would, in turn, raise Slovakia’s gross borrowing needs and public indebtedness and compound pre-existing structural challenges such as population ageing.

Moody’s notes the efforts deployed by the Slovak authorities to diversify energy sources and to ensure an adequate supply ahead of the 2022-2023 winter season. At the domestic level, the government is implementing a plan to reduce Slovakia’s exposure to Russian energy imports by two thirds, partly by booking capacity in several European liquefied natural gas (LNG) terminals and importing Norwegian gas. According to the authorities’ estimate, the supply via LNG gas tankers would cover 34% of annual gas consumption in Slovakia, while the import of Norwegian gas would cover additional 32% of annual gas consumption.

As a further mitigant, current levels of gas storage are relatively high at 68.8% of total capacity, against 70.2% at the EU level, and 43.3% of annual consumption, against 18.7% at the EU level. [3] At the European level, Slovakia is fully engaged with its EU partners to find joint solutions to achieve energy security, partly by reducing demand as agreed by the EU Council on July 26. Finally, together with other EU countries, Slovakia benefits from crude oil delivered by pipeline being temporary exempted under the sixth wave of sanctions against Russia, which means the country’s short-term supply of oil is unlikely to be affected over the next year.

RATIONALE FOR AFFIRMING THE A2 RATINGS

The affirmation of Slovakia’s A2 ratings reflects the country’s solid economic strength, with high per-capita GDP levels, dynamic trend growth and moderate size. The A2 ratings also reflect Slovakia’s institutional strength being in line with that of peers, balancing the benefit of EU and euro area membership with challenges in the areas of rule of law and control of corruption. Slovakia’s fiscal metrics are also solid, with a moderate debt burden and strong debt affordability metrics. Finally, Slovakia’s susceptibility to event risk is driven by political risk, which has risen in Europe following the Russian invasion of Ukraine.

The affirmation of the A2 ratings also reflects Slovakia’s ongoing reform and investment projects in the context of the National Recovery and Resilience Programme (NRRP). Amounting to around 7% of GDP overall, the grant component of the NRRP comprises 58 investments and 58 reforms. In October 2021, Slovakia benefitted from the 13% pre-funding tranche worth EUR 823 million (or 0.8% of GDP). Since then, the European Commission endorsed Slovakia’s first performance-based funding tranche on June 27. Amounting to EUR 398.7 million (or 0.4% of GDP), the successful request reflects the completion of 14 milestones reforms in the following areas: judicial system, higher education and R&D, the fiscal framework, the energy system, sustainable mobility, anti-corruption, and the digitalisation of the country’s public sector. [4]

Regarding the pension reform, a key credit question given Slovakia’s ageing population, a draft bill to ensure the system’s long-term sustainability is currently being discussed in parliament. The main measure proposed links the increase in the retirement age to the increase in life expectancy. In addition, pensions will grow at 0.95 times the increase in average wages, which would slow pension spending growth. According to the authorities, the reform would improve long-term sustainability by around 3 percentage points of GDP. The adoption of the proposed cost-saving measures would be credit positive, helping to mitigate the impact of ageing on Slovakia’s public finances. However, Moody’s notes that the legislation and effective implementation of the reform remains at this stage uncertain.

Overall, while the Slovak authorities are committed to making progress on the programme of investments and reforms, effective implementation will require a long-haul effort. Given the combination of a relatively low absorption rate of EU funds, a high rate of irregularities regarding EU fund payments, a fractious political landscape and limited administrative capacity, Moody’s expects Slovakia to reap the benefits of NGEU only gradually.

ENVIRONMENTAL, SOCIAL AND GOVERNANCE CONSIDERATIONS

Slovakia’s ESG Credit Impact Score is neutral-to-low (CIS-2), reflecting low exposure to environmental risk and moderately negative exposure to social risks, as well as a strong governance profile.

Slovakia’s overall E issuer profile score is neutral-to-low (E-2), reflecting low exposure to environmental risks across all categories.

Slovakia’s S issuer profile score as moderately negative (S-3), reflecting low exposure to social risks across most categories. The primary exception is demographics, where population ageing continues to pose risks to the country’s long-term growth potential and fiscal sustainability.

Slovakia receives a positive G issuer profile score of (G-1). Although concerns remain about the control of corruption in Slovakia, Moody’s generally views the country’s institutional environment as being strong, supported by its membership of the EU and euro area.

The publication of this rating action deviates from the previously scheduled release dates in the EU sovereign calendar published on https://ratings.moodys.com. This action was prompted by the recent significant drop in Russian gas deliveries and the increased risk of further cuts in the coming months.

GDP per capita (PPP basis, US$): 35,463 (2021) (also known as Per Capita Income)

Real GDP growth (% change): 3% (2021) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 5.1% (2021)

Gen. Gov. Financial Balance/GDP: -6.2% (2021) (also known as Fiscal Balance)

Current Account Balance/GDP: -2% (2021) (also known as External Balance)

External debt/GDP: 132.5% (2021)

Economic resiliency: a3

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 03 August 2022, a rating committee was called to discuss the rating of the Slovakia, Government of. The main points raised during the discussion were: The issuer’s economic fundamentals, including its economic strength, have not materially changed. The issuer’s institutions and governance strength, have not materially changed. The issuer’s fiscal or financial strength, including its debt profile, has not materially changed. The issuer’s susceptibility to event risks has not materially changed.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

WHAT COULD CHANGE THE RATINGS UP

The negative outlook suggests an upgrade is unlikely in the near term. The outlook could be changed to stable if energy supply tensions with their economic and fiscal implications were to abate. A successful and swift implementation of the diversification strategy leading to a permanent reduction in dependence on Russian energy imports would also support a stable outlook. Finally, evidence that the energy cuts do not lead to permanent negative effects on Slovakia’s economic and fiscal metrics would be credit positive.

WHAT COULD CHANGE THE RATINGS DOWN

Slovakia’s ratings could be downgraded were energy constraints leading to permanent output losses, fundamentally altering the country’s economic strength. A weaker economy would, in turn, negatively affect Slovakia’s fiscal metrics via the automatic stabilizers and the government’s likely response to support the economy. Failure to diversify energy sources would weigh on Moody’s assessment of institutions and governance in Slovakia and exert downward pressure on the ratings. In addition, a significant rise in the event risk exposure would also be rating negative. While a rather remote scenario in Moody’s view, an escalation of the Russia-Ukraine military conflict into a war involving NATO members would exert very significant downward rating pressure.

The principal methodology used in these ratings was Sovereign Ratings Methodology published in November 2019 and available at https://ratings.moodys.com/api/rmc-documents/63168. Alternatively, please see the Rating Methodologies page on https://ratings.moodys.com for a copy of this methodology.

The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.

REGULATORY DISCLOSURES

For further specification of Moody’s key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody’s Rating Symbols and Definitions can be found on https://ratings.moodys.com/rating-definitions.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody’s rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider’s credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the issuer/deal page for the respective issuer on https://ratings.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody’s Policy for Designating and Assigning Unsolicited Credit Ratings available on its website https://ratings.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Moody’s general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://ratings.moodys.com/documents/PBC_1288235.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody’s affiliates outside the UK and is endorsed by Moody’s Investors Service Limited, One Canada Square, Canary Wharf, London E14 5FA under the law applicable to credit rating agencies in the UK. Further information on the UK endorsement status and on the Moody’s office that issued the credit rating is available on https://ratings.moodys.com.

REFERENCES/CITATIONS

[1] Eurostat 04-Aug-2022

[2] Eurostat 04-Aug-2022

[3] AGSI+, https://agsi.gie.eu/ 04-Aug-2022

[4] European Commission, Recovery and Resilience Scoreboard, https://ec.europa.eu/economy_finance/recovery-and-resilience-scoreboard/index.html 04-Aug-2022

Please see https://ratings.moodys.com for any updates on changes to the lead rating analyst and to the Moody’s legal entity that has issued the rating.

Please see the issuer/deal page on https://ratings.moodys.com for additional regulatory disclosures for each credit rating.



Olivier Chemla

Vice President – Senior Analyst

Sovereign Risk Group

Moody’s Deutschland GmbH

An der Welle 5

Frankfurt am Main, 60322

Germany

JOURNALISTS: 44 20 7772 5456

Client Service: 44 20 7772 5454


Alejandro Olivo

MD-Sovereign/Sub Sovereign

Sovereign Risk Group

JOURNALISTS: 44 20 7772 5456

Client Service: 44 20 7772 5454


Releasing Office:

Moody’s Deutschland GmbH

An der Welle 5
Frankfurt am Main, 60322

Germany

JOURNALISTS: 44 20 7772 5456

Client Service: 44 20 7772 5454

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