OREANDA-NEWS. Fitch Ratings has affirmed Slovenia's Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'BBB+'. The Outlooks on the Long-term IDRs are Stable. The issue ratings on Slovenia's senior unsecured foreign and local currency bonds are also affirmed at 'BBB+'. The Country Ceiling is affirmed at 'AA+' and the Short-term foreign currency IDR at 'F2'.

KEY RATING DRIVERS

Slovenia's 'BBB+' IDRs and Stable Outlook reflect the following key rating drivers:

-Previous government interventions have reduced the sovereign's vulnerability to the banking sector. The aggregated Tier 1 capital ratio was 15.9% in September 2014, up from 10.2% at end-2012. Transfers of impaired assets to the Bad Asset Management Company (BAMC) have led to a decline in non-performing loans (over 90 days past due) to 11.6% in January 2015 from 18.1% in November 2013. The health of the banking sector remains fragile but Fitch believes the risks posed by the financial sector to government finances and the economy have reduced significantly.

-In 2015, Fitch expects the fiscal deficit will be 3% of GDP, smaller than 5.3% in 2014, due to expenditure restraint and efficiency gains on tax revenues. Crucially Fitch assumes that there will be no new budget support for banks in 2015 (after it cost the budget 9.5% of GDP in 2013 and 1.9% in 2014). The set-up of the bank resolution fund (totalling EUR350m and financed by banks) should help protect the budget from potential bank support.

-General government gross debt (82% of GDP in 2014) is much higher than the peers' median (41%), partly as a result of substantial interventions to support the banking sector. Debt is set to peak in 2015, at 83% of GDP, before declining, consistent with a tightening fiscal policy, real GDP growth of 2% and a recovery in inflation towards the 2% target. Debt reduction could benefit from a lower cash balance (government deposits are high, at 11.6% of GDP at end-2014) and the allocation of 90% of the proceeds from future privatisations.

-Five-year average GDP growth of 0.2% p.a. is much weaker than the 'BBB' range median of 3% or the 'A' range median of 3.2%, partly reflecting Slovenia's recent banking crisis. Unemployment, at 9.7% in 2014 (annual average), is also high versus peers. However, GDP grew 2.6% in 2014, after contracting 1% in 2013. The rebound was primarily driven by high exports (+6.3%) and investment (+3.6%), supported by exceptionally high European Union fund disbursement.

Fitch expects growth to remain around 2% in the medium term, supported by a gradual improvement in the external environment and in domestic demand, in line with the clean-up in banks and corporates' balance sheets.

-The combination of high current account surpluses and private external debt deleveraging is strengthening external metrics from a weak position. Fitch expects the current account surplus to have been 5.9% of GDP in 2014, supported by improved cost competitiveness, and to remain around 5% in the medium-term. Net external debt, at 35.4% of GDP in 2014, is still high relative to the 'BBB' median (7.9% of GDP) but down markedly from 42.4% in 2012. Fitch expects it will reach 18.7% of GDP by 2016.

-Income per head in purchasing power parity, indicators of human development and governance are much higher than the 'BBB' peers' median, reflecting Slovenia's fairly high value-added economy and membership to the European Union.

RATING SENSITIVITIES

The main factors that could lead to a positive rating action are:

-Budget deficit reduction consistent with government debt on a firm downward path

-Progress in the clean-up of bank and corporate balance sheets

-Sustained economic recovery supported by structural reforms

The main factors that could lead to a negative rating action are:

-Deterioration in government debt metrics

-Sustained macroeconomic underperformance and/or deterioration of financing conditions relative to Fitch's expectations

KEY ASSUMPTIONS
Given the uncertainties involved, Fitch does not assume a contribution from the realisation of returns on distressed assets held on BAMC's balance sheet for its government debt projections. Likewise, Fitch does not take into account potential debt reduction from privatisation proceeds.

The European Central Bank's asset purchase programme should help underpin inflation expectations and support our base case that, in the context of a modest economic recovery, the eurozone will avoid prolonged deflation.

Fitch also assumes gradual progress in deepening financial integration at the eurozone level and that eurozone governments will tighten fiscal policy over the medium term.