OREANDA-NEWS. September 29, 2015. Fitch Ratings has revised Slovenia's Outlook to Positive from Stable, while affirming its Long-term foreign and local currency IDRs at 'BBB+'. 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
The revision of Outlook to Positive reflects the following key rating drivers and their relative weights:

Medium

Fitch expects the newly adopted fiscal rule to support structural budget tightening, putting the debt ratios on a more firmly downward path over the medium term, although potential divergence within the ruling coalition poses implementation risk. Fitch expects the government deficit to tighten to 2.5% of GDP by 2017 from 3% in 2015 and 4.9% in 2014, primarily due to improved cyclical conditions (4M15 tax revenue up 8.2% y/y). Our budget forecast assumes no further government support to banks, following stabilisation of the sector and the introduction of the new bank resolution fund (EUR350m).

After a sharp increase in recent years, Fitch expects government debt will peak in 2015, at 81.8% of GDP (from 22% in 2008) before slowly declining due to gradual fiscal tightening and growing nominal GDP. Proceeds from future privatisations could lead to lower debt than Fitch's baseline scenario. The share of non-residents' holding of government debt has markedly increased to 62% of GDP in 2014 from 29% in 2009, increasing exposure of government finances to global financial volatility.

Following government interventions, banks' capacity to resist shocks has improved considerably. Non-performing loans are still high, at 11.1% in July 2015, but down from a peak of 17.3% in November 2013, largely reflecting transfers to the bad bank. Capital ratios were 17.9% at end-2014, up from 11.4% in 2012. As deleveraging continues apace, Fitch expects bank credit to the private sector to contract 2% in nominal terms in 2015 and stabilise in 2016, removing a heavy drag on domestic demand.

The current account has switched to surplus from deficit, due to stronger exports following gains in competitiveness, weaker domestic demand relative to the pre-2008 period, lower oil and commodity prices, and reduced external interest repayments. Fitch expects the current account surplus will remain above 5% of GDP in 2017 after 7% in 2014 and a deficit of 2.3% on average in 2005-2010.

Slovenia's 'BBB+' IDRs also reflect the following key rating drivers:-

Membership to the EU underpins political stability and institutional strengths. Governance is much stronger than peers as illustrated by its World Bank indicators. GDP per capita is also high relative to similarly rated peers' median.

Gross and net external debt is higher than peers', reflecting private sector external borrowing before 2008 and government borrowing since then.

Slovenia's growth has been weak relative to the 'BBB' median in recent years, as the country was exposed to the eurozone crisis and its own domestic banking crisis. Unemployment, which we forecast at 9.4% on average in 2015, is high relative to 'BBB' peers.

GDP growth is recovering after a deep recession. Fitch expects real GDP will grow 2.3% in 2015 after 3% in 2014, driven by exports, private consumption (with unemployment down at 9.2% in 2Q15 from a peak of 11.1% in 1Q13) and a rebound in government investment. We forecast GDP growth will remain above its potential 2% growth rate but decelerate to 2%-2.5% by 2017 as a result of lower disbursements of structural funds from the EU. External trade will continue to contribute to growth as the euro zone gradually strengthens.

The ruling coalition in place since September 2014 has a narrow majority and unites parties with different political agendas. The coalition has, however, been able to agree on key reforms, such as the fiscal rule act and the privatisation of the second-largest bank to be completed by end-2015. The new institutional framework for privatisations should minimise political interference and support future privatisations .

RATING SENSITIVITIES
The main factors that could lead to a positive rating action are:
-Shrinking budget deficit consistent with government debt on a firmly downward path
-Progress in the clean-up of bank and corporate balance sheets
-Sustained economic recovery supported by structural reforms
The rating Outlook is Positive. Consequently, Fitch's sensitivity analysis does not currently anticipate developments with a material likelihood of leading to a downgrade. However, deterioration in government debt metrics or sustained macroeconomic underperformance could lead to negative rating pressure.

KEY ASSUMPTIONS
Given the uncertainties involved, Fitch does not assume a contribution from the realisation of returns on distressed assets held on the bad bank's balance sheet for its government debt projections. Likewise, Fitch does not take into account potential debt reduction from privatisation proceeds.
Fitch expects the global economy to perform broadly in line with assumptions set in its Global Economic Outlook (July 2015), in particular eurozone GDP growth, Slovenia's main trade partner, to reach 1.6% by 2017, up from 0.9% in 2014.
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