Three days before Christmas, international rating agency Fitch IBCA became the third major agency to downgrade Slovakia's rating in 1998. Government officials and economic analysts predicted, however, that the Fitch announcement would have little effect on the nation's borrowing ability, and that Slovakia's reputation would improve once an austerity package announced by the new government started to take effect.
"Fitch was only following the crowd," said ING Barings senior analyst Martin Barto, referring to ratings downgrades by the Moody's and Standard & Poor's agencies earlier in 1998. "We had a meeting with Fitch representatives on November 25, and the downgrade came so soon after the formation of the new government [on October 29] that it does not reflect strongly on the new cabinet's policies."
Fitch knocked Slovakia's long-term foreign currency rating down to 'BB+' from 'BBB-' on December 22. In addition, the country's short-term foreign currency rating was lowered to 'B' from 'F3' and the local currency rating was dropped to 'BBB+' from 'A-'. All the ratings categories were removed from Fitch's Rating Alert negative designation.
In explaning its decision, the agency recognised that recent elections had brought to power a government determined to strengthen democratic standards and rebuild relations with the international community. However, although the new government had moved quickly to address political issues, the agency warned that the fragility of the economic situation it has inherited should not be underestimated.
Deputy Prime Minister for Economy Ivan Mikloš agreed that the downgrading was merited. "Every economy has its inertia," he said. "We are now harvesting a crop of mistaken economic policies that were in operation here over the last few years." Mikloš added that he expected the agency would change its tune once the economic policies of the new cabinet began to take effect.
Under the previous administration of Prime Minister Vladimír Mečiar, the agency said, fiscal discipline was abandoned while corporate and bank sector restructuring processes were allowed to stall. As a result, Slovakia's export performance declined and a large current account balance deficit ensued.
In the past few years, Slovakia has been able to finance these persistent current account deficits with foreign loans. Nonetheless, this has come at the cost of a rise in external debt ratios, thereby eroding one of the economy's key credit strengths.
In light of the deterioration in the international economic environment since the third quarter of 1998, Fitch wrote, the task of meeting the nation's total financing needs for 1999 - likely to exceed $3 billion - has become complicated. Appetite for Slovak risk has been further moderated by the financial problems that are emerging at some of the largest corporations, such as steel-maker VSŽ.
Finance Minister Brigita Schmögnerová confirmed that the VSŽ crisis had affected the downgrade decision. "Representatives of senior foreign financial houses during negotiations with the Slovak cabinet said very openly that the situation at VSŽ created a very unfavorable climate for the restructuring of loans within the corporate sector," she remarked.
The key risk, according to Fitch, is that external imbalances and corporate problems will bring a loss of international market confidence, which will in turn force Slovakia into an external financing crisis. The country's international liquidity position - though still relatively comfortable - has steadily weakened as successive attacks on the currency have taken their toll on international reserves. This has hurt the government's ability to weather a financial crisis without international market access.
Nonetheless, Fitch IBCA stressed that the new government does have a good chance of retaining confidence and engineering a soft landing. What is required is a fiscal adjustment to cool the economy in the short-term. The government must also implement the structural reforms, particularly in the bank and enterprise sectors, required to lift Slovakia's long-term economic performance.
Addressing these issues will bring a large rise in public debt ratios as contingent liabilities are recognized. Ongoing support is likely to come from the international community, which views the current period as a 'window of opportunity' for Slovakia to find its way back onto the road towards building a market economy and a fully-functioning democracy. This means that, in the event of a balance of payments crisis, financial support from official creditors should be forthcoming.
Additional reporting
by Tom Nicholson
