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BY MARTIN KABÁT

Slovakia's rating cut hurts the innocent while the guilty go free

Moody's, the world's most prominent rating agency, downgraded Slovakia's rating from the lowest possible investment rating, Baa3, to Ba1 at the end of March, relegating Slovakia to the club of non-investment rated countries.
Two weeks later, the second most prominent world rating agency, Standard and Poor's, changed their long term rating view for the Slovak Republic. Although this latter measure did not mean a direct downgrade of Slovakia's rating, it was a sign that they are cautiously watching Slovakia's moves in the near future, and that they share Moody's pessimism regarding the development of the Slovak economy.

Moody's, the world's most prominent rating agency, downgraded Slovakia's rating from the lowest possible investment rating, Baa3, to Ba1 at the end of March, relegating Slovakia to the club of non-investment rated countries.

Two weeks later, the second most prominent world rating agency, Standard and Poor's, changed their long term rating view for the Slovak Republic. Although this latter measure did not mean a direct downgrade of Slovakia's rating, it was a sign that they are cautiously watching Slovakia's moves in the near future, and that they share Moody's pessimism regarding the development of the Slovak economy.

Neither the Moody's downgrade nor the S & P warning came as a surprise, but on the contrary had been expected for nearly half a year. Since the fall of 1997, the entire Central and Eastern European area, including Russia, has become less stable in terms of economic development. The region's relative stability has evaporated, and anxiety as well as cautiousness have started to prevail. This trend of negative economic development has also alerted foreign investors and banking concerns to be more careful when extending loans to entities from this region, and as a result the due diligence process (the period during which loans are managed) has become prolonged from about three months to five or even more.

These indications from investors have strongly confirmed that the investment environment in Central and Eastern Europe has deteriorated, and it will not be long before rating agencies downgrade the rating of the Czech Republic as well. In Slovakia, negative economic indicators include the consistently high fiscal and current account deficits, which have increasingly been financed by foreign and especially short-term borrowing.

The downgrading of the rating will worsen the situation of those Slovak subjects whose ambition is to obtain international loans for their modernization or reconstruction projects. Fewer companies will be able to bear the burden of the considerably higher interest rates that foreign loan providers will require, and fewer international entities will be willing to lend money to Slovak companies in need. While the yields on loans taken by the government and commercial entities averaged around LIBOR +60 basis points (b.p.) and LIBOR +150 b.p. respectively, these yields are now expected to increase by around 200 b.p.

Succinctly put, money has suddenly become more expensive, even for companies with better than average performances in 1997. These entities include petroleum giant Slovnaft, SPP (Slovak Gas Distribution) and SCP Ružomberok (a pulp and paper producer), companies which will very likely be obliged to pay higher interest rates on any loans taken despite their robust financial health.

The fact that money is more expensive will also negatively affect the position of the government in obtaining loans for state-financed projects such as motorway construction. Domestic, crown-denominated state debt currently bears an interest rate of around 24 percent per annum (p.a.). The last tranche of one-year government T-bonds were sold at an average yield of 25.2 percent p.a., while the average price for government debt rose to 23.4 percent p.a. so far this year.

The Slovak goverment succeeded at the end of January in placing 6 month zero bonds worth $ 200 million, at an interest rate of LIBOR+100 b.p., which was prepared as part of a bridge financing scheme for a seven year Eurobond issue that is currently under preparation and is lead managed by Nomura International. This issue should have occurred in autumn 1997, and the original idea was to prepare an issue worth $ 250 million.

Recently, however, the government announced a plan to place up to $1 billion in Eurobonds. In autumn the yield on the previous offers oscillated around LIBOR+60 b.p.: these same offers are still valid, but at an exorbitant interest rate of LIBOR+ 300 or more. If the government accepts bids at the level of 300 b.p. above US treasury bonds with the same maturity, they will automatically trigger a new benchmark for all Slovak entities. Which begs the question, is the government trying to hide the truth from voters and leave the bill for a future administration and business community to pick up?


Martin Kabát is an analyst for Slavia Capital.

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