Guy Norton in Zagreb -

The September 20 defeat of Prime Minister Borut Pahor's government in a confidence vote and a subsequent ratings downgrade has had an immediate knock-on effect on Slovenia in the international capital markets, with the cost of insuring the country's debt against default soaring in the past week.

After Moody's Investors Services cut Slovenia's sovereign credit rating on Friday, September 23 from 'Aa2' to 'Aa3' the spread on the country's credit default swaps rose to 270 basis points, up by 41.4% in the previous seven days. Meanwhile, the yield premium on Slovenian debt maturing in 2021 versus similarly dated German government bonds hit a record high of 333 bps - more than double the 147-bp level in early June when voters rejected proposed pension and labour market reforms in a referendum.

And there may be more bad news on the horizon, with fellow rating agencies Standard & Poor's and Fitch Ratings set to review their assessments of Slovenia's creditworthiness in the coming weeks. Both currently rate Slovenia one notch higher at 'AA'. Although Slovenia's ratings remain firmly in investment grade territory, any further deterioration will inevitably involve higher refinancing costs for the country's cash-strapped financial and corporate sectors.

Slovenian EU Affairs and Development Minister Mitja Gaspari acknowledged to Slovenian news agency STA that further rating cuts are possible, while admitting that Moody's assessment of the economic and political challenges facing Slovenia was "more or less right."

On review

Commenting on the reason for the downgrade, Alexander Kockerbeck, senior credit analyst at Moody's, noted that there were three main factors - weaknesses in the country's banking system, dangerously high levels of leverage among Slovenian corporates and growing political uncertainty over plans for fiscal consolidation and structural reforms that will be needed to prevent a further rise in government indebtedness over the medium term and to improve Slovenia's long-term economic prospects. Moody's has put the new rating on review for a further downgrade if the authorities in Ljubljana fail to address the concerns it has raised.

The export-dependent Slovenian economy was hit hard by the global economic downturn, with GDP shrinking by almost 8% in 2009. Although the country emerged from recession in 2010 when GDP rose by 1.4%, the growth prospects for the country remain anaemic, pressuring the government's finances. As a result, the country's budget deficit is running at 5.5% of GDP, almost double the 3.0% of GDP level allowed within the Eurozone. Meanwhile, government debt has been rising sharply, jumping from 38.1% of GDP at end-2010 to 45.2% of GDP at the end of the first quarter this year.

While the finance ministry acknowledged that the ratings downgrade did not come as a shock, it said it believed that Moody's had been excessively cautious in its rating and did not take into consideration all the economic measures already implemented by the Slovenian government. "The cut in Slovenia's credit rating did not take the government by surprise as it has itself, in recent months and weeks, often warned of the consequences that would arise if the urgently needed structural reforms were not adopted," it said in a statement.

In particular, the finance ministry regretted that proposed pension reforms were not approved in a referendum in June. As to the question of the political uncertainty following the defeat of the left-wing coalition government in a confidence vote in the National Assembly, the finance ministry said that Pahor, acting as caretaker premier, will consult with deputies in the hope of reaching a consensus on short-term measures that can be pushed through to enable the smooth continuation of fiscal consolidation.

With regard to fears that Eurozone member Slovenia will this week fail to back a new bailout package for Greece and reforms to the European Financial Stability Fund, the ministry warned that any delay on the vote or a failure to ratify the steps agreed by Eurozone leaders in July would be "counterproductive" and "and would negatively impact Slovenia's credibility in the international environment."