DBRS Confirms Kingdom of Spain at A (low), Stable Trend

DBRS, Inc. has today confirmed the Kingdom of Spain’s Stable trend on its long-term foreign and local currency issuer ratings at A (low), and the short-term foreign and local currency issuer ratings at R-1 (low).

The confirmation of the Stable trend reflects our view that the signs of macroeconomic and financial stability that we perceived in our last review have become more entrenched. The forceful policy response to the crisis, combined with bond purchases from the European Central Bank, is resulting in a stronger recovery supported by rapid employment creation, lower oil and energy prices, better financing conditions and higher confidence. We expect that these factors will continue to support growth despite the drag from very high unemployment and high public and private sector debt. The recovery should help to maintain the public deficit on a declining path through this year’s election cycle, and stabilize the public debt burden in 2016 at just over 100% of GDP.

Factors that could change the trend to Positive include signs of a smooth political transition through the coming regional and general elections, in which the new administration continues to consolidate public finances and address structural impediments to growth. Longer term, structural reforms that boost growth and employment, raise productivity, and improve the sustainability of public finances could accelerate debt reduction and put upward pressure on the ratings. Factors that could place downward pressure on the ratings include a weakening in the political commitment to fiscal adjustment, or a material downward revision to the medium-term growth outlook that derails the expected stabilization of the debt ratio.

Spain’s ratings are underpinned by a series of reforms that have stabilized the banking sector, partly through a consolidation of savings banks, and greater access of small and medium-sized enterprises to credit. Structural changes include measures that have contributed to wage flexibility and labor mobility, improved the efficiency of the public sector, implemented tax reforms, reduced healthcare and other costs as part of a spending review, simplified licensing procedures, removed bottlenecks in corporate insolvency resolution procedures, and increased education and job-search training programs. At 5.8% of GDP, the fiscal deficit remains high. However, a sustained fiscal adjustment is underway, and the fiscal framework has been strengthened across the general government. This adjustment is aided by positive growth since the third quarter of 2013. GDP growth was 1.4% in 2014 and is expected at 2.8% in 2015.

Combined with the benefits of the EU financial assistance program and expansionary policy from the European Central Bank, these measures led to improved sovereign and bank financing conditions, which have lowered interest costs for the public and private sectors. This has helped to restore investor and business confidence to above pre-crisis levels.

Prior to 2009, Spain experienced a loss of cost and price competitiveness as wage and price pressures rose. From 2009 to 2013, this was reversed as domestic demand declined and unemployment increased, while both unit labor costs and the real effective exchange rate fell. Price competitiveness was restored as wage moderation and productivity gains increased. In spite of recent low inflation or deflation, the structural improvements in product and services sectors have contributed to an improvement in competitiveness. Export capacity has expanded as the number of exporting companies increased and the value of goods exported rose. Furthermore, there was greater export diversification to markets outside of the European Union. This led to a large current account adjustment, from a deficit of 9.3% of GDP in 2008 to a surplus of 0.8% in 2014. The export expansion and recent decline in oil prices are likely to drive a small current account surplus in the coming years.

In spite of the strengthening economic recovery, declining fiscal deficits, and lower yields on new bond issuances, the public debt ratio continued to rise through the end of 2014, reaching 97.7% of GDP. The debt ratio is not expected to peak until 2016 at about 102%. This exposes the real economy to shocks. Nevertheless, once the debt ratio peaks, it is expected to gradually decline over the medium term. This trajectory is contingent on a sustained fiscal adjustment, a gradual economic recovery, higher price inflation, and no additional fiscal costs from possible bank recapitalizations.

The positive growth outlook is accompanied by improving labor market conditions as job creation has gathered pace. However, at 23.7% in 2014, unemployment, and especially youth unemployment, is high, labor market segmentation is a drag on economic activity, and there is a risk that long-term unemployment will become structural, leading to worker exclusion from the workforce. Generating higher quality jobs for a wider number of unemployed workers and reallocating resources toward more productive sectors is hindered by Spain’s business environment. There are obstacles to competition and innovation in professional services, and regulations are burdensome and fragmented. The risk is that these obstacles erode competitiveness gains.

High (but declining) private sector debt serves as a further drag on real activity. Following the exit from the financial assistance program and last year’s asset quality review and stress tests by the European Central Bank and European Banking Authority, the banking sector has stabilized. Bank capital and liquidity positions have strengthened, bank earnings are mainly positive, and market funding costs have decreased. The contraction of domestic private credit is slowing, while new credit to households and small-sized loans are picking up. The fragmentation between bank lending rates in Spain compared to parts of Northern Europe has begun to decline.

Since 1982, the two main political parties, the Popular Party and the Socialist Party, have governed Spain. Following the global financial crisis and a series of corruption charges against members of these two parties, among others, a more fragmented political system has developed with the rise of the leftist Podemos Party and center-right Ciudadanos Party. Recent polls suggest that the next government, to be elected toward the end of 2015, is likely to be a coalition of two of these four parties. This creates uncertainty regarding the policy framework of the next government.

Notes:
All figures are in Euros unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website under Methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website under Rating Scales.

The sources of information used for this rating include the Ministry of Economy and Competitiveness, Bank of Spain, Instituto Nacional de Estadística (INE), Eurostat, IMF and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

For further information on DBRS’ historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository see http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period while reviews are generally resolved within 90 days. DBRS’s trends and ratings are under constant surveillance.

Lead Analyst: Fergus McCormick
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 21 October 2010
Most Recent Rating Update: 10 October 2014

For additional information on this rating, please refer to the linking document under Related Research.