DBRS Revises Trend on Spain to Positive, Confirms A (low)

DBRS, Inc. has today confirmed the Kingdom of Spain’s long-term foreign and local currency issuer ratings at A (low) and changed the trend to Positive from Stable. DBRS also confirmed the short-term foreign and local currency issuer ratings at R-1 (low) with a Stable trend.

The Positive trend underlines DBRS’s view that the strengthening economic recovery outweighs uncertainty over governance in the next administration following general elections later this year. Voters will be weighing the benefits of a broad-based economic recovery, against a desire for change after years of austerity. Recent polls point to the likelihood of a Popular Party-led or Socialist-led coalition, and DBRS is of the view that the new coalition will continue the responsible fiscal and structural reform policies of the current administration. If this occurs, the public debt burden is likely to stabilize next year at close to 100% of GDP before declining.

An effective policy response to the crisis and accommodative monetary policy from the European Central Bank have led to favorable financing conditions and have supported the recovery. Labor market reforms and wage moderation have spurred rapid employment creation and higher confidence. Growth has been further boosted by lower oil and energy prices and a weaker Euro. However, high unemployment and high public and private sector debt leave the economy exposed to external shocks. Indeed, volatility in global financial markets and a weakening global economic backdrop are likely to weaken export performance. Nevertheless, the recovery looks set to continue next year.

Factors that could lead to an upgrade include a continuation of fiscal consolidation under the new administration, and the implementation of measures to reduce 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 further 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 and decline of the debt ratio.

Spain’s ratings are underpinned by the series of reforms that were implemented over the last several years, which stabilized the banking sector through a consolidation of savings banks, and greater access to credit for small and medium-sized enterprises. Also introduced were structural measures that contributed to wage flexibility and labor mobility, improved the efficiency of the public sector, reformed the tax system, reduced healthcare and other costs, simplified licensing procedures, removed bottlenecks in corporate insolvency resolution procedures, and increased education and job-search training programs. At an expected 4.2% of GDP this year, the fiscal deficit has reached a more manageable level, and the general government fiscal framework has been strengthened. This adjustment is aided by positive growth since the third quarter of 2013. GDP growth was 1.4% in 2014 and is expected at 3.1% in 2015. If Spain’s 2016 budget proposal falls short of EU spending rules, DBRS believes that additional adjustments will be forthcoming.

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 1.0% in 2014. The export expansion and low 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, reaching 99.5% of GDP in the second quarter of 2015. The debt ratio is not expected to peak until late-2015 or early 2016, before gradually declining. However, this trajectory is contingent on a sustained fiscal adjustment, a gradual economic recovery, and no additional fiscal costs from possible bank recapitalizations.

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 and smaller parties, 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 is likely to be a coalition of two of these four parties. This creates uncertainty regarding the policy framework of the next government. Nevertheless, a return to higher deficits is unlikely given the effect that this would have on investor confidence, in the form of higher bond yields, and penalties from the European Commission.

The positive growth outlook is accompanied by improving labor market conditions as job creation has gathered pace. However, at 22.4% in the second quarter of 2015, unemployment, especially among youth, 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 high quality jobs for a wider number of 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.

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, 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.

Notes:
The main points discussed in the Rating Committee were: (1) Spain’s recent economic performance, (2) the fiscal outlook as general elections approach, and (3) the financial sector. Other factors discussed include the balance of risks in the external environment.

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.

DBRS does not typically accept editorial changes other than to correct for factual, accuracy and/or to remove confidential, material non-public, or sensitive information that might otherwise be inadvertently disclosed.

Lead Analyst: Fergus McCormick
Rating Committee Chair: Roger Lister
Initial Rating Date: 21 October 2010
Most Recent Rating Update: 10 April 2015

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