DBRS Lowers Trend on Spain to Stable, Confirms A (low) Rating

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 Stable from Positive. DBRS has also confirmed the short-term foreign and local currency issuer ratings at R-1 (low) and confirmed the Stable trend.

The change in trend from Positive to Stable reflects the inability of the main political parties to form a coalition government following general elections on December 20th of last year, as well as the risk that a new government, when established, will roll back labor market reforms and fiscal consolidation measures. These policies have been instrumental in spurring rapid job creation and instilling confidence. Given the inconclusive electoral outcome, there is greater uncertainty over the future direction of economic policies.

There has also been significant fiscal slippage. During our last review of Spain, in October 2015, a deficit of 4.2% of GDP in 2015 appeared to be within reach. Instead, the actual deficit was 5.1% of GDP, above the 4.2% of GDP target and above our expectations. This raises our concern over the government’s ability to control expenditures, particularly at the regional government level. Furthermore, a large social security deficit presents a longer-term structural problem that is deeper than had appeared to be the case during our last review. The high overall deficit puts pressure on the incoming government to enforce fiscal sustainability. If persistent, policy uncertainty could undermine consumer and business confidence and contribute to a deceleration of economic activity, leading to higher government debt-to-GDP.

During our last review of Spain, we assigned a Positive trend on the assumption that voter opinion as reflected in the polls pointed to the likelihood of a Popular Party-led or Socialist-led coalition. Implicit in the polling results up until our last review was that a majority of Spanish voters favored the benefits of the economic recovery, in spite of the repercussions of fiscal discipline and labor reform, over a desire for a change in policies after years of austerity. Instead, voters expressed greater dissatisfaction with the traditional parties than the polls had indicated at the time of our last review, with better than expected results for the far-left Podemos Party, and far lower support for the centrist Ciudadanos Party. Given the fragemented nature of the electoral results, Spain’s political parties have not been able to form a government. Another election could take place in June 2016, although it is not clear that another election would provide a decisive result.

In light of new political landscape, factors that could lead to an upgrade include a new government that promotes confidence by improving fiscal sustainability across the general government. Implementation of structural reforms that raise productivity growth and accelerate debt reduction could put greater upward pressure on the ratings. Factors that could put downward pressure on the ratings have not changed since our last review: they include a prolonged weak political commitment to fiscal adjustment, or a material downward revision to the medium-term growth outlook that derails the stabilization and expected decline in government debt-to-GDP.

Spain’s ratings are underpinned by a series of reforms implemented since the 2008-09 financial crisis that lowered labor market rigidity, stabilized the banking sector, improved the efficiency of the public sector, reformed the tax system, reduced healthcare and other costs, simplified licensing procedures, removed bottlenecks in personal and corporate insolvency resolution procedures, and increased job-search training programs.

Accompanied by a strong fiscal adjustment, these reforms contributed to a return of confidence and a reduction in macroeconomic imbalances. Notwithstanding recent fiscal slippage, the deficit has been halved from 10.4% of GDP in 2012 to 5.1% in 2015. External adjustment is also evident in a current account balance that shifted from a deficit of 9.6% of GDP in 2007 to a surplus of 1.4% in 2015. Spain’s Eurozone membership is an integral component of its credit strength, both in terms of financial support, and in preferential access for its trade, financial markets and banking. Financial conditions have improved economy-wide as a result of the ECB asset purchase program, refinancing operations and other monetary policy operations.

These factors have made the economy more resilient to shocks. Real GDP growth returned to positive territory in 2013, and strengthened to 3.2% in 2015, more than double the Eurozone average. Real GDP is expected to decelerate this year to 2.7% as several of the factors driving growth – lower oil prices, the depreciation of the Euro – lose momentum. Despite this deceleration, strong job growth is expected into 2017. The banking sector continues to stabilize, and new bank loans to households and firms with low debt are increasing. Exports have also shown resilience as the number of exporting firms has more than doubled since 2000.

These strengths are offset by several credit challenges. The biggest near term challenge is the fragmented political system and resulting policy uncertainty, especially over how the new government will reduce the fiscal deficit. Another challenge is very high unemployment. At 20.4% in February 2016, high unemployment slows the adjustment of the economy, and labor market exclusion will likely eventually materialize in lower productivity growth. Despite the effective labor market reforms that were introduced, structural unemployment is estimated at 18.5%. Reducing unemployment partly depends on continued economic growth, since GDP growth is important for maintaining rapid job creation. Even with strong economic performance and a more resilient economy, high private and public debt further hampers growth. The shift in the current account from deficit to surplus is translating into a decline in external liabilities. However, net external liabilities remain high and leave Spain susceptible to shifts in investor sentiment.

Notes:
The main points discussed in the Rating Committee were: (1) the political environment and how conditions had changed since our expectations during our last review, (2) fiscal management and policy and how the 2015 results had changed since our expectations during our last review.

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, Ministry of Finance, Bank of Spain, Instituto Nacional de Estadística (INE), European Commission, AMECO, Eurostat, IMF, Haver Analytics, Metroscopia, Celeste-Tel, CIS, NC-Report, GESOP, Simple Lógica, PSOE, Sigma-2, PP, DYM, Invymark, My Word, GET, IAOCE, Dys, JM&A, Encuestamos, TNS Demoscopia, Deimos Statistics, A&M, Sondaxe, DBRS.

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: Alan G. Reid
Initial Rating Date: 21 October 2010
Most Recent Rating Update: 9 October 2015

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