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

DBRS Ratings Limited (DBRS) has today confirmed the Kingdom of Spain’s Long-Term Foreign and Local Currency Issuer Ratings at A (low) and its Short-Term Foreign and Local Currency Issuer Ratings at R-1 (low). The trend on all ratings remains Stable.

The confirmation of the Stable trend reflects DBRS’s view that the robust economic recovery and gradual correction of Spain’s macroeconomic imbalances are offsetting the risks arising from higher uncertainty and a slower fiscal consolidation path. The forceful policy response to the crisis, lower energy prices and the European Central Bank’s (ECB) easier monetary policy have resulted in a job-rich economic recovery and higher confidence. These benign economic conditions have underpinned the rebalancing process and moderated the vulnerabilities stemming from the still high public and external debt ratios. The recovery is expected to continue at a strong, albeit slower, pace. The political stalemate in Spain and the inability of its political parties to form a new government have increased uncertainty over the future course of economic policy. Although this has not dented growth materially so far, a protracted period of political deadlock could delay the implementation of additional measures to continue with the structural reforms and fiscal consolidation process.

Spain’s ratings are underpinned by a series of reforms that were implemented over the last several years to fix its labour market, competitiveness and banking sector problems. The clean-up and restructuring of the banking sector was vital to its stabilisation and for shoring up confidence in the system, which eventually led to renewed credit growth. Also introduced were structural measures that contributed to wage flexibility and labour 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.

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 to 5.1% of GDP in 2015 from 10.5% in 2012. External adjustment is also evident in a current account balance that shifted to a surplus of 1.4% of GDP in 2015 from a deficit of 9.6% in 2007. 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 across the economy 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 in 2016 is expected to repeat its strong pace in 2015 (3.2%), outperforming most other Eurozone countries. Growth is expected to decelerate in the following years as certain temporary factors lose momentum (energy prices, currency depreciation, and fiscal stimulus). Despite this deceleration, strong job growth is expected into 2017. The banking sector continues to stabilize while new bank loans to households and firms with low debt are increasing. Exports have also shown resilience as the number of exporting firms has increased by 48.6% since 2006.

These strengths are offset by several credit challenges. The biggest near-term challenge is the possibility of a deviation or reversal from the current economic policy course. The inability of the main political parties to form a new government in the past nine months, under the current fragmented political landscape, is raising concerns over the future path of economic policy. In light of the fiscal slippage last year and the still important macroeconomic imbalances, additional delays in the process of fiscal consolidation and economic reforms could increase risks in the medium term. Since 2010, Spain has undertaken a large structural fiscal adjustment (5.5 percentage points). However, 2015 represented a setback in the outlined fiscal consolidation path as the fiscal deficit exceeded its 4.2% of GDP target by approximately 0.9 percentage points. The European institutions cancelled the associated fine of 0.2% of GDP and laid out a new general government deficit path for Spain: 4.6% of GDP in 2016, 3.1% of GDP in 2017 and 2.2% of GDP in 2018. To comply with the new fiscal path, the government should adopt and fully implement consolidation measures for the amount of 0.5% of GDP in both 2017 and 2018.

Another challenge is very high unemployment. The rate of unemployment stood at 20% in Q2 2016. Labour market exclusion may eventually materialize in lower productivity growth. Despite the effective labour market reforms that were introduced, the long-term unemployment rate stood at 11.6% of the labour force in Q2 2016. 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 could hamper growth under a less benign environment. The shift in the current account to surplus from deficit is translating into a decline in external liabilities. However, net external liabilities remain high, leaving Spain susceptible to shifts in investor sentiment.

RATING DRIVERS
In light of the 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 couldput greater upward pressure on the ratings. Factors that could put downward pressure on the ratings 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.

Notes:
All figures are in Euros (EUR) 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. These can be found on www.dbrs.com at: http://www.dbrs.com/about/methodologies

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), General State Comptroller, Spanish Treasury, European Commission, AMECO, Eurostat, IMF, Haver Analytics and DBRS. DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS’s outlooks and ratings are under regular surveillance.

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

Ratings assigned by DBRS Ratings Limited are subject to EU regulations only.

Lead Analyst: Javier Rouillet, Assistant Vice President
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer, Global FIG and Sovereign Ratings
Initial Rating Date: 21 October 2010
Last Rating Date: 8 April 2016

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