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

DBRS Ratings Limited 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 Stable trend reflects DBRS’s view that the risks are balanced. Spain is undergoing a job-rich economic recovery and outperforming most other euro area members. Solid employment growth and low inflation have supported domestic demand. The economy is benefitting from the government’s reform efforts and tailwinds to growth from low oil prices, low interest rates, a weaker euro, and stronger economic activity in Spain’s main European trading partners. In the absence of material shocks, growth is expected to continue in coming years, albeit at a slower pace as the tailwinds lose strength, the output gap closes, and the fiscal stance becomes less expansionary.

While the formation of a new government after a period of political stalemate has reduced uncertainty, the current minority government has less room for manoeuvre. Therefore, DBRS does not expect substantial reforms to be implemented in the current legislature. However, the government’s commitment to fiscal consolidation and ability to implement it seems unscathed.

Spain’s ratings are underpinned by its large and diversified economy, which is the fourth largest in the euro area. Post-crisis, export-driven growth has led the recovery, which became more balanced as domestic demand strengthened. Spain’s export capacity has expanded as the number of exporting companies has increased and the value of goods exported has risen. The return of confidence has materialised in better financing conditions and is illustrated by stronger consumer and business confidence indicators.

The labour market and the economy overall are benefiting from the enhanced conditions set by the previous reforms. Moreover, these reforms have been key to a more balanced and strong recovery, improving the functioning of the labour market, boosting competitiveness, removing hurdles and bottlenecks to growth, and restoring confidence and credit in the economy.

Since the crisis, Spain has regained competitiveness on the back of wage moderation, greater labour market flexibility and a weaker euro. The Spanish economy has experienced a more structural improvement in competitiveness as a result of the implementation of reforms: more flexible labour markets, simpler and less restrictive product and services regulations, a new insolvency framework, and the introduction of de-indexation mechanisms. In light of the pick-up in headline inflation in 2017 driven by energy prices (base-effects), this will constitute the first test to the new de-indexation framework (having an impact on wages, public services, and pensions) and its ability to contain second-round inflation effects.

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 sector, financial markets and banking. Financial conditions have improved across the economy as a result of the European Central Bank’s (ECB) asset purchase programme, refinancing operations and other monetary policy operations.

These strengths are offset by several credit challenges. Spain’s government debt ratio remains high, although it is expected to decline gradually throughout the decade, provided that there are no significant shocks. The high level of indebtedness leaves the government more vulnerable to adverse shocks. On the other hand, the government has taken advantage of the low cost of issuance in recent years, both to reduce the cost of financing on outstanding debt and to lengthen the debt profile. Longer average debt maturities have helped to reduce rollover risk.

The fiscal imbalances are still large, albeit improving gradually. Spain has undertaken an important structural fiscal adjustment, especially between 2009 and 2014, but the structural deficit remains considerable at 3% of GDP. Fiscal policy was expansionary in 2015-2016, with an accumulated deterioration of 0.9% of GDP. Despite this stimulus, the headline deficit, at 4.5% of GDP including the financial assistance (0.2% of GDP), improved as a result of the strong cyclical recovery, low interest costs, and a series of fiscal measures to offset the lower-than-expected personal and income tax revenues.

Spain’s negative net international investment position remains high at 85.7% of GDP in 2016, leaving the country exposed to shocks or shifts in investors’ sentiment. Net marketable debt accounts for most of this, at 76.5% of GDP in 2016, with the cost of servicing fixed income liabilities less sensitive to the economic cycle than equity liabilities. However, Spain is likely to post a fifth consecutive current account surplus in 2017.

Over the medium term, the reduction in the imbalances will depend to a large degree on achieving durable growth. Boosting potential growth and enhancing the resilience of the economy will be key to the ratings. Spain’s low productivity is partially attributed to the large proportion of small firms and their low productivity levels relative to other large European peers. In spite of the marked improvement in recent years, unemployment remains very high, especially long-term and youth unemployment. Reducing the impediments to firms’ growth, enhancing innovation capacity and fostering competition could raise total factor productivity in the country. Also, increasing the employment rate, at 60.1% in Q4 2016, which is well below the euro area average at 65.9% in Q3 2016, could help to raise the growth outlook.

RATING DRIVERS
A continuation of progress on fiscal consolidation could put upward pressure on the ratings. Structural improvements in the resiliency of the economy, improving debt dynamics and enhancing the government’s ability to repay its debt, could put greater upward pressure on the ratings. Factors that could put downward pressure on the ratings include a weaker political commitment to fiscal adjustment or the materialisation of a sizeable contingent liability or external shock. A material downward revision to the medium-term growth outlook that derails the stabilisation and expected decline in the government’s debt-to-GDP ratio could also put downward pressure on the ratings.

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, Interational Monetary Fund (IMF), United Nations Development Programme (UNDP), Bank of International Settlements, 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, Global Sovereign Ratings
Rating Committee Chair: Alan G. Reid, Group Managing Director, Global Financial Institutions Group and Sovereign Ratings
Initial Rating Date: 21 October 2010
Last Rating Date: 7 October 2016

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