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

DBRS Ratings Limited has 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 is Stable.

Spain continues to grow strongly and to outperform the euro area average, with GDP and employment set to expand for a fourth year in a row in 2017. Key indicators suggest that the Spanish economy has become more competitive, flexible, and resilient since the crisis. The gain in competitiveness, which has supported a shift to current account surpluses amid the sharp deleveraging in the private sector, underscores the likely sustainability of the recovery. The recent strengthening of the euro is partially offset by overall better prospects for Spanish export markets. DBRS expects growth to remain above trend in coming years, albeit at a slower pace as the tailwinds associated with monetary policy and oil prices lose strength, the fiscal stance becomes less expansionary, and the output gap closes.

The Region of Catalonia’s bid for independence has increased political tensions in the past few months. Ahead of the planned referendum, which was declared illegal by Spanish Constitutional Court, market reaction was contained, with no indication of spillovers to the real economy. However, financial market volatility has intensified in the aftermath of the vote. There is a risk that the standoff escalates. A period of prolonged and elevated tension in Catalonia or political uncertainty in Spain at large could weigh negatively on the economy and public finances.

Several strengths underpin the ratings. Spain’s large and diversified economy is the fourth largest in the euro area. Export-driven growth has led the recovery since the crisis. Growth contributions have recently become more balanced due to strengthened domestic demand. Investment, excluding construction, is at pre-crisis levels. This happened at the same time that the private sector is making significant efforts to deleverage, which is important, as current private debt levels remain high relative to GDP. Strong job creation, better economic conditions, and higher confidence among consumers and businesses also support growth. The return of confidence and stronger bank capitalisation and balance sheets has improved financing conditions and access to credit.

Past reforms have played a key role improving the flexibility, resiliency, and competitiveness of the economy. These reforms helped improve the functioning of the labour market and remove some of the hurdles to growth. A more flexible labour market, and less restrictive product and services regulations have boosted job creation and improved the business climate. Unit labour costs declined 6.8% in Spain between Q3 2009 and Q2 2017, driven by a combination of wage moderation and productivity gains. By comparison, average costs increased 5.5% in the euro area. The progress in cleaning-up and restructuring the banking sector has been vital to its stabilisation, restoring confidence in the sector and improving the flow of credit to the economy.

Spain’s Eurozone membership reinforces its credit strength. Membership allows Spain financial support in the event of a shock and gives the country full access to Europe’s trade, financial, and banking sectors. Financial conditions have improved in Spain due to the European Central Bank’s (ECB) asset purchase programme, refinancing operations, and other monetary policy operations, as well as the improved condition of Spain’s banks.

Some credit challenges offset these strengths. The high level of sovereign indebtedness burdens the government and increases its vulnerability to shocks. The high debt ratio limits the fiscal space available. However, DBRS expects the debt-to-GDP ratio to decline gradually over the medium term. Gross financing needs remain high, but are declining. Prudent debt management and strong demand for Spanish government bonds mitigate rollover risks.

Catalonia’s bid for independence has progressively escalated political tension over the past few months. While DBRS expects uncertainty over Catalonia to persist in the near to medium term, the central scenario is that of continuity for Spain. This reflects legal and institutional safeguards that make a unilateral secession highly unlikely. Going forward, DBRS will continue to monitor how discussions evolve. Given the size and importance of the region in Spain, continued uncertainty associated with independence could weigh on the Spanish economy.

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

Despite the improvements, high structural unemployment and productivity limit potential growth. In spite of the significant employment gains, the unemployment rate is still very high (17.2% in Q2 2017). Long-term and youth unemployment have been declining, but are still high. At the same time, the labour market duality continues to be widespread. The large proportion of small firms with lower productivity levels relative to other large European peers partially explains Spain’s low productivity. The government is implementing measures to address labour market imbalances and to spur an increase in firms’ size.

RATING DRIVERS
The Stable trend reflects DBRS’s view that the risks are balanced. Provided that tensions relating to the situation in Catalonia are contained, upward pressure on the ratings is likely if recent economic and fiscal performance continues. Alternatively, a weaker political commitment to fiscal adjustment, a material downward revision to the growth outlook, or the materialisation of a sizeable contingent liability could adversely affect the ratings. A severe deterioration of the political environment, leading to a high degree of uncertainty affecting business investment, consumption and the country’s public finances, could also adversely pressure 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, National Statistics Office (INE), General State Comptroller (IGAE), Spanish Treasury, European Central Bank (ECB), European Commission, AMECO, Eurostat, Interational Monetary Fund (IMF), United Nations Development Programme (UNDP), Bank of International Settlements, Federal Reserve Board, AIReF, 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 and US 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 April 2017

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