DBRS Ratings GmbH (DBRS Morningstar) confirmed the Kingdom of Spain’s Long-Term Foreign and Local Currency – Issuer Ratings at “A”. At the same time, DBRS Morningstar confirmed the Kingdom of Spain’s Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (low). The trend on all ratings remains Stable.
KEY RATING CONSIDERATIONS
The Coronavirus Disease (COVID-19) has substantially affected Spain’s economic, fiscal, and debt projections. Nevertheless, recent signals, supported by the country’s strong vaccine rollout point to a solid recovery of the Spanish economy. Spain’s gross domestic product (GDP) decreased by 10.8% in 2020 and the government currently expects it to grow by 6.5% in 2021 and 7.0% in 2022. Although economic recovery appears underway, uncertainty remains high, particularly with regard to the potential for new vaccine resistant variants and on the potential economic effects of the full removal of government support measures. DBRS Morningstar considers that the strength and duration of the economic rebound will be key to abate longer-term risks associated with the pandemic. Key to Spain’s economic recovery will be the timely implementation of the Next Generation EU (NGEU) programme, expected to provide some uplift to the country’s growth momentum and possibly help raise Spain’s medium-term potential growth.
Following the unprecedented COVID-19 shock, Spain’s debt, in line with many European peers, increased substantially at the end of 2020 to 120.0% of GDP compared with 95.5% at the end of 2019. Nevertheless, the financing costs associated with this new debt have continued to remain near historical lows at the same time as the average life of debt increased. Spain has continued to benefit from the European Central Bank’s (ECB) monetary policies and as a result, debt affordability has continued to strengthen since the beginning of the pandemic despite the increase in its debt stock. As the economy continues to recover, stabilising and subsequently placing the debt-to-GDP ratio on a downward trend will remain critical for Spain to limit lasting effects of the pandemic on its credit profile. In its Stability Programme, the government foresees the debt ratio rapidly decreasing to 113.3% by the end of 2023, in line with the planned reduction in fiscal deficits and the recovery in GDP.
Spain’s “A” ratings remain supported by the country’s large and diversified economy, competitive export sector, and euro area membership. DBRS Morningstar expects these characteristics to support the country’s recovery. By contrast, Spain’s high public debt ratio and its reliance on foreign financing are sources of credit vulnerability. Spain’s high structural unemployment and temporality underscore labour market shortcomings. The pro-independence movement in the Autonomous Community of Catalonia (rated BB (high) with a Stable trend by DBRS Morningstar) remains in the background, although tensions have eased.
The ratings could be upgraded if one or a combination of the following occur: (1) successful implementation of a medium-term plan to rebalance public finances and place the debt-to-GDP ratio on a firm downward trend; (2) evidence of a strong recovery reducing concerns over long-lasting economic scarring; or (3) the introduction of economic reforms to enhance potential growth, possibly improving labour market functioning and raising productivity.
The ratings could be downgraded if one or a combination of the following occur: (1) evidence that the economic damage from the coronavirus pandemic is substantially larger and more persistent than expected; (2) a deviation from prudent fiscal policy commitment that further deteriorates public finances over time; (3) a sustained increase in funding costs; or (4) a threat to the territorial unity of Spain that substantially erodes the country’s economic and financial profile.
Recent Data Point to an Economic Rebound Following the Significant Shock in 2020
Although Spain entered the current crisis on a strong economic footing, its economy has been one of the most affected by the pandemic. Spain’s real GDP declined by 10.8% in 2020, compared with the decline of 6.4% for the euro area. Despite the substantial decline recorded last year, recent data indicate that economic recovery might be underway. Spanish GDP declined by 0.4% in Q1 2021 (qoq), largely reflecting the remaining restrictions taken by the Spanish authorities to contain the spread of new COVID-19 cases, but Q2 data has been much stronger increasing by 2.8%. This growth, boosted by strong household consumption of 6.6% bodes well for the rest of the year. In addition, economic recovery should continue to be supported by the strong vaccine rollout implemented by the Spanish authorities. After a slow start, the vaccination has gathered pace and as of 30 August 2021, 77% of the Spanish population had received at least one dose of the vaccine while 69% was fully vaccinated. This rapid increase in the vaccination rollout, placing Spain among the best performers worldwide, has been possible thanks to a strong pickup in the vaccination of the younger population during the summer. More than 70% of children and young adults aged 12 to 20 had received at least a dose of the vaccine by the end of August.
The summer season and the remainder of the year will continue to be affected by the pandemic, as some travel restrictions continue to apply. Tourism, although it strengthened in recent months, is likely to remain substantially below pre-crisis levels throughout the year. The full recovery of the sector which contributed to 12.4% of Spanish GDP in 2019 will remain conditional on the potential apparition of new virus variants. Latest data available at the end of July 2021 suggest that overnight stays in hotels in Spain during that month, while they increased by 125% compared to July 2020, remained 39% below their July 2019 level. This lower level reflected the strong decrease in the influx of international tourists (-59%), only partially compensated by the marginal increase of 0.4% in domestic tourism over the same period.
Spain’s macroeconomic recovery is likely to remain affected by the healthcare situation going forward. Current government forecasts, while they seemed somewhat ambitious a few months ago (see DBRS Morningstar’s: Spain's Medium-Term Fiscal Targets Ambitious On Growth) appear now in line, at least for 2021, with that of most forecasters. The government expects real GDP to rebound by 6.5% in 2021 and by 7.0% in 2022, with GDP going back to its pre-crisis level towards the end of 2022. High uncertainty, particularly on the tourism assumptions remain high, but a stronger than anticipated rebound in consumption on the back of pent-up demand could support growth momentum.
Over the medium-term, avoiding long-lasting economic damage will remain critical for the Spanish economy. In that regard, the temporary unemployment benefit scheme for workers, which has limited the rise in the unemployment rate to 15.3% at the end of Q2 2021 from 13.8% at the end of 2019, is viewed positively, particularly when compared with the 26.9% rate reached at the end of Q1 2013. Similarly, liquidity support measures through government guaranteed loans representing more than EUR 95 billion in guarantees to more than 685,000 enterprises, have so far prevented an increase in firms’ bankruptcies.
In addition, DBRS Morningstar considers that economic performance over the next two years is likely to be supported by the funds of the NGEU programme. Spain has recently started receiving NGEU funds in the form of a pre-financing of EUR 9 billion, corresponding to 13% of the country’s financial allocation under the Recovery and Resilience Facility (RRF), and the country is set to receive another EUR 10 billion before the end of the year. While this is below the EUR 27 billion initially budgeted for this year, the effective absorption of these funds will be critical to provide some uplift to the economic recovery in the coming months. Spain is expected to receive up to EUR 69.5 billion in grants under NGEU (6% of GDP) until 2026, of which 80% are expected to be frontloaded in the 2021-23 period. The recovery plan represents an important opportunity to boost investment and revive the stalled reform agenda. A successful implementation of the investments and reforms associated with these disbursements, could positively affect Spain’s long-term growth prospects, raising productivity and reducing structurally high unemployment.
Fiscal Position is Scheduled to Gradually Improve from 2021
Spain’s fiscal deficit widened significantly as a result of the pandemic, to 11% of GDP at the end of 2020 from a deficit of 2.9% of GDP at the end of 2019. The deficit deterioration reflected the economic shock as well as the country’s automatic stabilisers and the government’s targeted support measures implemented throughout the year. For 2021, the current estimate from the Independent Authority for Fiscal Responsibility (AIReF) stands at a deficit of 7.8% of GDP, slightly less negative than the government’s own forecast of a deficit of 8.4% of GDP. The deficit decline should continue with the further lifting of government support measures and strong economic growth. Current government forecasts , which highlight its commitment to fiscal consolidation, anticipate the deficit to decline to 5.0% of GDP in 2022 and 4.0% of GDP in 2023.
Over the coming quarters, DBRS Morningstar will primarily focus on the implementation by the Spanish government of its recovery plan, in particular via the delivery of milestones and objectives and the subsequent absorption of NGEU grants. The passing of the 2022 annual budget will therefore represent a key item for the government in coming months to deliver on its plan. In addition, as the plan requires the effective participation of all levels of governments, working hand in hand with regions and local governments will be key for its implementation to be successful. In its analysis, DBRS Morningstar will consider the type of expenditure and reforms implemented, while acknowledging that the assessment of the potential long-term benefits derived from the investments and reforms included in this plan is likely to take time.
The Public Debt Rose Markedly Last Year but its Cost Remains Near an All Time Low
Spain’s public debt ratio increased substantially in 2020 to 120.0% from 95.5% in 2019. While this increase is significant, the government, in its Stability Programme, anticipates the debt ratio to stabilise in 2021 before declining steadily thereafter to 113.3% of GDP in 2023. Maintaining a very high public debt ratio would leave Spain more exposed to future shocks, as it would hinder the country’s scope for future countercyclical fiscal policy; hence the importance for Spain to reduce its debt metrics over the medium-term.
DBRS Morningstar also considers that the very good funding conditions from which Spain and other euro area countries have benefited during this pandemic should provide leeway to rebalance their accounts. The ECB and the EU response to the pandemic underscores the considerable benefits associated with Spain’s membership of the euro area and of the EU. The ECB’s massive pandemic response and the various EU-backed financing facilities, including the grants under NGEU, are providing room for manoeuvre to European governments to appropriately respond to the pandemic and to accelerate structural reforms. The ECB’s stepped up sovereign debt purchases have so far allowed Spain to continue to enjoy close to historically low funding costs. In this context, DBRS Morningstar expects the Spanish Treasury to continue to lower the average cost of its outstanding debt in the next couple of years. As of July 2021, the average cost at issuance for 2021 was zero percent underpinning the strong affordability of Spain’s new debt. At the same date, the average cost of outstanding debt stood at 1.64%, well below the 4.53% recorded in 2007.
This overall decrease in funding costs occurred at the same time as the average life of debt outstanding increased to more than 8 years in July 2021, a historical peak, from 6.2 years in 2013, insulating the government from sudden increases in funding costs. The ECB’s financial backstop as well as Spain’s debt structure support DBRS Morningstar’s positive qualitative assessment of the “Debt and Liquidity” building block.
Spanish Banks Have so Far Effectively Coped With the Challenging Environment
The Spanish banking system entered the current economic crisis following a prolonged period of improvement in its capital ratios and asset quality. This happened following large-scale restructuring in the sector, tighter regulatory requirements, and the economic and housing market recovery in recent years. According to European Banking Authority data, the CET1 (fully loaded) capital ratio increased to 12.4% as of Q1 2021 from 9.6% in Q4 2014, exceeding regulatory requirements. In the same period, the financial sector’s nonperforming loans ratio shrank to 3.1% from 8.1%, to a level only marginally higher than the 2.6% of the euro area average. In stark contrast with the previous crisis, Spanish households and firms have leaner balance sheets, with indebtedness levels below those of the euro area, and there is currently no significant evidence that there would be imbalances in the Spanish housing market.
DBRS Morningstar considers that the combination of the state-guaranteed loans scheme, loan moratoria, and the ECB’s extraordinary liquidity and regulatory relief measures have played a crucial role in sustaining a healthy supply of credit over the last 18 months. Nevertheless, the current crisis is expected to weigh on banks’ asset quality, profitability, and capital ratios in coming quarters. Please see the Commentary “European Banks' Q1 Cost of Risk Almost Back To Pre-Pandemic Levels, But Unlikely to be Sustained” for more information. This comes on top of the more structural profitability pressures resulting from the low interest rate environment and strong competition, which have triggered significant consolidation operations in Spain in recent quarters. The state-guaranteed loans are however expected to slow the pace of deterioration in credit quality from the pandemic shock going forward. Although the sovereign will bear between 70%-80% of the losses that might arise from these loans, the great majority of banks’ loan book is not covered by this programme, and additional loan loss provisions are likely to be needed to cover future defaults.
The Political Environment Continues to Represent a Challenge to Ambitious Reforms and Somewhat Weakens Political Stability
Spain benefits from strong political institutions underpinning its economy. However, an increasingly fragmented and polarised political landscape has complicated cooperation and undermined the stability of governments in the past five years. At times, this has resulted in rolled-over budgets, hindered faster fiscal consolidation, and stalled the reform agenda. While the government managed to approve a full-year annual budget in 2021 for the first time since 2016, implementing key structural reforms is likely to continue to prove challenging given the fragmented coalition government.
In addition, while the Catalan pro-independence movement has somewhat eased its stance since 2017, a long-lasting solution remains elusive and tensions might resurface. Regional elections in Catalonia in February 2021 have confirmed the majority of pro-independence parties in the Catalan Parliament. While the pardons in June this year of formerly imprisoned regional leaders over their failed bid for independence in 2017 have eased tensions and paved the way for smoother cooperation between the central government and the region, pro-independence parties continue to push for a formal independence referendum. The constraints imposed by the political climate on Spain’s capacity to address key economic challenges and the uncertainty over the long-term situation in Catalonia continue to weigh negatively on DBRS Morningstar’s qualitative assessment of the “Political Environment” building block.
Spain’s Balance of Payments Has So Far Withstood Relatively Well the COVID-19 Shock
The disruptive effects from the restrictions impacting trade and particularly tourism flows have negatively affected external demand in 2020. Nevertheless, given the parallel decrease in imports, Spain has maintained a positive current account balance last year, at 0.7% of GDP. The Spanish economy remains nevertheless reliant on foreign capital, increasing the country’s vulnerability to sudden shifts in investor sentiment. Spain’s negative net international investment position (NIIP), albeit having shrunk since -97.7% of GDP at the end of Q2 2014, remained high at -84.1% of GDP at year-end 2020, particularly affected last year by the decline in nominal GDP. Spain’s NIIP position is nevertheless expected to restart its downward trajectory from 2021 onwards. Compared with the previous crisis, Spain remains in a much stronger external position thanks to a sharp improvement in cost-competitiveness and Spanish firms’ greater propensity to export.
Human Capital and Human Rights (S) were among the key ESG drivers behind this rating action. Spain’s per capita GDP was relatively low at USD 27,132 in 2020 compared with its euro area peers. This factor has been taken into account primarily in the “Economic Structure and Performance” building block.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.
F or more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/384029.
EURO AREA RISK CATEGORY: LOW
For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.
All figures are in EUR unless otherwise noted. Public finance statistics reported on a general government basis unless specified.
The principal methodology is the Global Methodology for Rating Sovereign Governments https://www.dbrsmorningstar.com/research/381451/global-methodology-for-rating-sovereign-governments (July 9, 2021). Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (February 3, 2021).
The sources of information used for this rating include the Ministry of Economy and Business, Ministry of Finance, Spain’s Stability Programme 2021-2024 (April 2021), Bank of Spain (Macroeconomic Projections 2021-2023, June 2021), Ministry of Health (daily COVID-19 updates), National Statistics Office (INE), General State Comptroller (IGAE), Independent Authority for Fiscal Responsibility (Report on the Updated Stability Programme 2021-2024, May 2021; Report on budget execution, public debt and 2021 expenditure rule, July 2021), Spanish Treasury (Presentation and Chart Pack, July 2021), European Central Bank, European Banking Authority, European Commission (Analysis of the recovery and resilience plan of Spain, June 2021), Eurostat, Bank for International Settlements, Organisation for Economic Co-operation and Development, International Monetary Fund, World Bank, United Nations Development Programme, the Social Progress Imperative (2020 Social Progress Index) and the 2019 Global Competitiveness Report from the World Economic Forum and Haver Analytics. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.
With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, this is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer.
With Rated Entity or Related Third Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO
DBRS Morningstar 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 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.
For further information on DBRS Morningstar 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. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.
The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/384028.
This rating is endorsed by DBRS Ratings Limited for use in the United Kingdom.
Lead Analyst: Nicolas Fintzel, Senior Vice President, Global Sovereign Ratings
Rating Committee Chair: Thomas R. Torgerson; Managing Director, Co-Head Global Sovereign Ratings
Initial Rating Date: October 21, 2010
Last Rating Date: March 5, 2021
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