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 Stable trend reflects DBRS Morningstar’s view that Spain’s strong economic growth prospects, following a period of severe deterioration caused by the pandemic, are expected to help improve its public finance metrics and mitigate risks. While Spain’s GDP rebounded 5.0% in 2021, the return towards its pre-pandemic levels has been slower than in the euro area, still weighed on by the only partial recovery in tourism-related activities. DBRS Morningstar expects Spain’s GDP growth rate to remain elevated, especially in 2022 and 2023, driven by a fuller recovery in foreign tourism and household consumption, and the European funds boost to investment. The near term growth outlook could be affected principally by the pandemic evolution and the implications from Russia’s military operations in Ukraine, mainly through the energy and inflationary channels. DBRS Morningstar will continue to assess the risks of long-term economic scarring, against the positive effects on potential growth and economic resiliency from the Next Generation EU (NGEU) programme.
The substantial increase in the public debt ratio triggered by the pandemic is starting to reverse. The debt ratio fell to 118.7% of GDP in 2021 from 120.0% in 2020 but still remains well above its 95.5% of GDP level in 2019. The strong cyclical tailwinds, lifting growth and shrinking the fiscal deficit, bode well for debt dynamics in coming years. Debt affordability continued improving during the pandemic, with the Spanish Treasury taking advantage of the extraordinary monetary and financial conditions created by European Central Bank’s (ECB) to both lower its average funding costs and lengthen its maturity profile. DBRS Morningstar expects conditions to remain favourable in spite of the expected beginning of the ECB’s monetary policy normalisation. Nevertheless, the implementation of a credible medium term plan to consolidate public finances on a durable basis and to put the debt ratio on a firm downward trajectory will remain crucial to rebuild fiscal space and to improve the country’s credit profile.
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, coupled with the implementation of its recovery plan to underpin 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 new labour market reform intends to tackle the high temporality. The pro-independence movement in the Autonomous Community of Catalonia (rated BB (high) with a Positive trend by DBRS Morningstar) remains in the background, although tensions have eased in recent years.
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; or (2) further evidence of a strong recovery and successful implementation of economic reforms that improve economic resilience and/or boost potential growth.
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 deterioration in Spain’s fiscal trajectory leading to a sustained increase in the public debt ratio; or (3) a threat to the territorial unity of Spain that substantially erodes the country’s economic and financial profile.
The Recovery Started Slow But Expected to Gain Speed
Spain entered the pandemic crisis after a period of strong economic performance and job gains, which saw output expanding 2.6% annually between 2014-2019 underpinned by a restoration of competitiveness and combined with private sector deleveraging. The pandemic shock, which impacted heavily its important tourism-related sector, triggered a contraction in Spanish GDP of 10.8% in 2020, substantially more pronounced than the 6.4% in the euro area. Spain’s statistical office estimates that the contribution of the tourism industry to GDP slumped to 5.5% in 2020 from 12.4% in 2019.
The ongoing economic recovery has been relatively strong in 2021 with GDP growth estimated at 5.0% but slower than in the euro area and leaving GDP at end-2021 still 4.0% below its pre-pandemic level. The main sources of the relatively slower recovery vis-à-vis the euro area relate to weaker private consumption and tourism service exports, still weighed on by the pandemic evolution. Encouragingly, the labour market appears to have adjusted more swiftly than the overall output level. As of Q4-2021, the number of employed people reached a historical record of 20.2 million and the unemployment rate dropped to 13.3%, the lowest rate since late 2008.
DBRS Morningstar foresees Spain’s GDP growth rates remaining elevated, especially in 2022 and 2023. Despite the potential impact from the rapid spread of Omicron in the near term, the European Commission now forecasts Spain to grow by 5.6% in 2022 and by 4.4% in 2023 supported by a gradual normalisation of international tourism, a recovery in private consumption, and the positive impact of the NGEU on investment. The very high levels of vaccination coverage in Spain, coupled with a rapidly improving pandemic situation both in Spain and its main source destinations, bodes well for a more forceful recovery of international tourism arrivals to Spain. The strength of the labour market recovery, coupled with still present pent-up demand, should support a strong recovery in private consumption in the next biennium. Despite the timely achievement of the milestones for the disbursement of the NGEU funds, the economic impact from the NGEU has been underwhelming in 2021 due to slower than expected execution of the actual projects and reforms. However, DBRS Morningstar takes the view that the increase in public and private investment should gather pace in the next few years.
DBRS Morningstar underscores that there are still several sources of uncertainty, including the evolution of the pandemic, the implications from Russia’s military operations in Ukraine, the persistence of supply side bottlenecks impacting Spain’s car industry, and the effects of higher than anticipated inflation and potentially faster normalisation of monetary policy. While Spain’s energy dependence on Russian oil and gas imports is limited compared to other European countries, the Spanish economy could still be severely impacted by higher energy prices as well as by a slowdown in its major trading partners.
DBRS Morningstar will continue to assess the medium to long terms impacts from the pandemic and the implementation of Spain’s recovery plan. DBRS Morningstar considers that the massive income and liquidity support provided by the government, propped up by European institution support, has helped contain the long-term scarring effects from the pandemic so far. The faster than expected labour market repair points in this direction. With respect to the Recovery and Resilience Facility (“RRF”), Spain is expected to receive up to EUR 69.5 billion in grants and could request up to EUR 70 billion of loans. A successful implementation of the investments and reforms committed in Spain’s recovery plan could positively affect Spain’s long-term growth prospects, raising productivity and reducing structurally high unemployment. The plan focuses on areas in need of investment such as Spain’s climate and digital transition. Effectively tackling Spain’s very high levels of job temporality, the relatively small size of its companies, and improving the labour markets resilience to shocks could lead to overall resilience and productivity gains in the future.
Fiscal Position is Expected to Improve Driven Principally by Cyclical Factors
Spain’s fiscal deficit widened significantly as a result of the pandemic, to 11.0% of GDP at the end of 2020 from a deficit of 2.9% of GDP at the end of 2019, related to the collapse in output, the activation of automatic stabilisers, and the support measures to counter the effects from COVID-19. Given the better-than-expected fiscal information so far, DBRS Morningstar estimates the deficit is set to decline to around 7.0% of GDP in 2021 helped by the good performance of revenues and the gradual withdrawal of the pandemic support measures. This compares favourably to the government’s latest estimate of 8.4% of GDP and our previous assumptions, despite the slower-than-anticipated recovery. If confirmed, this better than expected fiscal performance in 2021 and still strong cyclical tailwinds in 2022/2023, provide confidence to the fiscal repair path outlined in Spain’s Draft Budgetary Plan for 2022. The government projects the deficit to decline to 5.0% of GDP in 2022, to 4.0% in 2023, and to 3.2% in 2024. On the other hand, especially for 2022, the extension of potentially new measures to ease the pressure of higher energy costs on households and firms could somewhat negatively affect the deficit.
DBRS Morningstar notes that the fiscal repair that started in 2021, and is expected to continue in 2022, rely principally on cyclical factors and the phase out of COVID-19 measures. Given that the economy has not fully recovered, relying on cyclical forces to reduce the fiscal imbalance seems appropriate for now, however, tackling the post-pandemic structural deficit will require the implementation of a credible fiscal consolidation plan. The discussion around potential measures to strengthen the sustainability of the pension system and plans for a comprehensive tax reform, both in the context of the NGEU milestones and targets, could present opportunities in this direction (please see Spain: Positive Fiscal Recovery But Structural Challenges Remain: https://www.dbrsmorningstar.com/research/392639).
Public Debt Remains High but Affordability and Favourable Dynamics Mitigate Risks
The public debt ratio has started to decline in 2021 after the sharp increase in 2020 triggered by the pandemic shock. The debt ratio fell to 118.7% of GDP in 2021 from 120.0% in 2020 but still remains well above its 95.5% of GDP level in 2019. DBRS Morningstar expects the debt ratio to continue to decline in coming years, underpinned by a positive macroeconomic environment and declining fiscal deficits. The positive nominal GDP growth-interest expenditure differential is expected to support Spain’s debt dynamics, especially during in 2022-2023. Putting the public debt ratio on a firm downward trend over the medium-term will remain important to rebuild its counter-cyclical fiscal space to counteract potential future shocks.
DBRS Morningstar takes the view that the European institutions’ actions, including the ECB’s massive pandemic response and the various EU-backed financing facilities, have played a key role in allowing highly indebted sovereigns such as Spain to comfortably finance their pandemic responses and mitigate the associated short and medium term effects of the pandemic. Despite the higher levels of debt and materially higher financing needs during 2020 and 2021, the Spanish Treasury has managed to continue to lengthen the average maturity of its debt, lock-in lower rates, and broaden its investor base. The debt stock is predominantly euro-denominated and fixed-rate, which combined with its relatively long average maturity of 8.0 years in 2021, shields the government from sudden increases in funding costs.
Spain’s debt affordability remains favourable. The cost of debt outstanding for the central government dropped to 1.64% in 2021, well below the 4.53% recorded in 2007, and the average cost at issuance for 2021 was slightly negative. The general government interest burden continued to decline to an estimated 2.1% of GDP in 2021 from 3.5% of GDP in 2013. The recent surge of inflationary pressures in the euro area, albeit driven principally by energy inflation thus far, has increased the risks of a faster than expected monetary policy normalisation of the ECB and higher bond yields. The yield on the Spanish 10 year stood at 1.1% by end-February but still remains very low from an historical perspective. Even assuming a gradual increase in yields over time, the central government average cost of outstanding debt is expected to continue decline in coming quarters, as the interest costs on new issuances are expected to remain well below the more costly debt coming due, issued in the aftermath of the global financial crisis. Furthermore, the Spanish authorities are likely to request the loan portion of the NGEU, which could create additional interest savings at a time when spreads could be higher. The ECB’s financial backstop and 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. Several factors contributed to this including a large-scale restructuring and clean-up in the aftermath of the global financial crisis, tighter regulatory requirements, and improving macroeconomic conditions pre-pandemic. In addition to this, 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 during the worst of the pandemic.
Spanish banks’ profitability has recovered during 2021 as provisions related to potential credit losses, which increased due to COVID-19 in 2020, have normalised. While the structural profitability pressures resulting from the low interest rate environment and strong competition remain broadly present, the recent evolution of market interest rates and the potential monetary policy tightening in the medium term due to inflationary risks should ease pressures on net interest income. Asset quality has remained rather stable throughout the pandemic, with a slight decline in domestic nonperforming loans (NPLs) to 4.2% of total loans by November 2021, despite the significant economic shock. Nevertheless, DBRS Morningstar expects that once the full removal of government support measures has occurred the asset quality profile of Spanish banks will suffer a manageable deterioration during 2022/23, contained by the government’s guarantee programme covering 70-80% of the potential losses on a portfolio of over EUR 100 billion loans. On a positive note, most of the loan books subject to moratoria have already expired and are generally performing above initial expectations.
Strong Political Institutions Underpin The Rating But Political Climate Could Still Delay Reforms
Spain benefits from strong political institutions underpinning its economy. However, a fragmentated and polarised political landscape complicated political cooperation and undermined the stability of governments in the years prior to the pandemic. This challenged the ability of administrations to implement more ambitious fiscal or economic reforms. In addition, while the Catalan pro-independence movement has adopted a less confrontational stance since 2017 and cooperation between the central and regional governments has improved thus far, a long-lasting solution remains elusive and tensions might resurface. 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.
DBRS Morningstar views positively the progress so far in implementing the required milestones for NGEU disbursement, breaking the reform stalemate seen before the pandemic. However, DBRS Morningstar notes that passing material reforms could become more challenging as the date of the next general elections approaches, no later than December 10, 2023.
Spain’s Balance of Payments Has So Far Withstood Relatively Well the COVID-19 Shock
The measures to contain the spread of the pandemic, including travel bans and social distancing, have disrupted travel flows massively in 2020. Tourist arrivals to Spain dropped by 77.3% YoY in 2020. The increasing vaccination coverage throughout 2021 and improvements of the pandemic situation during the European summer season permitted an easing of restrictions. Tourism inflows recovered strongly in the second half of 2021, rising by 64.4% YoY in 2021, however, remaining still 62.7% below their 2019 levels. This positive trend in tourism inflows should continue provided pandemic concerns continue to recede as expected. Despite the substantial decline in the travel surplus, the current account remained positive at 0.7% of GDP in 2020, helped by the decline in the energy trade deficit and import compression. The current account is expected to remain positive in 2021 related to the recovery in the travel surplus and improving good exports despite the bottlenecks in the car industry. On the other hand, the increase in energy prices will weigh on the current account.
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) remained high at -77.3% of GDP at Q3-2021, although it has been steadily declining since 2014, with a brief deterioration caused by the pandemic. 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 GDP per capita, at an estimated USD 30,537 in 2021, remains relatively low 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.
For more information on the Rating Committee decision, please see the Scorecard Indicators and Building Block Assessments: https://www.dbrsmorningstar.com/research/393251.
EURO AREA RISK CATEGORY: LOW
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 Economic Affairs and Digital Transformation (Spain’s Stability Programme 2021-2024, April 2021; Spain’s Recovery, Transformation and Resilience Plan, June 2021; Draft Budgetary Plan 2022, October 2021), Ministry of Finance, Bank of Spain (Macroeconomic Projections 2021-2024, December 2021), National Statistics Office (Satellite Account of Tourism of Spain, January 2022), General State Comptroller (IGAE), Independent Authority for Fiscal Responsibility (Macroeconomic Projections Update, January 2022), Spanish Treasury (Presentation and Chart Pack, January 2022), State Official Gazzette (Climate Change and Energy Transition Law, May 2021), European Central Bank, European Banking Authority, European Commission (European Economic Forecast Winter 2022, February 2022; 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, the Social Progress Imperative (2021 Social Progress Index), 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/393245.
This rating is endorsed by DBRS Ratings Limited for use in the United Kingdom.
Lead Analyst: Javier Rouillet, Vice President, Global Sovereign Ratings
Rating Committee Chair: Thomas R. Torgerson, Managing Director, Co-Head of Sovereign Ratings
Initial Rating Date: October 21, 2010
Last Rating Date: September 3, 2021
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